SEVERAL telco stocks have reached their highest values in years as regulation settles down and companies position themselves for the national broadband network (NBN) world.
Dominant player Telstra has enjoyed steady rises in its share price since management finalised its billion-dollar deal with NBN Co and outlined plans for a cautious but confident acquisition program.
Telstra shares closed yesterday at $3.61, continuing an 18-month recovery from historical lows of $2.56 reached in late 2010.
Chief executive David Thodey confirmed recently that Telstra would pay a fully franked 28?-a-share dividend for this and next financial year, but was unable to say what the rate would be after that. At current trading prices, the dividend gives Telstra shares a yield of 8.33 per cent.
"Telstra considers a majority of shareholders prefer capital return in the form of fully franked dividends," Royal Bank of Scotland analyst Ian Martin wrote in a recent note to clients. "A build-up in franking-credit balance over the next three years may fund an additional 4?-per-share dividend in 2013-14, which would draw $500 million from excess free cash flow.
"What would Telstra do with the remaining $2.5 billion in excess free cash flow? A buyback would still seem to be a viable option given it reduces the share base and amplifies earnings-per-share gains as NBN payments ramp up."
Mr Martin expects Telstra to deliver pre-tax earnings of $10.5 billion this financial year, a 3.2 per cent increase on 2010-11.
Investors who have been holding Telstra shares continuously since it floated in 1997 have now received $3.71 in dividends per share 41? more than the $3.30 sale price.
Those who bought shares during the T2 sale in 1999 at $7.40, which coincided with the dotcom boom, have received $3.40 in dividends. They will have to hold on to their shares for another 14 years to break even, unless dividends are increased in coming years. And those who bought shares at $3.60 in the final government sale in 2006 have received $1.54 per share. For T3 owners it will be just a seven-year wait to break even.
Outside the top 200 sit Macquarie Telecom, iiNet and M2 Communications.
iiNet has a market capitalisation of $512 million and recently paid a 6? interim dividend on shares that this week closed at a multi-year high of $3.18. iiNet has recently resolved a long-running copyright court case, from which it expects to recoup about $6 million of its $9 million legal fees, and will benefit from regulatory decisions on Telstra's wholesale pricing.
In the past two years, iiNet has snapped up AAPT's retail customers, TransACT, and Internode. This gave it a 16 per cent market share in DSL broadband.
TPG is about three times the size of iiNet and recently reported net profit of $55.7 million for the six months to January 31, up 65 per cent on the previous corresponding period. It raised its interim dividend by 22 per cent to 2.75? a share. It has been trading at two-year highs of $1.90 since its half-year results and better than expected sales to corporate customers.
Small-business specialist M2 surprised the market recently with news it would buy retailer iPrimus, a quiet performer previously owned by North American parents. M2 hit a closing price of $3.06 this week, following a 40? slide since the start of April. But Canaccord BGF analyst Warren Jeffries has a bullish $5.10 target for the stock following its "strategic and highly complementary" acquisition of iPrimus.
"The iPrimus business will provide a quantum leap in earnings for the group, while also resulting in MTU [M2] establishing itself as the fifth-largest telecommunications company in Australia with the combining of the seventh (MTU) and eighth-largest businesses," he said in a recent note to clients.
More consolidation is likely in coming years as the NBN changes the industry landscape and telcos scramble to build scale and lock in customers. Other changes will come about because the NBN gives telcos access to customers they have never been able to serve before. For example, Vodafone plans to start selling services on the fibre-optic network and iiNet has recently started selling satellite broadband services for the first time.
Historically Telstra was the only telco able to access all households, although it does sell wholesale services to other carriers. Nationwide there are 10.6 million services in operation on the copper network, but only about 1.6 million are connected to competitors' equipment, according to the competition watchdog's latest report on competition in the telco industry. And the NBN provides an indirect industry subsidy with the government paying for infrastructure that all telcos will use to sell services.
Frequently Asked Questions about this Article…
Why has Telstra’s share price been rising and what does that mean for investors?
Telstra’s shares have climbed as regulatory uncertainty eased and management finalised a billion-dollar deal with NBN Co while outlining a cautious acquisition program. The stock closed at $3.61 after an 18-month recovery from a low of $2.56 in late 2010, and stronger cash flows tied to NBN payments have supported investor sentiment.
What dividend is Telstra paying and how attractive is its dividend yield?
Telstra confirmed it would pay a fully franked dividend of 28 cents a share for this and next financial year. At the then-current share price in the article, that dividend implied a yield of about 8.33%, which is a strong yield for income-focused investors.
Could Telstra use excess cash for buybacks instead of dividends?
Analysts in the article suggested Telstra has excess free cash flow and could pursue buybacks as well as dividends. A buyback would reduce the share base and boost earnings per share as NBN-related payments increase, making it a viable option alongside dividend returns.
How is the NBN likely to change competition among Australian telcos?
The NBN is expected to reshape the industry by giving all telcos access to new customers and shared infrastructure. That access lowers barriers for smaller players, encourages consolidation as companies scale to compete, and enables new services (for example, Vodafone planning to sell on the fibre network and iiNet offering satellite broadband).
What’s happening with iiNet and how could that affect its stock?
iiNet hit a multi-year high of $3.18 and has grown its DSL market share to about 16% through acquisitions (AAPT’s retail customers, TransACT and Internode). It also resolved a long-running copyright case and expects to recoup about $6 million of roughly $9 million in legal fees, which supports its financial position.
How have TPG and other smaller telcos been performing?
TPG, about three times the size of iiNet, reported a net profit of $55.7 million for the six months to January 31—up 65% year-on-year—and lifted its interim dividend by 22% while trading near two-year highs. Smaller specialists like Macquarie Telecom and M2 are also active, with M2 making a strategic acquisition of iPrimus.
What should investors know about M2’s acquisition of iPrimus?
M2 surprised the market by announcing it would buy retailer iPrimus. The deal is expected to be highly complementary and to significantly boost M2’s earnings and scale — an analyst noted the combined group would become the fifth-largest telecommunications company in Australia. The stock closed at $3.06 after some recent volatility.
How dominant was the legacy copper network and what does that imply for competition?
The article notes there are 10.6 million services on the copper network nationwide, but only about 1.6 million are connected to competitors’ equipment. Historically Telstra had the broadest access, but the NBN changes that dynamic by providing shared infrastructure funded by the government, effectively subsidising industry access and increasing competition opportunities for other telcos.
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