Australia | Dec 16 2008
By Andrew Nelson
Telstra’s high handed approach to its relationship with Canberra looks to have blown up in its face, with the national carrier yesterday being ruled out of further bidding in the National Broadband Network (NBN) scheme. The news saw shares drop to their lowest point since listing in November 1997 with at least three of Australia’s big brokerage houses dropping their rating on the company.
Shares were as low as $3.36, down more than 7% earlier this morning after dropping more than 12% yesterday when the Australian Federal Government told the company it would be ruled out of further participation in plans to build a nationwide high-speed Internet network because its submission lacked a plan for small businesses to provide goods and services to the network. The inclusion of such plan was not optional, but a requirement.
This is where the finger pointing starts, because Telstra said it provided its small businesses plan to the regulator in early December after submitting its bid by the November 26 deadline. Telstra chairman Donald McGauchie said the government couldn’t have dreamed up a more trivial reason to exclude the company.
In Response, Federal communications minister Stephen Conroy said supporting small businesses is not a a “trivial matter” and confirmed he couldn’t accept Telstra’s small-business plan, as it was submitted after the November 26 deadline. As such, the government could have set itself up for legal action by other bidders.
Either way, there is no doubt the decision is bad news for Telstra. It is not only a blow to the group’s plans to strengthen its dominance in Australia’s high-speed Internet market, but it also casts a shadow of doubt over the company’s entire long term strategy.
Broker reaction post the government’s rejection has generally reflected this and resulted in at least three downgrades on the stock. But, even the brokers who have downgraded are struggling to define the real implications for Telstra.
GSJB Were, Macquarie and ABN Amro all moved the stock from their version of a Buy to their version of a Hold this morning. All three maintained earnings forecasts and only GSJB Were changed its valuation and target price, but this was due more to a change in its financial modelling than to the decision.
The broker thinks that we’re a long way from the end of the story, as there’s a good chance that none of the remaining bids are worthy of further consideration. If this is the case, the minister will have to restart the tender process, potentially opening the door back up for Telstra. This makes sense to the broker, as it sees Telstra as the only logical builder of the NBN.
This fits in with the general view of most of the brokers, with everyone thinking that Telstra has some chance of getting back into the process.
JP Morgan is a clear exception to this, with the broker saying there is no possibility the government will re-engage Telstra in the negotiation. The broker fully expects the government to proceed without Telstra and the Panel to recommend one or several bids to the government by the end of January.
“Today’s was the rather spectacular regulatory backlash we had warned investors against for the past six months”,said JP Morgan analysts Laurent Horrut and Colin Morawski.
So why the downgrades?
GSJB Were admits there is a real chance the government could find one or more bids are worthy of further consideration. If this is the case, Telstra will likely be out of the running. On the broker’s numbers, the valuation under this worst case scenario drops down to around the current share price, so it is not so much a case of any more downside in the decision, it just removes some of the upside risk.
The broker thinks the company is in superb shape operationally, but now that the spectre of higher risk has raised its ugly head, the investors that have been using the stock as a safe haven over the last year or so may now decide the haven isn’t as safe as they thought it was. Look at the selling over the last few days and you’ll see this sentiment has been borne out.
To quote UBS, “Our forecasts remain unchanged, however we believe there are no catalysts to drive a near term re-rating.”
Macquarie pretty much agrees, saying it’s the elimination of the upside scenarios, even if only on a short-term basis, that makes it very difficult to identify any sort of positive catalyst for Telstra in the next two months. At the same time, the broker thinks there will be plenty in the way of negative catalysts, hence its downgrading of the stock.
The broker thinks the company will deliver a weak 1H result in February and most likely announce a further top up of Telstra Super following an actuarial review of the December quarter performance. On top of that, it is now more likely that hostilities between Telstra and the government will likely increase. That’s why Macquarie sees little upside in the share price over the next few months and has downgraded to Hold.
ABN Amro is a little less mixed in its view. The broker thinks, if anything, the company’s actions and subsequent exclusion demonstrates it would rather take its chances in the market investing and operating against any rival broadband builder and free of any regulatory inconveniences that would ultimately put a significant cap on profits.
The broker admits even its worst case scenario where Telstra is excluded from all aspects of the project makes little impact to its FY09 or FY10 forecasts. Nevertheless, says the broker, the regulatory uncertainty has been lifted to a new level. This risk and the lack of any tangible near term upside is what pushes the broker to drop from Buy to Hold.
Merrill Lynch mirrors this sentiment, saying even if the NBN contract goes to another bidder, according to its estimates the earnings impact will be minimal until FY11.
So it all comes down to how you look at it. Merrill Lynch thinks that Telstra’s exclusion is a relatively minor issue and believes the government is just playing hard ball as part of an extended negotiating process. It, like GSJB Were, sees the likelihood of significant investment in high-speed broadband as unlikely without Telstra.
The one issue that most of the above mentioned broker have skirted well around is the regulatory risk that Telstra may now be facing. It is simply too hard to factor it into their models, so we’re told.
This is where JP Morgan’s reaction to the news differs to most, as it is upfront in assessing this massive risk to the company. Remember, the broker is so far alone in assuming the government will definitely not revisit its decision and that it will look to deliver the NBN project without Telstra.
If this is the case, the broker sees no reason at all why the government would not engineer a regulatory framework that enables the roll-out by a third party. This would most likely result in the further operational separation of Telstra and the chances of this happening have now ”dramatically increased”.
The question that remains to be answered is: Have Sol and Co finally written a check they can’t cash?
It seems JP Morgan is unequivocally on the affirmative side, while the other seven remain still undecided. One thing all eight agree on is that there is still a long way to go in this complicated saga, so it is too soon to tell.
