28min read
PREVIOUS ARTICLE Maximise Your Income On These ... NEXT ARTICLE Bankers and Builders -- Stocks...

Although its many critics point to its somewhat rocky start, the National Broadband Network is underway.  Opponents cry out that governments should leave such ambitious infrastructure projects to the private sector.  The plan to make a broadband network linked by fibre optic cable – not old technology copper – reaching about 93% of Australian consumer dwellings, educational and medical institutions, and commercial businesses is nothing more than a costly boondoggle, they say.  

What is worse in the critics’ eyes is the even costlier plan to bridge the gap to the remaining 7% through a combination of satellite and wireless connections.  In their view, the promised speeds of 100 megabits (MBS) per second may never materialise and even if that dramatic increase of 18 times the current broadband speed in Australia is reached, why should taxpayers pay the price?

Proponents liken the creation of the NBN (National Broadband Network) to the development of a national road and rail system over the last two hundred years.  In truth, not all Australians are aware the ambitious NBN undertaking is part of a national strategy towards developing a 21st century digital economy, with economic sectors sharing the NBN infrastructure.

The FTTP (fiber optic cable to the premises) technology underpinning this effort is, in the eyes of most experts, a truly transformative technology, just as copper wire was in its day.  Expert opinion from scientists and academic researchers has not been enough to mute the controversy over the NBN, but what do leading private sector technology companies have to say?.  

IN 2010 shortly after it became obvious the votes were there to pass the controversial NBN legislation, executives from tech juggernauts Google, Intel, and Microsoft extolled the long term benefits of the undertaking.  Google’s head of engineering envisions “a world of opportunities for all Australians,” and went on to say the NBN will spur innovation, economic growth, and entrepreneurship in the same way the electric grid did in the 20th century.

Intel and Microsoft both see NBN as vital to Australia’s global competitiveness in an increasingly digital economy.  More recently, Google Chairman Eric Schmidt cited a Deloitte study showing the Internet already accounts for 3.6% of Australia’s GDP, with a five year growth forecast averaging 7% – a growth rate twice as fast as the rest of our economy.

Transformative technologies can be delayed and deferred, but history says they always win out in the end.  The early phase of the NBN rollout is in the hands of the government created NBN Company; and is to a great extent positioned as a telecom network.  Although history also tells us the existence of network infrastructure spurs the creation of additional products and services enabled by the network, no one can as yet predict what they will be, or the companies that will create them.  Investors will have to watch and wait for those opportunities.

Right now, the opportunity lies in the Telco sector, where the NBN will change the face of the competitive landscape.  Australia’s giant, Telstra, faces loss of market share from smaller providers unable to compete without the new network, but it remains to be seen which companies may emerge as winners, and how Telstra will fare in the new NBN environment.

Here are seven Telco stocks all serious Australian long term investors should consider adding to their investment watch lists:

Company

Code

Market Cap

Share Price

52 Week Hi

52 Week Low

Telstra

TLS

$41,809M

$3.36

$3.45

$2.69

TPG Telecom

TPM

$1,409M

$1.78

$1.88

$1.23

Hutchison Telecom

HTA

$1,232M

$.04

$.09

$.04

M2 Telecom

MTU

$509M

$3.27

$3.62

$2.27

iiNet Ltd

IIN

$488

$3.03

$3.23

$2.10

Singapore Telecom (Optus)

SGT

$396

$2.40

$2.57

$2.16

Amcom Telecom

AMM

$266M

$1.10

1.14

1.59

 

As you can see from a cursory overview of these numbers, with the exception of penny stock HTA, all these shares have performed well, with current share price well above their 52 Week Lows and reasonably close to their 52 Week Highs.  First, let’s look at the 800 pound gorilla in this space – Telstra.

TELSTRA (TLS)

As you may know, NBN Co negotiated an $11 Billion dollar purchase of Telstra’s existing network with payments spread over time.  Although this agreement was reached in June of 2011, payment details were unclear, in part due to the planned NBN rollout in phases.  

Much to the delight of existing shareholders and a positive sign for prospective investors, on 19 April 2012 the company announced an anticipated $2 to $3 Billion dollars in excess cash flow over the next three years from the projected NBN rollout.  Company management went on to state it intends to issue a dividend of $0.28 per share in 2012 and 2013.  What’s more, in line with their commitment to maximising shareholder value, they anticipate putting the free cash flow in the hands of investors via increased fully franked dividend payments commencing in 2014.

Despite the potential of increased competition as a result of the NBN rollout, analysts are positive on Telstra’s prospects going forward.  In recent broker recommendations, analysts at Credit Suisse, BA-Merrill Lynch, and Citi were anticipating the company would be announcing a schedule for share buybacks.  The decision to increase dividends in the near future may disappoint some, but much of the uncertainty regarding the timing of the NBN payout and what Telstra planned to do with the extra cash has been lifted.

Currently the company offers a full line of telecom services across voice, mobile, data and internet products.  In each of these categories they are either the dominant player or hold significant market share.  While those who espouse a glass half empty mentality might shy away from Telstra due to the potential of lost market share, the glass half full crowd sees opportunity.  Freed from the operational costs of maintaining its own network and flush with capital, Telstra is in an excellent position to expand its range of offerings.  They are already heavily investing in cloud computing services and application solution services in anticipation of what the increased speeds with the FTTP network can handle.

In a market where bundled services are becoming increasingly important to both consumers and businesses, TLS is better positioned than most of its potential competitors, many of whom do not have presence in all telecom markets.

While the NBN has been hotly debated and the details of the buyout long in coming, the share price of TLS year over year does not reflect those concerns.  Here is a chart comparing TLS against the ASX 200:

While 2011 and the first quarter of 2012 have been less than stellar for the overall market, TLS shows a gain of almost 20%, year over year.  

TPG Telecom (TPM) – iiNet (IIN) – Hutchison Australia (HTA)

Led by highly regarded entrepreneur David Teoh, TPG Telecom may be in the best position of any Aussie Telco to actually grab market share from TLS.  Their competitive strategy is low pricing and some strategic acquisitions might put them in a more competitive position with TLS.

In 2011 TPM acquired a 7.2% stake in Western Australian Internet Service Provider iiNet, fueling speculation of a possible takeover.  There have also been rumors of their interest in HTA, which is actually a joint venture with Vodaphone Australia.  HTA was the first Telecom to introduce 3g service in Australia, but in 2009 they entered into a 50/50 partnership with Vodaphone, which has not been finalised to this day.  However, they have a respectable share in the mobile phone market, which TPM does not.  HTA is the poorest performer in the sector, as evidenced by their share price performance chart:

In the new broadband world consolidation among some of the smaller players is a possibility and TPM already has some of the groundwork in place to augment its product offerings.  But why would a currently successful company like TPM have any interest at all in tiny HTA?  Perhaps for the same reason investors should have the troubled company on its watch list.  Once the details of the operational partnership with Vodaphone Australia are finally complete, HTA could get back in the game.

Finally, here is a comparison of share price performance year over year for IIN and their possible suitor, TPM:

Amcom (AMM) and M2 (MTU)

M2 currently refers to their business model as “infrastructure light” as they have relied on network infrastructure of larger Telcos like Telstra to focus on small and medium businesses.  As such, they are not in a position to realise any significant cost savings via the new fibre optic network.  Although their past performance in terms of fundamentals has been solid, it remains to be seen what impact the NBN will have on their business.

Amcom is unique among the Telco’s in that they already have their own fibre optic network in place to serve their business customers.  They are a wholesaler and combined with the fact their network is already proven should, in theory, protect them from competition post NBN rollout.  However, in practice, they are somewhat at risk.  Their business model not only offers corporate and government customers a solid communications network, but also provides IT solutions to run on the network.  As previously discussed, Telstra has plans to expand their presence in the application solutions segment of the business.  In truth, no one knows how the Telco’s will adapt to the changing environment.  However, in many cases past performance can provide some indication of the company’s capabilities.  

Up to this point, market participants prefer AMM to MTU, as evidenced by their one year share price comparison:

The final stock from our list is Singapore Telecom (SGT).  This company is majority owned by the Singapore government and operates in Australia via its subsidiary, Optus.  You may know Singapore has its own plans for a government funded broadband network but they have yet to work out the details of phasing out SGT’s existing copper network.  In addition, the company has operations throughout Southeast Asia, and sovereign risk in some of those countries remains a factor.  In short, if you believe in long term possibilities arising from Australia’s NBN, there are better plays than SGT.

Finally, let’s take a brief look at some market valuation and fundamental performance numbers for these seven Telco’s:

Company

P/E (Price to Earnings)

P/EG (Price to Earnings Growth)

ROE (Return on Equity)

Dividend Yield

TLS

11.96

1.61

26.8%

8.3%

TPM

13.59

.45

15.2%

2.8%

HTA

-13.2%

MTU

11.43

.39

29.5%

5.3%

IIN

11.36

.80

16.1%

4.2%

SGT

9.42

.37

15.5%

5.3%

AMM

15.97

.91

12.2%

3.3%

 

The P/E for the Telecommunication Services Sector is 12.07 with a P/EG of .93.  It is interesting to note that despite its lackluster share price performance, MTU shows a respectable dividend of 5.3% and the highest Return on Equity (29.5%) of any stock in the table.  When you look at Telstra’s outstanding dividend yield of 8.3% (and with the knowledge they have the cash to maintain their dividend going forward) and their impressive ROE of 26.8%, it is hard to argue against this stock for less risk tolerant investors.  Their sheer size and expertise puts them in an excellent position to redefine the nature of telecommunications services.  

The full impact of the NBN is years away.  Patient investors should monitor how the current players are adapting to the new world.  

 >> Click here to read other articles from this week’s newsletter

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.