FYI | May 04 2006
By Greg Peel
Unbundling the local loop is probably not often a discussion at Sunday barbecues, but telco investors on both sides of the Tasman have been kept somewhat on tenterhooks as the vagaries of an unbundled local loop, or ULL, are played out.
Telstra (TLS) has been bouncing up and down in share price a bit lately, and it’s no surprise that a lot has been written about the situation, and that there is little consensus.
Having said that, there is only one Buy recommendation for Telstra in the FN Arena database, and four Sells (the rest are Hold). The Sell side’s main concern is the potential for dividends to be cut due to reduced earnings. Those earnings reductions would stem from competition imposed by the ACCC for Telstra’s existing local network (the so-called "loop") and the next generation FTTN network (fibre to the node), both of which will impact Telstra’s traditional fixed line earnings.
("Unbundling the local loop" refers to providing access to competitors on Telstra’s longstanding copper wire network for the purpose of broadband access in particular. The network was originally simply the provider of fixed lines. "Fibre the node" introduces newer technology to replace copper and significantly speed up broadband access. This has big implications for delivery of television. The competition wants to be in on this as well, despite it being Telstra’s cost).
In short, the nay-sayers feel the inherent competition of the highly technologically-driven telco market is sufficient to suggest there is very little perceived value in telco investment into the future. This might be considered a more macro view.
From a slightly more micro point of view, Credit Suisse (Telstra’s sole champion) feels the market is overlooking something. ULL considerations have been the major concern to date, but FTTN makes ULL somewhat redundant. Competitor telcos are halting any ULL attack plans to formulate a strike on FTTN instead. Thus, concerns about what the ACCC might impose on ULL are immaterial.
This, says CS, has led to undervaluation of Telstra. The CS analysts have set a target price of $4.78 for the telco. If you take this figure out of the entries, the remaining average target price is $3.95.
Interestingly, Credit Suisse’s stance on Telecom New Zealand is the opposite (as of today). The analysts have downgraded the Kiwi telco directly to Underperform from Outperform, leaving it as the sole Sell recommendation amongst three Buys and five Holds.
The reason for the downgrade is the NZ government’s announcement on regulatory changes. The changes are to introduce ULL (ie to allow competition on the existing network) while reviewing the possibility of public sector investment into the network. At the same time, the government will not allow Telecom to reduce its prices in the face of competition.
How do you run a publicly-listed, private enterprise under those restraints?
That’s pretty much Credit Suisse’s view. The impact of these changes is so material that CS can’t see any certainty in capital investment going forward. There are no positive share catalysts.
The FN Arena database shows not everyone agrees. SB Citigroup, for one, suggests the "bark" of the government changes is much worse than the "bite".
For starters, the unbundling of the "last mile" (that refers to the connection to your house or business from a network "node") was a given, says Citi. The surprise was the decision for further structural separation and de-facto price control over Telecom’s local services (called "naked DSL").
The experience of other markets suggests however, says Citi, that the effect of naked DSL on incumbents is muted, if there is any. What was more surprising was the government ban on Telecom lowering prices to compete with other infrastructure based operators. It just won’t work, says Citi.
Thus Citi believes this part of the regulation will ultimately be reviewed. On the analysts calculation, "If the stock falls below NZ$5.30 (equivalent NZ$ closing price on the ASX) it implies that competitors will be successful in capturing more than 37% of the NZ fixed line market (versus currently 17%). This is virtually impossible because of the inherent technological limitations of DSL."
That is why Citigroup says buy Telecom NZ.
The biggest problem with telco investment is that everything moves so fast in the world of technology and so slowly in the world of government. It’s no surprise there are plenty of Hold recommendations across the market. It seems like a case of "Hold – to see what happens next".