T3: The big call

The Telstra prospectus covers 65 pages and I think most people understand the high income and the fact that subscriptions have to be in by next Thursday. I expect there’ll be a very heavy demand. The prospectus is a strange mixture of facts and warning. So today I want to turn to four pages that will help you get the nub of what a long-term investment in Telstra is all about.

First turn to page 29. Halfway down the second column, where directors are describing their strategic objectives, in an amazing 11 words you will see that Telstra aims at an EBITDA margin of 46–48% by 2010. EBITDA means earnings before interest, tax and depreciation and amortisation '” it’s the gross profit margin. Normally you can’t get such high margins unless you offer something different to your competitors. Currently Telstra margins are about 42% but they’re boosted by fixed line phones, which are winding down.

If Telstra is going to achieve high margins by 2010 then its total transformation has to succeed. The new coordination of systems must deliver. Yellow Pages printed online has to be a bonanza and the 3G phone system and the media content have to be enormous winners. To achieve high margins, the new Telstra management has picked out non-regulated areas to invest its cash flow. If the regulator cuts up rough and, say, gives Telstra competitors access to the 3G phone system at low prices, or Google and other competitors hit Yellow Pages, then Telstra shares will be in trouble.

To see what that means, turn to page 40.Two-thirds of the way down, last year Telstra earned 25.7¢ a share and paid out 34¢ in dividend '” the second year in a row it has not covered its dividend. Despite its high cash flow, you can’t keep that up. This year it’s promising 28¢ but if Telstra does not achieve those high margins, the dividend must come down.

Now turn to page 28. At the top of the first column and you will see that a transformation of this size, speed and complexity has not been attempted by any other telecommunications company in the world. New chief executive Sol Trujillo has brought in his amigos to transform the company to reduce the reliance on fixed line phones. They’ve never done anything of this magnitude before. If they pull it off, Telstra will be a very powerful company and the investment in T3 in will be a very good one. If they fail, the share price will fall.

On the top of page 43, the company explains that it has not invested in the so-called fibre to the node network because the regulator demanded that it sell that to its competitors at low prices. Australia will fall behind the world if it does not install a fibre to the node network and such a network will also make the Telstra transformation zing. The greatest risk to Telstra is that the Government will keep punishing it to force it to give in. Appointing Geoffrey Cousins as a director was part of that punishment. There could be a lot more punishment to come.

The biggest risk facing Telstra is that those margins will not be achieved because of the war with the Government and those who are taking up the shares are punting that Australia can’t succeed without a strong Telstra and that eventually the Government will give in. Those who reject the offer believe that fighting the Government while undertaking a complete transformation is just too risky.