Australia | Mar 12 2007
By Greg Peel
When analysts reported on the Telstra (TLS) first half result last month, they remained just as polarised about the ongoing fortunes of the telco as they were before the significant stock price rally post T3 (Views Polarised On Telstra; Australia; 16/02/07). A month on, nothing much has changed.
One plan that has been bandied about is that Telstra should be split into two companies, with the working titles of NetCo and ServCo. The former would own and operate Telstra’s substantial telecommunications infrastructure just like any other utility company (gosh, anyone remember something called the PMG?) and the latter would be the marketing company competing with everybody else in the market on fixed line, mobile phone and broadband services et al.
The “bulls”, note the analysts at Citigroup, believe 1+1 will equal 3. Indeed, if Citi’s analysts split Telstra into two parts theoretically, and apply the EV/EBITDA multiple (enterprise value divided by earnings before interest, tax, depreciation and amortisation) applicable to utilities on the one hand, and retail on the other, their sum-of-the-parts valuation rises from $3.87 to $5.50.
A utility can support much higher levels of gearing, and typically trade on 8-11x multiples compared to global telco averages of 6-7x, Citi points out.
This all sounds like a wonderful exercise on paper, but Citi poops the party by suggesting that NetCo should trade at a 25-30% discount to your common or garden utility given the risks associated with new technology. By the same token, ServCo would suffer from a significant increase in competition if it is pushed out of home and left to fend for itself.
When all said and done, Citi has come up with a total value accretion figure on a split of – drumroll – 2 cents. In other words Citi’s valuation would rise from $3.87 to $3.89. Woohoo. The analysts are betting on only a 20% chance of management going with the split idea. They maintain a Sell rating and a target price of $3.90.
Meanwhile, back on the cattle station, the bulls are sticking to arguments beyond any notion of a break-up as to why Telstra is a Buy. Credit Suisse analysts reiterated this morning that the real value lies in the NextG mobile network.
CS notes that 415,000 customers have joined NextG in the past three months, and that growth has actually accelerated post the first half result. Both handsets and wireless broadband cards are on the up. CS suggests management’s guidance of 2.5-3.0% revenue growth in FY07 will prove conservative.
(Note: Macquarie argues Telstra ALWAYS exceeds guidance and thus the market is already factoring that in, leading to an overvalued share price).
CS also recognises that “handset breadth” is working in Telstra’s favour, with 13 different models along with 13 different broadband data devices being available to the market by the end of March. And the problem of slow CDMA (code division multiple access) migration (another stumbling block for Macquarie) will now be addressed, with Telstra offering much cheaper 850Mhz handsets.
It would be uneconomical for Optus (SGT) to replicate Telstra’s 850Mhz network, says CS, and Optus is Telstra’s biggest competitor. Other players such as Vodafone and Hutchison operate in metro areas only. In other words, CS analysts are looking for Telstra to pick up a major market share advantage.
Credit Suisse predicts the market will upgrade Telstra’s FY08 earnings by some 10% soon. It rates Telstra Outperform with a $5.05 target. While once lonely at the top, CS has now been surpassed in the target stakes by ABN Amro ($5.20) and Deutsche Bank ($5.30).
ABN agrees with the mobile market argument as well as advantages in PTSN (public telephone switched network, or the old fashioned way). Deutsche believes Telstra’s core telephone services are undervalued if one removes Sensis and Foxtel valuations from the share price.
The bears won’t have a bar of it. As well as Citigroup and Macquarie they include GSJB Were, JP Morgan and Merrill Lynch. UBS is the only Neutral in a 4/1/5 B/H/S ratio. The average target is $4.43. That’s pretty much where the share price is now.
Footnote: Readers of the Sydney Morning Herald letters page will have noted the recent exchange of horror stories regarding telco service. One told of being hassled to death by Telstra after switching to Optus (exactly what happened to this writer) while another reported a ten minute solution from Telstra in switching broadband to a new address that Optus couldn’t achieve at all. Having been pleased with Optus to date, my latest experience has left me cold. My broadband connection was shut off for 48 hours last week – without warning – to facilitate a CHANGE OF NAME on my account. As an internet-based journalist, a broadband connection is somewhat important. The woman in Mumbai, to put it lightly, could not have cared less.