Telstra's New Line

Australians are feeling pretty chuffed with themselves at the moment. And it’s no wonder given 15 years of uninterrupted economic growth, the lowest unemployment rate for decades, and '” despite a minor blemish in some foreign land '” the best cricket team in the world. But when it comes to telecommunications, we’re miles behind. And while that might not be great for Australian consumers, it means there are plenty of case studies for those trying to read the runes for Telstra’s future.
You see Telstra is not the only national carrier to have its cosy monopoly busted wide open by deregulation, or to face competition from fierce and nimble competitors. And it’s not the only phone company to see its traditional source of profitability '” fixed-line phone calls '” rapidly diminish.

OVERSEAS EXPERIENCE
Year ended 31 Dec (30 June following year for Telstra)	2000	2001	2002	2003	2004
Fixed line subscribers (not inc ISDN)
Deutsche Telekom (€)	31.9m	30.1m	28.6m	27.2m	26.2m
France Telecom (€)	29.8	29.5	29.2	28.8	28.5
Telstra ($A)	10.4	10.5	10.4	10.4	10.3
Mobile subscribers (wholly owned subsidiaries)
Deutsche Telekom (€)	29.5m	45.5m	53.9m	61.1m	69.2m
France Telecom (€)	33.1m	43.2m	49.9m	48.6m	54.0m
Telstra ($A)	5.2m	5.9m	6.6m	7.6m	8.2m
Broadband lines
Deutsche Telekom (€)	0.1m	1.4m	2.9m	4.1m	6.1m
France Telecom (€)	0.1m	0.5m	1.4m	2.5m	4.4m
Telstra ($A)	0.1m	0.2m	0.4m	0.8m	1.7m
Net cashflow from operating activities
Deutsche Telekom (€)	10	11.9	12.5	14.3	16.3
France Telecom (€)	6.6bn	7.1bn	11.8bn	11.3bn	12.8bn
Telstra ($A)	6.6bn	7.1bn	7.1bn	7.4bn	8.2bn

It’s all happened before overseas. So we packed our bags, headed into cyberspace and took a look at those that have been there, done that and come home with the T-shirt. In the table, you’ll find some interesting statistics for Deutsche Telekom and France Telecom, but we could just as easily have picked British Telecom or Telecom Italia '” they’ve all had the same experience.

The first three rows of the table show the drop-off in the number of fixed-line customers. For the overseas companies, the past five years have been fairly drastic and, as Telstra itself has pointed out, once the decline starts, it doesn’t stop. Deutsche Telekom has seen its number of fixed-line customers fall by 18% during the past four years.

The obvious question, though, is where have all these people gone? They have not stopped communicating; they’re just doing it by other means. The next section of the table shows the increase in mobile phones and broadband connections, which would appear to be where people have headed.

But, as Telstra has pointed out to Communications Minister Helen Coonan, the new revenues are not as profitable as the old. In Telstra’s case, it needs $1.74 of new revenue to replace $1 of old. That doesn’t sound too good, but let’s take a look at what it really means for Telstra’s profitability.

In the year to 30 June 2005, fixed-line revenue represented 34% of Telstra’s total revenue. We’ll make the drastic assumption that it loses 30% of that revenue over the next five years. It would only need to increase its other revenues '” from broadband, mobiles and other services '” by 24% to maintain its profitability. And that would need an annual growth rate of just 5%, which is not only possible, but highly likely.

The overseas experience bears this out. Despite falls in fixed-line customers of 18% and 4% respectively, both Deutsche Telekom and France Telecom are producing significantly more cash than they were five years ago.

These two companies have faced all the same challenges as Telstra: significant government ownership, tight regulation, poor reputations for customer service, competition and ageing infrastructure, to name a few. But they continue to dominate their respective industries and generate vast quantities of cash.

Rest assured that Telstra is not about to disappear from under your nose. The share price has risen 4% in the past fortnight and is now trading on an extremely undemanding forecast price/earnings multiple of 13. We’re upgrading to long-term buy.