Telstra (ASX: TLS) is Australia’s largest full-service telecommunications company and offers fixed line and mobile telecommunications services to consumers, businesses, enterprises, and governments through its owned infrastructure. The company owns 8,200 cell towers, 58 data centres and is one of the largest operators of submarine cables in Asia with an undersea network of more than 400,000 km. Telstra also owns 35% of pay TV company, Foxtel, and provides access to 60 satellites through four teleports.
Telstra once owned Australia’s legacy fixed line copper broadband network infrastructure that connected most of Australia’s homes, however, this has since been largely replaced by the government owned National Broadband Network (NBN). Around 65% of Telstra’s EBITDA is from mobile and fixed services. Telstra is the clear domestic market leader with regards to 5G, with the company’s 5G network expected to reach around 75% of the domestic population by June 2021.
In March 2021, Telstra announced an update on its T22 restructuring plan, with the business being split into four distinct subsidiaries, to be owned by a new holding company, Telstra HoldCo (to be voted on at the October 2021 AGM):
- InfraCo Fixed: will own physical infrastructure assets of Telstra’s fixed telecommunication network, including ducts, fibre, data centres and exchanges. NBN Co has an ongoing lease agreement with Telstra for access to this critical infrastructure (while also compensating Telstra for its loss of customers due to the forced migration from its legacy fixed line network to the NBN).
- InfraCo Towers: will own Telstra’s 8,200 mobile tower assets.
- ServeCo: will be the customer facing business, where Telstra’s retail operations and the spectrum and technology that support them will reside.
- Telstra International: will, among other things, own Telstra’s subsea cables.
Overall, the planned restructure is a positive development for Telstra as it positions the business to maximise the value it extracts from its infrastructure assets, while creating a high degree of strategic optionality for management going forward.
The monetisation of InfraCo – Towers is already well underway, with Telstra seeking binding offers from external parties by Q2FY22 (i.e., late 2021). Monetising these assets will ultimately enable share holders to realise some of the hidden value in Telstra shares (under the old structure). The capital raised will provide the company with added liquidity to strengthen its balance sheet and to help underwrite a continuation of its dividend payout at 16 cents per share. We believe Telstra stands to raise between $3.4 - $5.1 billion (equivalent to $0.28 – $0.43 per share) from the sale of its mobile tower assets (assuming the sale of 100% of Telstra’s stake), based on an EV/EBITDA multiple of 16x – 24x. We view this as reasonable, with recent transactional evidence in the sector pointing to multiples of 15.5x – 26.0x being realised, while publicly traded tower companies, like American Tower and Crown Castle, trade at forward EV/EBITDA multiples of ~ 21.0x – ~24.3x.
We expect the InfraCo – Towers business to attract significant demand from institutional investors such as large pension funds, given the defensive, annuity style income offered by these infrastructure assets, which is particularly appealing for institutional mandates in the current low yield environment.
Over the medium term, with the added flexibility provided by the new corporate structure, Telstra will also have further opportunities to untap hidden shareholder value. One widely speculated possibility is that Telstra (via InfraCo – Fixed) can now bid for NBN Co at some point down the line (without violating current NBN legislation that aims to avoid the creation of a monopoly), should the government want to privatize the taxpayer owned company, as has been flagged as the “end game” by both political parties in the past.
Overall, Telstra’s outlook has improved following the recent update on T22, which should enhance the company’s ability to deliver value to shareholders. However, at its current valuation (FY22 PE multiple of 23.8x) we believe that much of the upside has been priced into the name. Moreover, with ongoing uncertainty facing its mobile division following years of aggressive price competition that has been margin dilutive for the business, we view TLS as a HOLD at present. We would be more comfortable accumulating shares at a level that offers a higher margin of safety, around the $3.20 mark or lower.
We believe the ASX offers a range of high-quality income stocks that are better placed than Telstra.
- Infrastructure asset monetisation: we believe the monetisation of InfraCo – Towers in FY22 could enable Telstra to raise between $3.4 - $5.1 billion, which can be used to reduce the company’s net debt and underpin future dividend payments. Under the new structure, there may also be further opportunities for Telstra to monetise its assets held within InfraCo – Fixed and Telstra International for example, which could help untap additional shareholder value.
- Potential NBN merger: the new structure gives Telstra the ability to bid for NBN Co in the medium to long term, via the subsidiary InfraCo – Fixed, which could create significant synergies for the merged entity.
- 5G mobile market leadership: Telstra has a clear first mover advantage in the 5G space and will have the broadest network domestically, which could enable the company to increase its mobile market share and upsell existing customers to higher priced packages, therefore, benefiting its APRU (average revenue per user) and hence its margins.
- Margin expansion / earnings momentum: after years of intense price cutting amidst a competitive industry setting, which has resulted in Telstra’s ARPU falling and therefore, margin dilution; there is the potential for a reset across the domestic telco landscape, particularly after the resignation of the TPG founder and chairman, David Teoh. This could result in a more constructive industry environment, where Telstra is able to increase its pricing across its mobile and fixed line products (which account for 65% of EBITDA), therefore, improving its ARPU and margins. In addition, Telstra has achieved ~$2.0 billion in cost-outs since FY16 and has increased its FY22 cost-out target by $200 million to $2.7 billion. Moreover, Telstra’s ‘NBN headwinds’ (i.e. the recurring net negative recurring earnings impact of the forced migration of customers from Telstra’s legacy network onto the NBN) peaked in 1HFY21 and will be lower in 2HFY21 and “substantially less” in FY22, eventually dwindling to zero with the NBN’s rollout now complete. The removal of this significant ongoing drag on earnings is a positive for the trajectory of the company’s profitability going forward.
- 5G fixed wireless product: in late 2020 Telstra announced 5G Home Internet– a new way of delivering fast and reliable internet to customers and an alternative to the NBN. The uptake of this new solution could lure some customers away from other existing NBN providers. Telstra aims to scale up this product over the next 12 months or so, which provides the company an opportunity to improve its broadband margins.
- Competition: over the last 3 years, aggressive price competition has been significantly detrimental for Telstra’s mobile and fixed ARPU and therefore margins. There is a risk that heightened competition in the industry could cause further margin dilution and result in Telstra’s market share declining in the mobile and/or fixed space (where ~65% of Telstra’s EBITDA is derived).
- Weaker than expected monetisation outcomes: there is the risk that Telstra’s monetisation efforts are ultimately unsuccessful and undershoot market expectations, starting with the separation of InfraCo -Towers in FY22.
- Regulatory risk: the telecommunications sector is heavily regulated and faces an ongoing threat of unfavourable government intervention.
- Disappointing cost-out achievements: after increasing the FY22 cost-out target by $200 million to $2.7 billion, there is the risk that Telstra fails to meet this benchmark.
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
(“ASR”). ASR is part of Amalgamated Australian Investment Group Limited (AAIG) (ABN: 81 140 208 288 Level 13, 130 Pitt Street, Sydney NSW 2000).
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