Australia | Sep 08 2010
By Greg Peel
Hands up. Who's had a call from Telstra lately offering all sorts of cheap new deals and packages? Nearly of all you huh? I did, but it took me half an hour to explain to Mr Patel I'm with Optus. But now that Optus has abandoned the promotion of cable television delivery, I do have a new Foxtel satellite, which makes me a quasi Telstra customer. That included all manner of freebies.
Telstra is dying. That much was clear from its recent profit warning – that which drove Telstra's price to its lowest level in history. Despite making solid inroads into the competitive mobile market, the telco has not been able to offset the flood of customers abandoning their antiquated fixed-line rental phone services forever.
And land lines are all about the old copper network that relentlessly stubborn Telstra shareholders cried foul about losing to the socialist government. Well sorry, but it looks like all is lost. Or not.
The formation of a Labor government was dependent on the support of two independent members who were strong backers of the rollout of Australia's fibre to the premises (FTTP) network. The National Broadband Network and related NBNCo will go ahead – it is certain. And thus it is all but certain Telstra will receive the $11bn the government previously offered for its now redundant infrastructure.
In reality, the government is paying up for the underground and overhead conduits and power pole networks through which Telstra's copper now runs, rather than the copper itself. But the copper is still handy as well, given it allows the fibre network to be rolled out gradually without costly replication and without cutting anyone off in the meantime.
This also means the rollout will not cost anything like the $43bn price attached to a replication network, but that's another story. The fact is Telstra is in a fight for its life which has absolutely nothing to do with government policy and everything to do with the previous blindness and recalcitrance of management. It is just as much in Telstra's interest to attempt to reposition itself to compete more effectively in the telco world of the twenty-first century as it is to, now, prepare for structural separation. And to do so the company does not need to seek expensive debt funding, or raise dilutive equity. It's about to be handed $11bn. In cash.
Citi, Credit Suisse and Deutsche Bank were all this morning in agreement that the election win to Labor is a positive for Telstra, if for no other reason that it removes the uncertainty of what was to transpire. There are a lot of things stock markets don't like, and uncertainty is right at the top of the list.
But the win, and subsequent NBN endorsement, is also positive enough for that $11bn alone.
Citi suggests that there remains downside risk to Telstra's revenues in FY11-12. This is not good, given management's FY11 guidance of around $10bn in earnings or a 40% margin is its lowest in history. But even if revenues do drift further, Citi suggests Telstra still has enough free cashflow to self-fund (and fully frank) its plus-100% dividend payout ratio. If there were any further doubt, the proceeds of the SouFun IPO will provide extra comfort.
Let's face it. Were Telstra no longer boasting a market leading yield, who'd buy it?
Furthermore, Citi notes that were Telstra's new strategies aimed at improving market share in non-fixed line businesses to be slow to show results, the $11bn is there to fund ongoing dividend obligations.
Citi believes Telstra has reached a floor in its valuation. Looking through the cycle, Citi sees the stock worth $3.20 to $3.60 in an NBN world, and backs that up with a $3.60 target price and Buy rating.
Credit Suisse has calculated, taking into account its valuations for Telstra's non-fixed line businesses and the $11bn, that the market is valuing the fixed line business at only 0.8x earnings. “This is too bearish in our view,” says CS.
Credit Suisse also believes Telstra can maintain its dividend and believes the stock should re-rate towards the analysts' $3.40 discounted cash flow valuation. This is subject, however, to the company showing it can deliver on its market share strategies.
It is also subject to shareholders actually approving the $11bn, which they'd be mad not to now that telstra has shown it can die all by itself.
CS has set its target at $3.40 (Outperform).
Deutsche Bank notes Telstra's recent decision to spend $1bn on its new strategy suggests the company is moving to position itself well ahead of the NBN rollout in order to become a more competitive and customer focused (am I hearing that right?) organisation. Says Deutsche:
“[The NBN rollout ratification] provides more certainty on industry structure and a path for compensating Telstra for decommissioning the copper network, with the accompanying benefit of short term cash flows offsetting the longer term challenge of losing the benefit of vertical integration and competing with other carriers in the NBN world.”
Got that? Another way of putting it is that while Telstra may be losing the monopoly it had on the wholesale market through its infrastructure ownership, from which it could lever off to provide competitive retail services once upon a time, the $11bn in cashflow provides an offset as Telstra looks ahead to years down the track when the fibre network will be handed over to NBNCo and the cashflow will stop.
On that basis, suggests Deutsche, the NBN is “marginally” positive for Telstra.
Deutsche (Hold) has set a target of $3.15. The stock is currently trading at $2.89 and offers a 9.5% fully-franked dividend yield.
