Telco Turmoil

Yesterday’s ultimatum to Telstra by the Government certainly came as a big surprise and has many Australians wondering what this means for them. And certainly there are a lot of stakeholders here: virtually every Australian has either a direct or indirect association with the telecommunications giant. And a giant it is. Telstra is one of the biggest companies in Australia, and indeed the world (it’s ranked 410 in the Fortune 500) with a market capitalisation of around $40 billion, it employs about 42,000 people and last year generated around $25 billion in revenue. The group has approximately 9 million customers and 1.4 million shareholders. Those that do not own Telstra shares directly will almost certainly have exposure through their superannuation fund. Little wonder everyone is talking Telstra this week.

Right at the outset we need to remind ourselves that most of what is being said at the moment is pure speculation; we simply don’t know exactly how all of this will play out. Indeed, the company in question has yet to respond formally and there will undoubtedly be substantial and ongoing negotiation well before the situation clarifies. So given all of this uncertainty, I’d like to explore some practical considerations that are relevant to the average Australian, and if possible encourage people to avoid panicking and buying into rumour and speculation.

Before we explore the possible ramifications for shareholders, the first thing we need address is how this will impact consumers, and thankfully this is rather straightforward. Put simply, the separation of retail and wholesale arms of the business will reduce costs for wholesale customers, which will in turn reduce costs for consumers. Undoubtedly this is a good thing. What’s also a good thing is that it will encourage competition which will in turn lead to lower costs and better service. Few people, outside of Telstra, would question this and indeed this was no doubt the Government’s primary motivation for its undertaking.

The situation is less clear for shareholders, although I’d suggest that things won’t be nearly as bad as what many people are making out. The functional split of the business will cost money to implement and this will reduce profitability in the short term. However, we can at least estimate these costs with a reasonable degree of accuracy and, in a perfect world, account for this on the market in an objective way. Although it’s very early days, analysts have suggested that these costs would amount to around $100 million, and although that sounds like a lot, its just 4 cents on a per share basis. It’s not insignificant, but at the same time it isn’t massive.

What’s more difficult to estimate is how the change would impact the company’s earnings capacity. More competition and less advantageous fee structures aren’t going to help the bottom line, and of course this is why Telstra isn’t thrilled by the Governments announcement. The degree of impact is very difficult to determine, especially at this early stage, but again we need to keep things in perspective.

The change does not mean that Telstra will no longer be profitable, and will no longer provide value for investors. Yes, the situation won’t do any favours for the share price, but that doesn’t mean that investors will lose everything. Indeed for most investors, who have access to the Telco through a fund, it’s unlikely that even a significant pull back will change things significantly. As large as Telstra is, it holds only a 3.5% weighting in the ASX 200, so for an index fund it could go all the way to zero and have only a minimal effect on overall fund performance. Even funds that give Telstra a much higher weighting will have their returns buffered by the performance of its other assets, so in and of itself it won’t change things significantly over the longer term.

What about those that hold shares in Telstra, and nothing else? Well as harsh as it sounds, this is the price you pay for putting all your eggs in one basket. Diversification is the cornerstone of any sensible investment strategy, and those who ignore it do so at their own peril. Although the opposition has claimed that the Government has pulled the rug out from under shareholders feet, the truth is that every single company in the world is exposed to unexpected and indeed unpredictable negative events. 9/11 and the US credit Crisis impacted virtually every listed company around the world. Here at home there are a hundred examples; consider the impact to Qantas from Avian flu or the drop in earnings suffered by Tabcorp from equine influenza. There are few guarantees when it comes to investing in listed companies, and if you can’t accept this then you shouldn’t be involved in the share market.

Finally, I would advise long term investors to avoid panicking. While shares sold off by a massive 4% yesterday, the very next day, as I write this article, it has recovered over 2.5% and is trading at $3.19. Those that sold off in a panic yesterday, it turns out, pulled the trigger too early. Of course, that doesn’t mean shares won’t reverse direction again tomorrow but the point is that important investment decisions should never be made in haste with fear as the primary motivator (just consider those who sold out of the market in March this year).

Make the markets work for you

Andrew Page