Dialling back on Sensis is a good call for Telstra

Five years ago, had someone suggested Telstra sell its Sensis directories business for a price that implied a value of about $1 billion for the assets being sold and retained, they would have been laughed at.

The sale of a 70 per cent stake in Sensis to US private equity firm Platinum Equity for $454 million has produced roughly that outcome. It provides a quite vivid illustration of how rapidly and dramatically digitisation has overwhelmed the traditional directories sector.

Even back in 2005, it was evident that directories businesses, while still generating torrents of cash and attracting huge interest from private equity buyers, were under severe threat from the likes of Google and the accelerating growth of online search engines. Telcos were exiting the sector around the world, with private equity buyers paying big prices for the perceived cash cows.

Sensis, however, had defied gravity, growing revenue consistently at mid-single digit rates and earnings in the mid-teens while producing earnings before interest, tax, depreciation and amortisation margins of more than 50 per cent.

It was in 2004, as Telstra headed towards the final phase of its privatisation that was launched in 2006, that Bob Mansfield was dumped as Telstra chairman and Ziggy Switkowski was fatally undermined as chief executive for pursuing a plan to merge Sensis with Fairfax. With hindsight, the plan might have changed the history of both groups.

At that time and, indeed, for a couple of more years, Sensis’ value in a sale or spin-off (options seriously and consistently looked at by its board from the mid-2000s) was seen as close to $10 billion – if not more.

With a history in running a successful directories business, Sol Trujillo was one who seriously considered the sale option. However, he was convinced the business could provide a highly strategic and valuable digital media growth platform for a group whose core fixed-line business was in steady and inevitable decline.

As Telstra’s only substantial non-telco business – it was still growing and throwing off lots of cash – Telstra couldn’t bring itself to exit the business. It also had a Plan B up its sleeve, if and when the impact of online really hit.

It wasn’t until 2011 – well after the financial crisis had savaged the capacity and willingness of private equity to pay big prices for directories businesses –  that Sensis’ revenues and earnings abruptly imploded.

Revenue suddenly began falling at double-digit rates and EBITDA at more than 20 per cent per annum. Plan B was immediately activated.

The concept was to leverage Sensis’ major asset, its massive SME customer base, to transform the business from selling advertisements to small and medium-sized enterprises to providing customer leads and online support for those businesses.

It was recognised from the outset that the strategy would produce lower-margin revenue, although Sensis under-estimated the costs and difficulty of a transition which it knew would take some years before the group’s revenue and earnings base could be stabilised.

Even though it is now the largest digital marketing services and online directories business in the country and digital revenues have been rising at double-digit growth rates, Sensis’ EBITDA is still falling at a rate of about 20 per cent a year.

In 2005, Sensis had EBITDA of more than $1 billion. Last year EBITDA was $571 million and Telstra chief financial officer Andy Penn said today he expected EBITDA to be 20 per cent lower again in the 2014 financial year, which implies EBITDA of just over $450 million.

It is easy to conclude with hindsight that Telstra should have sold the business when the market for directories was bubble-like in the pre-financial crisis period. But the performance of Sensis – arguably the most successful business of its type in the world until it hit the wall in 2011 – and its role within the overall Telstra portfolio made a sale a much more difficult decision than it might appear today.

Although Telstra announced the sale of 70 per cent of Sensis to Platinum Equity for $454 million today – which values 100 per cent of the group at only $649 million – it isn’t actually selling 70 per cent of the entire business. Telstra will retain Sensis’ voice services and will supply a range of services to Sensis on an arm’s-length basis.

Platinum Equity, Telstra says, is paying about 2.4 times the EBITDA of the ‘new’ Sensis.  As noted earlier, Andy Penn’s commentary suggests Sensis’ EBITDA in 2013-14 will be around $450 million.

The EBITDA multiple in today’s transaction implies that the assets Telstra will retain and the income it will generate from supplying services to Sensis will generate EBITDA of more than $180 million. If the transaction multiple was applied to those earnings, the total valuation of Sensis as it is today would be around $1 billion.

Apart from releasing a big lump of cash from the sale and continuing David Thodey’s program of simplifying his portfolio and shedding non-core assets, Thodey believes operating Sensis as a stand-alone business under Platinum Equity’s control will bring a focus and agility that wasn’t attainable while the business remained within Telstra.

Telstra will retain an exposure to Sensis’ upside, if any, with the directories business still likely to experience continuing shrinkage.

The Sensis deal follows December’s sale of Telstra CSL mobiles business in Hong Kong, which will release $2 billion and generate a $600 million profit. The Sensis sale will generate another $454 million of cash, although there will be an accounting loss of about $150 million.

Thodey is rapidly building up a cash store that could be used either for acquisitions to accelerate Telstra’s shift into network applications and services or deployed in capital management initiatives.

As important as the war chest he is building, however, is the continuing simplification and increasing strategic focus within the group as Thodey prepares and reorients it for a post-national broadband network future.