Tuesday, September 29, 2009

My Holdings - Telstra

Greg Fraser, analyst, Fat Prophets
Perversely, the government's ultimatum to Telstra to physically untangle its network from its retail business provides a smidgin of certainty. Shareholders now know they will own two companies after Telstra complies with the minister's decree.

The first will be a network company. It will have about nine million residential and business customers, plus a clutch of wholesale customers who pay to access Telstra's network to connect their own customers. The regulator -- the Australian Competition and Consumer Commission -- will have very strong powers to set and control the price of access to this network.

It will effectively operate along the lines of a utility and will therefore generate steady earnings, but with minimal growth.

The second will be a retail company. It will still own some networks, such as the Next G mobile network and the Next IP network that Telstra spent several billion dollars constructing over the past few years. These networks are the platform for delivering you-beaut services such as wireless broadband internet, 3G mobile and fixed line broadband connections via the HFC cable network or ADSL2+. In addition, this company will own Sensis and a 50percent stake in Foxtel.

This scenario assumes Telstra submits a plan the ACCC finds acceptable, thereby allowing Telstra to keep its Foxtel and HFC cable assets.

On separation, the market should be able to transparently value each business. It may be that the parts are worth more than the whole, even after allowing for the cost of the exercise.

It is possible most of the bad news is already reflected in the share price. If so, shareholders have little more to lose and much to gain by hanging in there. After 10 years of transforming the business, Telstra's cash flow is healthy and able to sustain the current dividend or even increase it, though that is for the board to determine in light of the new information.

Quantitative Analysis
Telstra is a financially sound company with a very strong free cashflow generation. Although it has a debt/equity ratio of around 140%, it is able to pay down all the debt using just 4.5 yrs of free cashflow. It has predictable earning power and its ROE, ROA and even ROC is very acceptable at 29%, 9% and 13.5% respectively.

At current price, Telstra is valued roughly around 10x P/E with a dividend yield of 8.5%. My own estimate of a fair value for Telstra using Free Cashflow is around $3.30.

Qualitative Analysis
Telstra is a triple play company similar to singapore telcos which are operating in a protected regulatory environment. While I was staying in Australia, Telstra was and still regarded as the defacto company for your residential line as well as for Cable TV. If you do not subscribe to their internet service and subscribe to a 3rd party internet provider instead, the 3rd party provider still need to pay for usage of Telstra DSLAM network. On the mobile front, it still has a good market share against Optus and Three.

Current speculation about the proposed breakup, like what the Fat Prophet analyst above who is a value investor, has probably been priced into the stock and upside potential could be great if the broken up entities are listed and valued at a premium.

Vested at $3.24

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