Telstra's turnaround is Thodey's calling card

Telstra's strong growth in earnings and its increased dividend to shareholders highlight its balanced strategy of investing in new growth vehicles while improving shareholder returns.

David Thodey and his board have sent a carefully-constructed series of messages to their shareholders this week, which provide a preview of Telstra’s medium-term future.

The week started with the announcement that Telstra had paid $US270 million to increase its stake in a US video streaming and analytics company, Ooyala, to 98 per cent.

The overall $US350m investment is the first investment by the newly-formed Global Applications and Platforms group, which is charged with establishing global growth vehicles in markets adjacent to Telstra’s core. With that deal, Telstra took its investment in new 'e-businesses' last year to more than $500m.

It is an illustration of Thodey’s ambition of developing software and applications-based new businesses that will enable Telstra to evolve into a global technology company rather than a domestic telecommunications business.

Today, however, Thodey laid out the other two planks of Telstra’s financial strategies.

The one that will please shareholders the most is the increase in dividends and the $1 billion off-market buyback. Together they will return $4.7bn to shareholders.

That signals that while Telstra plans to pursue a strategy that balances its need to invest in new businesses to generate growth in a post-national broadband network, it is also mindful of shareholders’ aspirations for improved returns.

The other is that Telstra is continuing to invest heavily in its leading mobile business. It invested $1.1bn last financial year, expects to spend another $1bn this year and also has $1.3bn committed to spectrum purchases in September.

In a nutshell, Thodey is pursuing a capital allocation strategy that balances the need to develop new growth vehicles with maintaining its dominance of mobiles in the domestic market while also sharing the benefits of its improving financial condition -- and the growing streams of cash from its NBN deals -- with shareholders.

Telstra is able to satisfy those three objectives because it is generating strong growth in cash flows and earnings. Profit was up 14.6 per cent and free cash flow, thanks to the sales of the CSL mobile business in Hong Kong and most of Sensis, rose almost 50 per cent to $7.5bn. Excluding those sales, Telstra still had $5.1bn of free cash flow.

While, without CSL, Telstra’s outlook for the 2015 financial year is for low single-digit income growth and for earnings before interest, tax, depreciation and amortisation to also be flat, it still expects to generate free cash flow of between $4.6bn and $5.1bn. Capital expenditures will be around the same level of recent years -- about $3.7bn.

While Telstra continues to renegotiate the terms of its agreements with the federal government and NBN Co to reflect the change in the NBN roll-out from a fibre-to-the-premises network to a multi-technology roll-out, there was a glimpse of the future, with income from the existing arrangements rising from $399m last year to a quite material $640m.

Another insight into the evolving nature of Telstra’s revenues and earnings came with the 27.8 per cent increase in the income of its network applications and services business, on which Thodey is placing increasing emphasis and for which he has significant regional ambitions.

The result was helped by less of a drag from Telstra’s past. Its fixed line business -- its highest margin business -- has been in continued decline. However, last year Telstra was able to slow the rate of revenue decline to only 0.8 per cent, with growth in data revenues almost matching the rate of decline in voice services.

Its sector-leading mobiles business grew revenue 5.1 per cent and improved its EBITDA margin by 2 percentage points, to 40 per cent, while growing its customer base by 6.2 per cent to 16 million.

Telstra also achieved very strong cost control, with expenses rising a modest 4 per cent, well below the rate of growth in income. Thodey said there is still scope for improved efficiencies.

Telstra's cash flows and balance sheet are strong enough to support a continuation of a balanced strategy of acquisitions, distributions to shareholders and investment in the existing business.

Its target gearing range is between 50 per cent and 70 per cent. Its actual gearing is 43 per cent after reducing net debt by 20 per cent, to $10.5bn. It is also highly liquid, with $5.5bn of cash.

Thodey made it clear that Telstra has the financial capacity to make a major acquisition if it wants to.

Even contemplating that possibility is an indication of how far Telstra has come over the past five years. It's also an indication of how good a job Thodey and his team have done in improving the quality of its performance, in preparing it for a future without its fixed line near-monopoly and in creating the opportunity and capacity to build or buy new growth businesses to replace that lost income and earnings.

Related Articles