Telstra’s back on track with Andy Penn holding the reins

Telstra CEO Andy Penn. Ahead of the comany’s results announcement on Thursday, Telstra has announced a 16c dividend. Picture: Alan Barber

Not so long ago there were mutterings in the investment community about whether Andy Penn should call time in the top job at Telstra. Was his great 2018 transition strategy of T22 much more than a cost-cutting exercise? Where was the growth? Why was NBN in such a controlling position on pricing?

Ahead of its results on Thursday, Penn is in charge of a different looking beast, with short and long-term strategic options for growth. Ongoing negotiations between the government, Penn and Telstra chair John Mullen are now multi-layered and very nuanced, involving competition, technology, geopolitics, Covid-19 and of course, tens of billions of dollars. One of the most respected telecoms analysts in the country, New Street Research’s Ian Martin, has been following Telstra for the best part of 25 years.

“Telstra was staring down the barrel a year ago,” he said. “The T22 plan had been put on hold because of Covid, mobile roaming and fixed line costs were affected and you still had another year or more of NBN migration to go. The outlook was pretty uncertain.”

In June, a $2.8bn deal took the market by surprise. The Future Fund and two other giant investors took a 49 per cent stake in Telstra’s mobile tower portfolio. Martin says the high valuation, at 28 times EBITDA, is akin to US companies. Telstra, however, has managed to achieve a deal where it more or less retains control.

Martin describes it as a sale and leaseback but with protections, in­clud­ing repurchase options Telstra has in place. This, he says, is excellent risk-based financing. For shareholders, it is a leaseback where the payment is in dividends: a new way to finance growth.

“What Telstra has is three long-term investors that want to buy into the income stream from the towers. To grow that income stream you’ve got to have relatively active management working out how you grow that business. And that is a fantastic outcome, because the growth in the sector over the next decade is going to be in this digital economy and the infrastructure of the digital economy which requires a lot of small cell towers.”

Much value is still locked up in Telstra’s relationship with NBN Co. In the near term, the ACCC chief Rod Sims says he wants to see a reset of regulatory arrangements for NBN Co, in the prices it charges the telco retailers.

“They don’t work at the moment; we’ve spent $50bn on this thing. The CVC pricing, the fixed price versus the variable price – Telstra, Optus, TPG Vodafone – are very concerned that they get charged too much for the usage, so big issues there with how we price the NBN,” Sims says.

“That will take at least a year to resolve and there is no easy way to resolve it because ultimately it is going to force some rethink of the valuation of what the NBN really is,” Martin says.

On Tuesday, NBN Co reports its annual results and what it says on pricing will be watched closely.

The inevitable government rethink on NBN Co presents the real prize for Telstra – the chance to reopen negotiations to unlock the huge cashflow due to the telco for the lease of infrastructure over the next three to four decades. “It’s probably worth $25bn-$30bn. That’s certainly not reflected in the share price,” Martin said.

In 2017 Telstra had grand plans to do exactly this by securitising the cashflows but was forced to ditch them when NBN Co refused to allow the deal.

Martin says any discussion to revisit the issue is beyond the next election, but you can bet Mullen has the issue in mind as he talks to the government about other ways Telstra may be called on to step up in the national interest this year.

Telstra is talking with government over plans to secure communications in the Pacific through buying Digicel, as China increases its influence in the region.

The challenge for Mullen and management is to ensure they do not expose Telstra to too much downside risk. As to how these talks interlink with NBN, you’d have to be a fly on the wall.

Martin has confidence in Mullen’s leadership. “He has been very good in terms of hands-on control, relationship with Andy and management.”

Before any deal was struck to monetise future NBN cashflow, Telstra would need to separate its Infraco assets from the rest of the business, a hugely complex task given how interdependent the businesses have been. What sort of structure or divestment options emerge are unclear, but no doubt are on virtual whiteboards at a number of top financial advisers around the country.

Martin believes Penn’s T2 strategy and 5G rollout are going pretty well. After several years of mobile service revenues (now the main part of Telstra’s earnings) in decline, he expects to see a turnaround in the next year.

“At the end of this calendar year in effect they no longer have the fixed line business, and so we should be able to pull out most of the cost associated with that. There is a lag between when the business is transferred to the NBN and when they get the cost out so that should be coming through in the year ahead and into the following year.”

The other growth leg for shareholders is Telstra’s enterprise business. This week the telco said it was buying patient management software company MedicalDirector in a likely $350m deal. “Telstra’s health business has a lot of potential,” said Martin. “The most opaque part of Telstra is the enterprise sector and there are some verticals there – health, mining, agriculture – which leverage Telstra’s mobile network and their enterprise expertise.”

Ahead of its Thursday results, Telstra has announced a 16c dividend. Martin expects underlying EBITDA at $6.7bn.

“But Telstra has said is that they need to get up to $7.5bn over the next two years, in order to maintain that 16c dividend, so it’s really the read through from that $6.7bn and the year after that’s important,” he said.

On Monday the government gave Penn another reason to smile with a higher 45 per cent limit on the frequency spectrum it could buy to boost regional 5G mobile coverage at the auction later in the year. The ACCC had recommended 40 per cent and Telstra had lobbied for 43 per cent.