Following on from my post about seeing value in Telstra, now that the much-anticipated Telstra2022 strategy is in the market, we like the new direction, and sense that TLS’s share price plunge may be coming to an end.
Having recently acquired a position in TLS we were very interested to understand the direction the company intends to take over the coming years. To recap, we recently bought TLS shares because we thought that, while the various headwinds facing the company were well-understood, the market may have under-appreciated some longer-term sources of potential upside. The possible sources of upside we had identified were:
- Scope for greater-than-anticipated cost reductions;
- An improvement over time to NBN economics, possibly through reduced NBN wholesale charges or through fixed wireless substitution; and
- Scope for significant growth in services in operation flowing from the introduction of 5G.
The disclosures from the company on 20 June gave us some additional insight into these potential upsides, and generally we were comfortable that the proposed strategy addressed the items that it needed to. In particular, the announcement highlighted:
- An extension of the productivity program target from $1.5 billion to $2.5 billion cost out by FY2022, facilitated in part by initiatives to simplify the customer experience and the operating structure;
- Plans to ensure TLS remains the premium brand in the market and “wins” in 5G, underpinned by significant capital investment in the network and an early rollout;
- Creation of a new infrastructure business unit to hold fixed-line infrastructure assets; and
- Plans to monetise up to $2 billion of assets to strengthen the balance sheet.
The first two of these points directly address two of the sources of longer-term upside we had identified, and we are very much of the view that these are the sorts of things that TLS should be doing. The merits of improved productivity are self-explanatory, and the scale economics of mobile telephony are such that preserving TLS’ dominant market position and “winning” in 5G is the only sensible course.
The other initiatives we see as less critical. Our valuation assessment for TLS looks through to the nature of the underlying cashflows, and reorganising those cashflows into different boxes may create optionality and the scope for a rating arbitrage down the track, but does not impact our assessment of underlying value. Similarly, plans to monetise assets may well be beneficial, but unless the value realised is dramatically greater than the value of the assets in the hands of TLS shareholders, this is at the margin.
Beyond the highlighted points, the company also began to address the issue of NBN economics. In particular, management flagged that a growing number households may find in future that their needs for connectivity may be able to be met by mobile services rather than fixed connections. We expect to see further development of this theme in the years ahead.
Overall, our assessment is that the strategy TLS has set out is very much in line with where it should be, and we gained comfort in the longer-term prospects for growth in earnings and value.
There was, however, a sting in the tail, in the form of underlying FY2019 EBITDA guidance that fell below the market’s expectations and prompted further declines in the TLS share price. In looking at this downgrade, however, we are reasonably sanguine.
Part of the near-term headwinds reflects an expectation that markets will continue to be highly competitive into FY2019, and that revenue will suffer as a result. Related to this, TLS is surrendering a pool of revenue over the next few years at it simplifies its customer experience and eliminates things like excess data charges. While this introduces some short-term earnings pain, we see it as part of creating a stronger business beyond that. Our hope for TLS is to see it become a highly efficient market leader that enjoys superior economics to its competitors by virtue of market position and scale advantages. Driving productivity gains is an important part of this. Pleasing customers and protecting market share by sharing some of those gains with them is another, and this needs to happen sooner or later.
When we bought into TLS earlier in the year, we expected that we may well be too early with the investment, and that the share price could continue to decline. Our response to this was to take a small initial position with a view to adding to it as opportunity presented.
Our view in this regard is unchanged, but we now feel that the end of TLS’s long and painful price decline is getting closer, and that the key investment question has now changed. The question as to whether TLS is able to identify the correct strategic path has been substantially answered. The question that matters now is whether TLS management is able to execute that plan in the years to come.