Network Nerves

Ord Minnett recently raised its recommendation on Telstra Corp to Buy from Hold, and news that TPG Telecom (TPM, Lighten) plans to build a fourth Australian mobile network does not change our investment thesis.


Even prior to Telstra’s slide in early to mid April – which was sparked by fears over the potential adverse impact of TPG's plan on existing operators' businesses – Telstra shares were trading at a level that implied a 20% cut in its dividend. But we expect the dividend to be sustained as the company goes about its strategic transformation.


In fact, with an acceleration in National Broadband Network (NBN) payments coming in over the next three years, leverage at the low end of the range, circa 50% of the share register being retail investors, and a management team early into their tenure, we believe a dividend cut should not even be up for discussion at this time.


Telstra shares currently sport a circa 7.4% dividend yield and are offering significant value. In our view, share buybacks would be the most prudent use of NBN payments to reduce dividend payments, while securitisation could further increase the magnitude of buybacks. We estimate a $10 billion buyback over the next five years would reduce dividend payments by circa 20%. Given Telstra’s cost of debt is less than 4%, we see it as more accretive to buy back shares than to retire debt.


The threat of a fourth mobile operator in Australia has come one step closer to reality, but the actual impact is still 2–3 years away and yet to be determined. It is still hard to see how competitive or disruptive TPG could be to the industry, and more importantly to Telstra, given TPG is spending $600 million for only a barebones network that covers just 80% of the population. We do not see such a sub-scale network as being able to attract the customers that are paying a premium for Telstra’s network.

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