Optus dials up the right numbers

Despite a fall in revenue, the telco's rising EBIDTA and free cash flow indicate Kevin Russell's decision to focus on existing customers rather than scale is working well.

It may not look like it at first glance but despite the fall in both fourth quarter and full-year earnings it would appear Optus is tracking nicely along the strategic path Kevin Russell has set for it.

Russell, chief executive, consumer and chief country officer for the SingTel/Optus group in Australia, is pursuing a less than conventional strategy for the business. Eschewing growth for growth's sake, he has been prepared to let Telstra absorb the significant growth in available customers over the past year, has cut his handset subsidies and has focused on reducing costs and improving his customers’ experience and service levels.

Optus experienced a 7.5 per cent fall in earnings for the year to March (down 6.9 per cent in the March quarter) on revenue that was 4.6 per cent lower (5.4 per cent lower for the quarter).

In the core mobile business, and within quite a tough environment for the two smaller wireless carriers, Optus experienced a 5.9 per cent decline in mobile revenue for the year to March and earnings before interest, tax, depreciation and amortisation for the business virtually flatlined, with growth of 0.3 per cent.

Russell, however, wouldn’t have been displeased with the result because there were some encouraging signs that his strategy was gaining traction towards the end of the year.

If the March quarter is compared to the December quarter that immediately preceded it there may still have been a 4.8 per cent fall in revenue but EBITDA rose 21.5 per cent, the EBITDA margin in the mobile business rose from 26 per cent to 34 per cent and underlying earnings were 42 per cent higher. Free cash flow soared from $191.1 million to $549 million.

The Optus strategy that Russell embarked on last year is to create a more sustainable and profitable business by making its existing customer base more profitable rather than by aggressively chasing scale. It’s why it has reduced its handset subsidies and has focused on customer outgoing service revenues.

It’s also why Optus is restructuring its retail network to quit third party channels and focus on its own branded outlets in order to get better control of its customer service. In time, that ought to be reflected in lower churn rates (there was some improvement in the March quarter) and better margins.

At the same time there has been a significant investment in the Optus network to improve its coverage and quality and narrow the network quality advantage Telstra has enjoyed. Optus is rolling out its own 4G network and recently participated in the "digital dividend" spectrum auction, spending $649 million to strengthen its 4G coverage.

So the focus is not on growth per se, or on market share, but on profitable growth from its existing base of customers.

The other dimension to the strategy is an attack on the group’s cost base. Operating expenses were down 6.4 per cent for the year and 8.8 per cent for the March quarter. Between the December quarter last year to the March quarter this year costs were down 13.4 per cent. Optus has nearly 1000 fewer employees today than it had a year ago and staff costs that are 15 per cent lower.

Its cost of sales is also dropping because of its lower handset subsidies, which Goldman Sachs recently said were at their lowest levels for three years.

Telstra has also been reducing its subsidies as the carriers shift away from sub-economic pricing towards competition based on data allowances in an environment where they are all substantially expanding the capacity of their networks at significant cost – Optus has invested more than $2 billion in its businesses in the past two years – and will need to lift their profitability to generate reasonable returns on their capital.

Vodafone, which suffered a massive leakage of customers because of network degradation, is investing $2 billion to upgrade the network and its service quality and is now actively marketing it to try to win customers back, which could again alter the competitive dynamics if it can deliver good customer experiences. Its handset subsidies are more aggressively priced than its major competitors.

It would appear, however, that Russell is less concerned about what his competitors do than he is in creating a business with stronger fundamentals and a stickier customer base. The composition of his numbers in the latest quarter suggests that he is making significant progress.