Telstra invests to safeguard its future

Andy Penn knows and understands the challenges confronting Telstra (TLS) as it moves inexorably into the national broadband network environment, shedding revenue and margin in the process. The $3 billion of extra investment over the next three years that he unveiled today is a response to them.

The additional investment, lifting capital expenditures from their current level of about $4 billion a year to $5bn and the “capex-to-sales” ratio from 15 per cent to 18 per cent, will go into further upgrades of its wireless network, some selective investment in its fixed network services and in digitising its core platforms to improve customer service by simplifying the myriad platforms and systems within the business.

While much of the investment is in future-proofing Telstra’s wireless network and preparing for the eventual transition to a 5G environment, it is also a recognition of the remarkable rate at which traffic on its network is growing — growth in data traffic has averaged 60 per cent a year over the past five years.

Telstra’s sobering experience earlier this year, when a succession of network outages undermined its reputation for network superiority and jeopardised its pricing premia, may also have been a factor in the decision to lift investment to its highest level since 2008-09, when it was building out its 3G network. Telstra has already committed $250 million to shoring up its existing network in response to those outages.

That increased investment program and a $1.5bn share buyback (from the proceeds of the sale of most of its interest in Autohome, the Chinese online car business, for a profit of $1.8bn) were unveiled with Telstra’s annual results today, results that continue to reflect the impact of the NBN rollout and the intensifying competitiveness of the industry environment.

The broad picture provided by the results is consistent with its recent performance and guidance. Revenue growth was modest — 1.9 per cent on a reported basis, 4.7 per cent if measured against Telstra’s guidance — and earnings before interest, tax, depreciation and amortisation were down 0.6 per cent, to $10.5bn.

The group’s historically high-margin fixed line services continue to shrink at a controlled rate as they are displaced by the NBN and voice services continue to shift to wireless and IP platforms, while its core mobiles business’ growth has slowed in the face of increased competition (and, perhaps, the impact of the outages).

Lower average revenues per user were a pointer to the increased competition as its rivals continue to gear up for the NBN, as well as the continuing re-emergence of Vodafone as a viable competitor.

Data and IP revenues are growing solidly, with income from a presence in global connectivity boosted by last year’s Pacnet acquisition, and the network applications and services business also had substantial growth. They are, however, lower-margin businesses.

Revenue from Telstra’s NBN deals is ratcheting up as the NBN rollout accelerates, rising 66 per cent to $1.35bn, with another $233m flowing from Telstra’s role in the NBN build.

Penn and his team are acutely aware that as services continue to migrate from its fixed network to the NBN that there will, it has calculated, be a $2bn to $3bn loss of earnings before interest, tax, depreciation and amortisation within the next few years.

Through growth in the non-NBN segments of the business, investments in new business, acquisitions and productivity improvements, the task is to offset that earnings leakage and create a platform for future growth while still trying to transfer Telstra’s fixed network dominance into an NBN environment where it has no structural advantages. So far, while it is still early, it is doing all of those things, including building very solid market leadership in NBN services, quite effectively.

The mix of declining high-margin legacy income, rising lower-margin income from the big push into global connectivity and applications and services and the now-material NBN-related flows creates a confusing picture of low top-line and earnings growth disguising a lot of activity and change and reallocation of resources below the surface.

So far Telstra has been able to manage the complex tensions between what it was pre-NBN and what it aspires to become quite effectively. It is planning/hoping for more of the same this financial year, with guidance for income growth in the mid to high-single-digits and EBITDA growth in the low to mid-single-digits.

With the NBN rollout momentum continuing to accelerate, however, the urgency of the response within Telstra will also have to increase and its deployment of its $3.5bn to $4bn a year of free cash flows will have to be intelligent and effective if it is to create platforms for meaningful growth in future.