Telstra on the right track
Telstra (ASX:TLS) shareholders have seen quite a few false dawns before, but there’s mounting evidence to suggest that this time the sun may really be coming up.
Telstra shares are over $3.50 for the first time since August 2009. They hit a low of $2.61 in December 2010, were one of the best performing blue chips of the past 12 months and have added 5.4 per cent this year. They are currently trading at $3.51, up 1.2 per cent for the day.
That’s not to say all will be rosy here from here on – though we know the day is breaking, the weather forecast is still a little uncertain.
A charmed past
The Telstra of 25 years ago was a business with some wonderful economics that was hamstrung by government ownership and an accompanying mindset. It was the monopoly provider of essentially a legacy asset – the already-installed copper wire network – that required relatively little maintenance and new spending.
Accordingly, it had very high margins (the bloated cost base notwithstanding) and life was pretty good. The only problem was that technological advancement made fixed-line telephony an endangered species.
Into choppy waters
The transfer of Telstra into public hands came around the same time as a true technological revolution. Basic mobile phones started to become widespread in the early 1990s, and the internet took off around the same time.
Over the following 20 years, our use of communications technologies has changed dramatically – mobile phones have become smaller, cheaper and infinitely more powerful as the internet continues to change our lives, particularly in its latest, mobile, iteration.
Despite the volleys of criticism to the contrary, Telstra handled that two-decade transition reasonably well. Of course hindsight gives us the unfair opportunity to point out the mistakes, but Telstra had to confront a seismic shift in the way we communicated, the end-point of which was to make Telstra’s own legacy business irrelevant.
It is a devilishly difficult thing to accomplish. Telstra’s biggest hurdle was replacing very high margin fixed-line business with a much lower margin mobile and broadband one.
The extra competition and technological ‘arms race’ mean these two markets are far more capital intensive, and have pricing models which offer more talk time and data for the same or lower prices almost year-in and year-out.
Notwithstanding that consumers talk more when their phones are always with them, the task was herculean – the rate of fixed-line decline was just too much to adequately staunch, especially in the early years. When combined with the massive technology infrastructure spending required to build the new mobile networks, Telstra was swimming against some ferocious tides.
Transformation almost complete
Now, however, we are seeing signs of sustainable recovery. The company is paying down its debt and will be receiving $11 billion from the government (over time) as compensation for handing over much of its infrastructure to the NBN.
If you’ve phoned a Telstra call-centre recently, you’ll know that the level of service, while not perfect, has improved greatly.
The company is still enduring the painful transformation from government utility to nimble technology retailer, and has a way to go, but the changes are bearing fruit (helped, no doubt, by the good people at Apple who have transformed the mobile internet).
Telstra is desperately keen to avoid the mistakes of the past – to not be caught napping when the new waves of technology arrive. It is also keenly aware of the competition in its business and the ease with which consumers can change carriers for a better deal.
Pricing, speed and content are the success factors in mobile telephony/internet and home and business broadband.
Filling the war chest
With that recognition, the company disappointed some analysts and shareholders recently when it declined to announce a large-scale capital return. Instead, Telstra decided to retain the excess funds, expected to be between $2 billion and $3 billion over the next few years.
Let’s not overlook that great result – after borrowing to pay dividends for years until recently, Telstra is now generating significantly more cash than it needs.
The problem is that cash retention is a double-edged sword. After seeing companies go to the wall or significantly dilute shareholders due to excessive debt during the GFC, I’d love to see nothing more than Telstra extinguish its debt.
Of course, you’ll have analysts decrying a '‘lazy balance sheet’', but to tweak a Warren Buffett truism, leverage is the only way a smart company can go broke. Give me a debt-free company earning strong cash flow any day.
The risk for shareholders is that the billions of dollars start to burn a hole in Telstra’s pocket. Acquisitions start to look attractive, delusions of grandeur start to percolate and all of a sudden we’re not that far from a billion dollar plus purchase with a less than certain outcome.
Of course, management also don’t want to leave themselves exposed to another seismic technology shift either – hence their desire to maintain flexibility.
David Thodey and his team have earned the right to call the shots – everything we’ve seen so far suggests he and Telstra’s management are a safe hand on the tiller and the company looks to be good value.
Still, complacency is dangerous for companies and investors alike, and overpriced or strategically questionable acquisitions would be a significant concern and a reason to reconsider our faith in the company.
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Scott Phillips is an investment analyst at The Motley Fool.Scott owns shares in Telstra. You can follow him on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).