The Australian senate passed the Telecommunication Legislation Amendment (Competition and Consumer Safeguards) Bill 2010 with a vote of 30-28, paving the way for the rollout of the national broadband network (NBN).  In the amendment, Telstra will be required to separate from its wholesale arm, thereby relinquishing its monopoly on the copper network, which is currently used for fixed telephone lines and ADSL internet services, and in return the government will give Telstra $11 billion. So after that, Telstra will become a retailer like every other communications company in Australia. What does the future hold for Telstra now? To begin to answer that question we must first, dive into the past to see where Telstra came from.

Back in 1992, the Australian Telecommunications Corporation (known as Telecom Australia) merged with the Overseas Telecommunications Commission to form the Australian and Overseas Telecommunications Corporation (trading as Telecom Australia). The name was later changed from Telecom Australia to Telstra in 1995.

The first suggestion of privatising Telstra/Telecom Australia originated from Paul Keating while he was still the Federal Treasurer in the Hawke Labor government.  However, as Hawke was against the idea, the initiative was killed off. After Keating challenged Hawke for the Labor leadership, he tried to reintroduce the initiative but ran out of time when he lost the “unlosable” election of 1996 to John Howard. It was then up to John Howard to privatise Telstra which he did in three steps, in 1997, 1999 and 2006.

Yet even after Telstra was privatised, it kept its monopolistic position in the telecommunications sector of Australia. Telstra owned more than 90% of all telecommunications infrastructure in Australia, as well as operated as a retailer. Every other provider who entered the market had to go through Telstra and since Telstra was competing against them as a retailer as well, a conflict of interest was created sparking several ACCC stoushes.

Now, in order for Telstra to participate in the National Broadband Network, it must relinquish control of the copper wire network as well as the cable broadband network to the government in return for $11 billion. Telstra does get to keep its 50% stake in Foxtel, delivering pay television services over the cable network as well as satellite. Under the current proposals for the NBN, which can of course be amended or scrapped altogether (the CBD metro is a perfect example highlighting how nothing should be considered a given until its finished when it comes to governments building infrastructure), the NBN Co (which is the government owned entity that will take over Telstra’s copper network and cable broadband infrastructure) will replace Telstra’s ancient 60 year old copper network with fibre optics capable of reaching 93% of the Australian population.

This is a positive initiative to both Telstra and the Australian public. If the copper network remains in the hands of Telstra, there is no incentive for them to innovate or improve the network as it is not their core business and partially because Telstra knows that it will never run out of customers since there are areas where the only option is Telstra. With the NBN Co owning the network, it will be different, because the network does become NBN Co’s core business, so the NBN will be encouraged to improve and innovate. Furthermore, the NBN is a quantum (though I really should say ‘giant’ since quantum technically means the smallest amount of any physical entity) leap forward in speed and technological possibilities. The NBN will open a wealth of opportunities for both Telstra and Australia. It will give Telstra a way out of an ancient and very obsolete piece of infrastructure, and be able to have the ability to innovate and create long term value for its shareholders. Telstra’s income from fixed line services which include, PSTN (local phone line), ADSL and cable internet have been steadily declining since 2008 as shown in the table below[1]. The table below shows the amount revenue generated from each connection type. Mobile includes all mobile voice, video and internet services as well as any income from the sale of handsets. ‘IP and data access’ refers to revenue from wholesale operations.

The most notable decline has been in fixed line services in particular, suffering declines of 4.9% and 8% in 2009 and 2010 respectively. This is understandable and logical as price of mobiles and calls from mobiles continue to decline. Telstra’s CEO acknowledged this as far back as 2005, telling investors that: “In terms of the current revenue outlook, the PSTN voice decline will continue to put pressure on the company’s top line and margins. Total PSTN voice revenue is expected to fall again this year at an accelerated rate.”

Consumers will naturally start swapping their fixed landlines to mobiles, especially with the introduction of Vodafone’s infinite mobile plans, where you can get infinite local and mobile video and voice calls, SMS and MMS, excluding 13/1300/1800 numbers all for only $45 a month, with 1GB of internet data. The estimated number of households which have ditched the landline altogether and are solely reliant on mobile service is approximately 12% and that number is set to rise. This is reflected in the line graph below, as revenue for Telstra from mobiles jumped from 2004 as fixed line revenue declined from 2008. All dollar values in the graph below are in $m.

Telstra has the largest and fastest mobile network in Australia, so it is in the best position to capitalise on the shift from landlines to mobiles. Telstra is not the cheapest provider, but Vodafone and Optus clearly demonstrates that the cheapest is not always the best. For example, Vodafone’s network has been plagued by dropped calls, reception problems and slow 3G data due to the number of people on their network and a software glitch preventing them from upgrading their infrastructure.

Due to the length of the separation process combined with unexpected election outcome of a minority government, there is a lot of uncertainty surrounding Telstra, and accordingly its share price is at a significant discount. The process to get the separation approved will take at least 6 months, as it has to be approved by Telstra’s shareholders as well, and getting the NBN up and running would take even longer. There are a lot of things that can occur in the meantime – the NBN initiative may even be scrapped if Labor loses the next Federal election to the Coalition. However, I strongly believe that even if the NBN is scrapped and Telstra is forced to separate, the intrinsic value of Telstra is more than its current share price. Telstra has Australia’s largest and fastest mobile network, it dominates a market which is set to grow as people increasingly ditch their phone lines in favour of mobiles. Telstra will still be able to provide services that require the copper network; it just have to get it though NBN Co like everyone else.

Telstra’s earning per share (EPS) was 31.4[2] cents for fiscal 2009, a 0.46% decrease from fiscal 2008’s 32.9. Taking the price at the close of the last trading day, which was $2.74[3] on Friday 10^th Dec 2010, Telstra has a price to earnings (P/E) ratio of 8.73(2dp), while Telstra’s biggest competitor, Optus, which is owned by Singapore telecommunications Limited (SGT). SGT had an EPS of 19 cents, so taking SGT’s closing price on Friday 10^th Dec 2010 of $2.43, the P/E ratio is 12.79(2 dp). A high P/E can indicate an overpriced stock, but can also reflect that the market is optimistic about the company’s future prospects, and conversely a relatively low P/E ratio can indicate that the market is pessimistic about the company or it can mean that the company is being overlooked by investors and is “a diamond in the rough”. Furthermore, Telstra’s dividend yield is 0.28/2.73 = 10.22% (2dp) which is significantly higher than SGT which is 11.4165/2.43 = 4.70% (2dp). So at least for now, Telstra is a good buy just by the dividend yield alone, this of course will change as more information is released.

Telstra’s future is definitely cloudy and uncertain and relies on many various variables, however, with the information currently available; Telstra is definitely a buy at $2.74. Telstra will not collapse without its copper network monopoly, and has already begun to transform its operations in anticipation of this. Telstra has also radically changed its mobile internet plans to become more competitive and combined with its far superior coverage, this will continue to increase Telstra’s market share in the Australian mobile market. I strongly believe that the market has over-compensated for the uncertainty, and the share price should definitely higher than its current levels. Telstra’s future is not as gloom as its share price suggests.

Disclaimer (as at 10th December 2010): I am currently employed by Telstra as a tech expert and I currently hold 6500 TLS shares at an average weighted cost price of $2.67(2dp). As of Friday, 10^th December 2010, TLS represents 9.36% (2dp) of my entire portfolio.

[2] Obtained from Page 14 of Telstra’s 2010 Full financial statement which can is located here:

http://www.telstra.com.au/abouttelstra/download/document/tls734-telstra-financial-results-for-the-year-ended-30-june-2010.pdf

[3] All prices obtained from asx.com.au