Australia | May 01 2007
By Greg Peel
Telstra (TLS) has confounded many an analyst, although not all of them.
When the third tranche of instalments were due for sale some seven months ago, most analysts were giving the issue little hope of reaching subscription. Institutions were forced to buy up, given Telstra’s dominant market capitalisation, but why would twice-bitten mums & dads want to go again into this ailing telco juggernaut?
It’s all history now, as the lure of a hefty yield for the punters and a general re-rating of global telco stocks has sent the Telstra share price mostly up ever since.
Another development that has surprised many analysts has been Telstra’s success in the competitive mobile market. Placing great faith in its NextGen network, the assumption was that competition from a plethora of mobile providers would render Telstra’s initiatives as a waste of time and money. But that, too, is history. Telstra has performed exceedingly well in mobile, and competitors such as Optus (SGT) have been losing market share.
While mobile was enough to make analysts take another look at their valuations, the next development was the ALP’s announcement that, if elected, it would spend part of Peter Costello’s Future Fund and build a fast broadband network by hook or by crook. Evidence suggested that Australia was being left behind by the rest of the world in internet speed and flexibility while John Howard was happy watching black & white re-runs of Bellbird.
The ALP policy hinted that a public/private partnership (PPP) would likely be the way to get a fast broadband system built, and that fibre-to-the-node (FTTN) was the way to go. Telstra should have already been building an FTTN network by now, but it couldn’t come to any satisfactory commercial arrangement with the ACCC.
The major problem was that the government insisted even the remotest of Australian residents should pay no more than the city folk, lest they be considered discriminated against (and lest the government lost the support of the Nationals). Telstra thus took its ball and went home. Howard didn’t care. He’s still trying to get his head around VCRs.
But the ALP policy announcement brought the subject to the fore once more, as the market knew the government would have to come up with a counter. So far all they’ve managed is a tirade from Peter Costello about Labor dipping into the Future Fund. This was executed with no sense of irony, despite a large proportion of the FF being currently invested in Telstra shares.
The FTTN issue was raised by the ALP back in March, and this, again, gave analysts cause to think that there might still be value in Telstra shares yet (or at least gave them an excuse to lift their target prices closer to the share price). The point was that FTTN must come to a head.
Two months later, it is still coming to a head. Calls for Australia’s need for FTTN grow louder each day, and Kevin Rudd’s robust popularity is causing the government to become more and more reactive to Labor policy initiatives. In other words, like climate change, the government may yet be forced to act on FTTN before the election at the end of the year.
This is the thinking behind Macquarie telco analysts’ latest update on Telstra. Macquarie was originally part of the “you’ve got to be kidding” camp when it came to share price valuation. The analysts rated the stock Underperform.
Today they have lifted the rating to Neutral, and increased their target price from $3.90 to $4.40 (share price currently around $4.74). The extra 50c represents a valuation placed on what the analysts call the FTTN “carrot”.
Macquarie calculates Telstra would need to spend $3.5bn to build an FTTN network. Given what the ACCC has insisted, the incremental returns Telstra would receive from this network, over and above its existing copper network, would simply not be commercial. However, an electoral push is on.
The analysts suggest three possible scenarios.
One: Nothing happens. Eventually Telstra’s copper network returns will decline to a point where building an FTTN network is the only solution. This is where we are now, and FTTN could take years yet.
Two: As threatened, another consortium will build the FTTN network Telstra won’t. There are already moves afoot to address this possibility, but the fact remains that even if a PPP could be set up with another team, Telstra will still own the “last mile” – that copper wire that extends from the “node” (a junction box somewhere near your home or business) to your home or business. FTTN, by definition, will only install fibre optics as far as that node. Thus Telstra still has the capacity to charge for the last mile.
Were this network to be built anyway, Macquarie suggests the loss of Telstra’s network monopoly could cost up to $1.00 off the share price.
Three: Telstra is given some sort of incentive – a carrot – to build the FTTN network and do so commercially. This could happen whoever might be in power. As the Macquarie analysts put it:
“This incentive might not lead to the most efficient pricing or competitive outcome, but would lead to the network being built”.
Macquarie has seen fit to back Scenario Three, and hence the addition of 50c to valuation. That’s how much Macquarie deems the carrot to be worth.
As of this morning the FNArena database was showing a 4/3/3 B/H/S ratio on Telstra, with an average price target of $4.77 from a range of $3.66 to $5.54. (Although UBS’ $3.66 has not been readdressed since September last year. JP Morgan is next lowest and stoic at $3.97.)