Telstra buys time instead of shares

David Thodey's decision to skip a share buyback or dividend increase will give him more room to produce a bigger payday for shareholders further down the track.

The market was expecting Telstra to foreshadow a share buyback at today’s investor briefing. However, despite Telstra confirming that it will have excess cash as a consequence of its $11 billion national broadband dealings, it doesn’t appear one is imminent.

At the briefing David Thodey and his new chief financial officer, Andrew Penn, confirmed that Telstra would have excess cash of $500 million to $1 billion this financial year and would add another $1 billion in each of the next two financial years.

They made the implicit case, however, as to why neither a buyback nor an increase in Telstra’s 28 cents a share dividend made sense in the near term, albeit without explicitly ruling anything out.

Essentially, the size of a buyback Telstra could do today simply wouldn’t be large enough to make a material difference to its performance statistics and share price, while it doesn’t have the franking credits to pursue its preferred way of distributing cash to shareholders – an increase in its dividend. The company did, however, signal that by 2014 it would have the required franking capacity, which will generate some expectations.

The objective of the briefing wasn’t to signal anything related to capital management was imminent, but rather to provide the market with a very clear and detailed framework to understand how Telstra will think about its balance sheet and its deployment of excess cash going forward.

The framework will itself impose disciplines on Telstra as it considers buybacks, dividend policy and acquisitions in future – the market will test its decisions against the framework.

Whether or not Telstra does have $2 billion or $3 billion of excess cash by 2014, of course, depends on whether it does actually generate those excess cash flows and whether or not it spends them.

The NBN rollout is already well behind schedule, which could affect the timing of cash flows from NBN Co to Telstra, and there is the prospect of a change of broadband policy after the next election.

Thodey, however, made it clear that the $11 billion of net present value Telstra is contracted to receive from the current deal would be the starting point for any new negotiations and also confirmed that the Coalition’s preferred network, a fibre-to-the-node network rather than the current fibre-to-the-premises network, might actually accelerate the cash flows Telstra receives because the rollout would be quicker.

The implosion in Sensis’ revenues and earnings might also affect the amount of excess cash Telstra ends up with.

The other question mark over any capital management in the near to medium term is Thodey’s ambition of growing new businesses and profit streams as Telstra migrates from its proprietary high-margin copper network on to the NBN.

It does see potential to develop its network applications business and cloud services capabilities but Thodey also referred to Telstra’s media assets and the newly-enlarged Foxtel business in particular.

Within Telstra’s framework for thinking about capital management is the potential for strategic acquisitions, which it says would only be made if they were more value-accretive than a share buyback of similar magnitude.

Thodey was candid in saying that if James Packer were to put his Consolidated Media up for sale, as has been speculated, Telstra would be interested in buying it. Consolidated Media owns 25 per cent of Foxtel and has a half share, alongside News Corp, of the lucrative Fox Sports joint venture.

He acknowledged, however, that there would be significant regulatory obstacles to a Telstra purchase of Consolidated Media and inevitably very significant undertakings would have to be made to gain Australian Competition and Consumer Commission clearance of any deal.

Thodey was also keen to talk up the positives that he sees flowing from the NBN, which he believes will enable the group to enhance its broadband and mobiles offerings and increase the value of its customers, while simplifying its processes. Telstra's ability to bundle a range of products and services, and its scale, ought to give it a material advantage in an NBN environment.

A sidelight of the briefing – but one that provides an interesting insight into Telstra’s perspective on the deal it struck with NBN Co and the government – was Thodey’s recollection of a strategy paper written by former chief executive in 1995.

In it, Blount predicted the voice revenues from the copper network would be zero by 2010, which Thodey used to illustrate the fact that Telstra had long known that the copper network revenue base was in an inexorable decline.

‘’What’s different with the NBN is that Telstra is going to be paid to decommission its copper and HFC networks,’’ he said.

He also said that the NBN would enable Telstra to realise its vision of a new network architecture that would provide a rich customer experience faster than it had anticipated (without re-stating the point that the new platform for Telstra services would be funded with other peoples’ money).