Value in telco shares

Rapid in­dus­try change, es­pe­cially with the NBN roll­out, and in­creas­ing com­pe­ti­tion make it hard for in­vestors to find value

Money Magazine Australia - - CON­TENTS - Roger Mont­gomery

The telecommunications sec­tor en­dured an an­nus hor­ri­bilis in 2016, with slump­ing share prices re­flect­ing the un­cer­tainty of the vi­a­bil­ity of var­i­ous busi­ness mod­els ahead of the com­ple­tion of the NBN roll­out. Down­grades, write­downs and cap­i­tal rais­ings are just some of the events share­hold­ers have had to en­dure.

So how should in­vestors think about a com­plex and ex­tremely dy­namic sec­tor and what are some of the con­sid­er­a­tions be­fore de­cid­ing whether val­u­a­tions have be­come at­trac­tive since the sell-off?

Fif­teen years ago life was sim­pler: a res­i­dence en­joyed dial-up in­ter­net ac­cess, with speeds 100 times slower than to­day, shop­ping cat­a­logues clogged mail­boxes, CDs and DVDs clogged shelves and draw­ers, and teens ar­gued about who could use the phone next. Smart­phones didn’t ex­ist and the only wire­less de­vices were the TV and roller door re­mote con­trols. Back then it took less time to walk to the video store, come home with a DVD, watch the movie and re­turn it than it did to down­load one.

The speed of change is now as fast as the con­nec­tiv­ity we de­mand from our in­ter­net ser­vice provider and com­pe­ti­tion is en­sur­ing prices keep fall­ing. Mean­while, ever faster speeds cre­ate new ser­vice cat­e­gories to which de­vice man­u­fac­tur­ers and ser­vice providers must en­able ac­cess.

This recipe of promis­ing more data and ser­vices at ever-lower prices is not an easy menu item for op­er­a­tors to de­liver. Com­bined with more than 110 com­pa­nies of­fer­ing ac­cess to the NBN alone, it makes nav­i­gat­ing the fu­ture very dif­fi­cult for in­vestors and there­fore valu­ing op­por­tu­ni­ties al­most 100% guess­work.

De­spite de­clin­ing prices, Aus­tralian telecommunications con­sumers have still had to pay sub­stan­tial pre­mi­ums, par­tic­u­larly to Tel­stra, com­pared with their over­seas coun­ter­parts, as well as ac­cept­ing slower and in­fe­rior ser­vices. Tel­stra has ben­e­fited most from con­sumers’ un­wit­ting will­ing­ness to pay pre­mium prices. Lim­ited com­pe­ti­tion, such as where Tel­stra is the only provider (to 46% of fixed-line ser­vices, for ex­am­ple), means some 3.5 mil­lion con­sumers are ad­versely af­fected by the mar­ket struc­ture.

Mean­while, it is ar­gued the sub­sidi­s­a­tion of Tel­stra, through the univer­sal ser­vice obli­ga­tion (the re­quire­ment to en­sure that phone ser­vices, pay­phones and pre­scribed car­riage ser­vices are rea­son­ably ac­ces­si­ble to all peo­ple in Aus­tralia on an eq­ui­table ba­sis) en­trenches its mar­ket dom­i­nance. It might be just one rea­son con­sumers are pay­ing more. Other rea­sons in­clude the dis­par­ity in spec­trum own­er­ship be­tween op­er­a­tors, which acts as a bar­rier to com­pe­ti­tion.

Re­gard­less, data de­mand is surg­ing. De­mand on fixed net­works grew by 40% from 960,000 ter­abytes (TB) to 1.3 mil-

lion ter­abytes, and mo­bile data in­creased by more than 50%, from 72,000TB to 110,000TB. A sig­nif­i­cant con­trib­u­tor to this ris­ing ap­petite for data is the pre­pon­der­ance of au­dio-vis­ual stream­ing ser­vices such as Net­flix, Presto and Stan, while a ris­ing num­ber of con­nected de­vices in homes – from an av­er­age of eight in 2016 to more than 20 in the next four years – will con­trib­ute fur­ther to data de­mands.

As an aside, price is also driv­ing data de­mand. In just the past four years prices for sim­i­lar data plans have fallen by more than 80%.

This growth in data de­mand has in­creased com­pe­ti­tion be­tween providers of both fixed-line and mo­bile ser­vices, re­sult­ing in in­creased data quo­tas and bun­dled sub­scrip­tions to stream­ing ser­vices. And to top it off, the telecommunications in­dus­try will change sig­nif­i­cantly as the NBN rolls out. The roll­out and mi­gra­tion to the net­work will raise is­sues for reg­u­la­tors, the in­dus­try and con­sumers. New bot­tle­necks may be dis­cov­ered, there’ll be new pres­sures on bat­tery back-up ar­range­ments, Tel­stra may gain a com­pet­i­tive ad­van­tage from ac­cess to sig­nif­i­cant in­for­ma­tion flows, while smaller ser­vice providers will de­mand and re­quire a com­pet­i­tive and ef­fi­cient ag­gre­ga­tion and back­haul mar­ket.

To com­pete against Tel­stra’s circa 60% mar­ket share (and 51% of whole­sale NBN con­nec­tions com­pared with 24% for TPG and 8% for Vo­cus), ei­ther sig­nif­i­cant scale or dom­i­nance of a grow­ing niche (for ex­am­ple, VOIP) is re­quired. The re­sult has been a wave of land-grab­bing merg­ers and ac­qui­si­tions, such as Vo­cus/Nex­tGen/M2 and TPG/PIPE/AAPT/iiNet.

In 2016, to­tal tele­coms ser­vices rev­enue ex­ceeded $40 bil­lion and grew at 2% for the 12 months to June 2016. Much stronger than ag­gre­gate growth is be­ing gen­er­ated by sec­ond-tier providers; how­ever, Tel­stra still dom­i­nates.

Ad­vances in the dig­i­tal econ­omy, as well as multi-in­dus­try use of the in­fra­struc­ture and the “in­ter­net of things”, will see an on­go­ing in­crease in whole­sale rev­enues and open up op­por­tu­ni­ties in data an­a­lyt­ics, cloud com­put­ing and ser­vices that haven’t been imag­ined yet, while the con­nec­tion of lit­er­ally bil­lions of de­vices puts pres­sure on the in­fra­struc­ture.

As the fu­ture moves to­wards the NBN, it is be­lieved a more level play­ing field will be cre­ated, but mar­gins will con­tinue to be pres­sured. If you’re think­ing the telco sec­tor in Aus­tralia is an in­con­dite gal­li­maufry, you’re not too far from re­al­ity.

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