Roy Davidson, 22 March 2018


Telstra is Australia’s largest telecommunications and information services company providing a full range of mobile and broadband services. The company also owns 50% of the leading pay TV operator, Foxtel.

The Australian Government, through Government owned NBN Co has begun the rollout of the National Broadband Network (NBN). The NBN is Australia’s Government owned fibre network. The construction of the NBN fundamentally changes the industry and TLS’ position within it. TLS loses its broadband network advantage forcing it to compete on a more level footing with its competitors, buying services off NBN Co. The impact so far has been to create an ‘earnings gap’ that TLS has not yet provided comfort to the market it is able to fill. Margins have also been falling as customers switch to NBN services. TLS is receiving payments from NBN as customers switch over from TLS’s copper and cable networks, which will amount to roughly A$11bn.

TLS has announced it intends to invest up to A$3.0bn in its own mobile networks over three years to deliver the next generation of networks and drive cost savings, revenue growth and an improved customer experience. Whilst this will undoubtedly preserve TLS’ network advantage, high competition may compete anyway any financial benefit and we are somewhat cynical that TLS can generate an adequate return on investment to fill the emerging ‘earnings gap’ as NBN payments reduce. This investment will utilise the cash flow provided by NBN, with little headroom for material acquisitions or the progression of TLS’ Asian growth strategy.

TLS recently announced a change to its dividend policy, forced by its reinvestment needs and earnings pressures as a result of increased competition and the NBN rollout. The new policy will TLS pay out between 70 and 90% of earnings from FY18, down from 100% previously. This sees total dividends fall from 30 cents per share in FY17 to an anticipated 22 cents per share for FY18. It is the first cut in the dividend since its listing in the 1990’s.

TLS is facing strong competition in all its major markets. We are concerned that this heightened competition will reduce the returns from its incremental investment in networks and reduce earnings growth from its already meagre level from FY19 onwards. This view was recently confirmed with TLS slashing its dividend. Furthermore, rising bond yields are putting pressure on the share prices of all defensive dividend paying companies. Whilst TLS is a high quality business, we see better opportunities in Australia, until TLS can illustrate a more convincing forward earnings growth track.

Potential downside risks for TLS include 1) increased competition, 2) regulatory change, and 3) rising interest rates.