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Telstra: From Voice-over-Phones to Data-over-Devices

By David Dittman on October 18, 2012

Catherine Livingstone, chairman of AE Portfolio Conservative Holding Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY), said this week at the company’s annual general meeting that it hopes to return to dividend growth in 2014 and to stick to regular increases every six months beginning in that fiscal year.

The dividend for fiscal 2013 will remain a fully franked AUD0.28 per share “subject to the normal approval process, and there being no unexpected material events.” Telstra is sticking with two-year dividend guidance initially issued during its October 2011 annual general meeting.

This timeline was established with Telstra’s “capital management framework” in mind as it made its way through final negotiations over its participation in and contribution to Australia’s National Broadband Network (NBN).

Long-term capital management goals remain in place: to maximize returns to shareholders; to maintain financial strength; and to retain financial flexibility. The short-term concern of NBN negotiations no longer operative and its “over-arching” framework now well established, Telstra in fiscal 2014 will return to its normal practice of “considering dividend on a half yearly basis.”

Telstra has been a significant winner since it debuted with the other seven of our “Eight Income Wonders from Down Under” as the components of our initial Portfolio in the inaugural issue of Australian Edge on Sept. 26, 2011. Through the close of trading in Sydney on Oct. 17, 2012, the stock had generated a total return in US dollar terms of 52.67 percent.

The S&P/Australian Securities Exchange 200 Index is up 31.27 percent during this timeframe and on US dollar terms. The S&P 500 Index, meanwhile, has returned 28.64 percent, the MSCI World Index 24.48 percent.

From the end of the first quarter of 2012, when concerns about Europe and slowing global growth reemerged, the stock is up 22.19 percent in price-only terms. The S&P/ASX 200 is up 4.45 percent in local, price-only terms, the S&P 500 3.72 percent, the MSCI 2.11 percent.

Much of Telstra’s outperformance is based on the reliability of its operations performance and the ample cash flows they generate in a tense time for investors. Telstra is able to consistently reinvest in its all-important wireless network and to sustain one of the most generous payouts in the global telecom space.

Investors did sell the stock hard in mid-August, when the company announced fiscal 2012 results and reiterated its plan to emphasize network reinvestment and financial strength and flexibility over a share buyback, a raised dividend or a special payout. The stock slid from a three and half year closing high of AUD4.07 on Aug. 6 to AUD3.70 two weeks later.

Telstra is trading around AUD4 as of this writing, with a dividend yield of 7 percent. The share-price rally this year has been driven by the flight to its quality as well as the finalization of its NBN arrangements and continuing recognition of its ability to invest in its network.

But Telstra hasn’t raised its dividend since February 2005, and it hasn’t declared a special dividend since November 2005. We boosted our buy target in mid-2012 on the NBN deal. But we’ve held firm since, as our primary criteria for higher valuation is dividend growth over time.

That’s not to say Telstra isn’t building a more valuable business. Quite the contrary, in fact, as last month the company announced a plan to spend AUD1.2 billion to expand its 4G network so it covers 66 percent of the Australian population by mid-2013, up from 40 percent coverage at the time of the announcement.

This level of investment separates Telstra from would-be competitors in its home market. Mobile network traffic is doubling every year, as smartphone connections to wireless broadband networks proliferate. Connectivity is driving telecom growth, and Telstra is better positioned than its competitors to capitalize because of the way it’s managed its cash flows.

Demand for data is growing exponentially, as traditional voice and messaging services are joined by new demand for video, social networking and real-time mapping capabilities. Business users want access to enterprise via secure networks that Telstra also provides.

Turning customer demand for mobility into long-term shareholder returns is Telstra’s top priority. But network applications, web browsing and “the cloud” are the drivers of growth in this new era, as opposed to phone calls.

Telstra rolled out its 3G network in 2006; it covers 99 percent of Australia’s population. The upgrade to 4G will expand the capabilities of what’s already the largest mobile broadband network Down Under, with faster speeds in more places. Telstra reported 8.5 percent growth in mobile revenue in fiscal 2012 to AUD8.7 billion.

Telstra’s fixed-line network is also adjusting to this new telecom world, as demand for video has pushed annual traffic growth to 50 percent. During the 2012 Australian Football League season Telstra provided 1.7 million mobile video streams but nearly 15 million fixed-network streams.

The company has sold more than 400,000 of its proprietary T-Boxes, a personal video recorder/high-definition TV tuner with Internet access that’s enabled the download for viewing of more than 5 million movies through the BigPond on demand service.

A third key trend in telecommunications is the use of network applications and services, which is widely referred to as “cloud computing.” Cloud-based services and storage are growing in parallel with data usage. Telstra’s goal is to deliver data to any device, anywhere on its network, anytime its customers want it.

Telstra conceives of its network as its platform for innovation. The “smarter” its network, the more likely the apps it hosts will help end-users satisfy their entertainment or business needs. During fiscal 2012 revenue for Telstra’s Network Applications and Services unit grew by 10.5 percent to AUD1.3 billion.

The cloud was Telstra’s fastest-growing revenue segment in fiscal 2012. The company continues to leverage existing relationships with large Australia-based enterprises and government entities, and part of its Asian expansion is based on “following” Australian businesses as their operations expand into greater Asia.

Telstra has completed a couple relatively small acquisitions in recent months that will allow it to develop applications and solutions in-house for its growing roster of network services clients.

Telstra’s ability to invest in its infrastructure on a scale domestic competitors simply can’t match will help it win business of large enterprises that want a solution that includes hosted networks and applications. And more and more companies–as they attempt to cut costs–will follow this route.

As Australia continues to roll out the NBN Telstra’s considerable suite of media content will also continue to generate solid growth. In this segment Telstra doesn’t care how the customer accesses the network because the customer will be accessing Telstra content. At the same time, its 4G network will make the user experience much better for customers demanding more and more services, accessing networks in more and more ways.

4G is all about speed and reliability, and Telstra is the king in Australia.

One area management continues to focus on is customer service. Part of their efforts–the major part, in fact–is on providing the fastest, most reliable network in Australia. Another part is streamlining the actual customer contact experience so users stick with Telstra and actually become advocates on its behalf.

This is a big leap. But customer attraction and retention is probably the most important factor for a 21st century telecom. Telstra has added 3.3 million customers over the past two fiscal years, in a population of 28 million “sim cards.” (Australia’s actual population is 22 million, but some people have more than one mobile device connected to a network.)

This is impressive growth. Better performance at the customer service level, in management’s view, will also drive better performance at the financial level…and that will translate, eventually, into dividend growth.

Management sees great potential for “cloud” growth in Australia as well as across Asia. Company-wide management expects “growth to continue” in fiscal 2013, with low single-digit income and earnings before interest, taxation and depreciation growth. Management forecast cash flow for the fiscal year of AUD4.75 billion to AUD5.25 billion.

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