Almost half the Telstra share base comprises retail investors who rely on the company’s dividends to shield them from the impact of lower interest rates.
What few Telstra shareholders realise is that the global Huawei saga of recent months has the potential to link future Telstra dividends to the flow-on repercussions created by the Huawei bans imposed by the Australian and US governments.
The Huawei significance to Telstra and vast areas of Australian industry is rarely discussed in public but is the subject of intense strategic discussion in the US and Australian telecommunication industries.
Paradoxically, Telstra and the four big Australian banks have all paid out huge dividends, much to the relief of Australian retirees. The dramatic change in the Australian equity management industry means that AustralianSuper and the other industry funds will be asking all major Australian companies to set out their long term plans.
Banks will have to confess that they under-invested in technology and will need a major catch up.
Telstra will have to confess that it’s likely that it too will have to increase its investment well beyond that provided for in its “T2” program. The next stage of the digital revolution involves artificial intelligence, cyber security and a complex web of telecommunication services usually linked to cloud computing.
The most obvious company to lead the provision of these services in Australia is Telstra, although obviously Optus and Vodafone/TPG (if they are allowed to merge) will also be contributors. If top of the range digital telecommunications technology is not available in Australia then large areas of Australian business activity, including services, will fall behind the rest of the world. The consumer market is less affected.
Low returns remove advantage
In theory that industrial market requirement provides a fantastic competitive advantage for Telstra, Optus and TPG/Vodafone. But for many years, across the globe, the rewards from telecommunications activities have been low and in totality the industry has under invested.
The Chinese were among the first to realise just how significant this new industrial revolution stage would be to telecommunications and, via subsidisation, took Huawei from a relatively small provider of the essential components that enable telecommunications companies to service this new market, to the world’s largest. It has a huge research program.
In theory, the western world should not have allowed China such a free reign to dominate. But with Facebook, Amazon, Google and Microsoft making huge profits from other parts of the internet revolution, the challenge the Chinese thrust posed over the long term was not recognised.
A significant part of the trade war between the US and China is about databases and components for the telecommunications revolution. While China is way ahead in telecommunications, in other parts of the computer revolution it is dependent on the US for essential components. The pending agreement is unlikely to cover all these areas.
Huawei is the dominant telecommunications supplier. Running second and third are Ericsson and Nokia and there are also smaller players. The gap between Huawei and the rest is big.
Because the rewards in an unsubsidised world have been low, American companies have not been big developers of the technology. Suddenly Huawei has been banned and so it becomes essential that those affected by the ban, including Australia, gain access to the latest telecommunications technology so our companies can fully participate in the world of artificial intelligence and other services and be protected from cyber-attack.
The second player in the industry, Ericsson, has a market capitalisation less than Telstra. Ericsson was recently slapped with a billion-dollar fine by the US Justice Department for some obscure activity at a time when those parts of the world that have banned Huawei desperately need Ericsson to step up to try to bridge the gap. The Americans have badly wounded an essential supplier which leaves US and Australian telecommunications companies in a state of some shock.
Two alternatives
If the ban on Huawei is continued then there are two clear alternatives. One is for Ericsson and /or Nokia to be funded in a way that will see them invest vast amounts in new product development to enable them to catch up. A second alternative is for America and Australia to begin the high cost task of bridging the gap so their industries can keep up with those propelled by Huawei.
It is likely that the Americans realised that unless they took strategic action at this time then China would completely dominate this next stage of the revolution. So they are probably prepared to wear the medium term pain. But unless governments are prepared to help fund development, telecommunication companies are going to be required to step up and in some way fund the massive investment in research and development required to catch up with Huawei. Irrespective of who leads the catch up and how it is funded, Huawei patents will double the difficulty of the task.
Until the ban, like the rest of the world, Telstra was set to be more dependent on Huawei and the patents they have taken out. If Telstra and its US counterparts have to invest into this catch up program they will need greater returns to generate the funds. But so will Ericsson and Nokia.
Telecommunication has become a low margin business and so far has not been able to convert its importance in the next stage of the industrial revolution into worthwhile profits. If Telstra is forced to help fund the gap created by the absence of Huawei, then it will put increased pressure on the company to separate its infrastructure assets in an attempt to continue to provide high shareholder income. But, of course, the Telstra infrastructure company can only gain revenue by the parent company paying generous fees to use that infrastructure, which hampers the amount of money available to fight the Huawei battle.
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