Stock in focus – Telstra

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At some point in time, it will dawn on the government of the day that the communications habits of consumers have evolved from curly plastic fixed lines to flashy glass mobile devices.

Telstra realised that truism nearly 10 years ago, when it began building its next generation mobile network.

For all his bluster and bravado, former Telstra chief executive Sol Trujillo did Telstra and its shareholders an immense favour by shaking the company out of its torpor. In October 2006, when the Next G mobile network went live nationwide, Telstra gave itself an advantage in the new era of communications that it will not relinquish.

To be sure, there have been blemishes along the way, with initial pricing of the service too high resulting in lost market share. But under David Thodey’s tenure, the company has galloped back into the lead by embracing the culture of mobility.

Focus on mobile

Various industry reports place the number of households that are mobile-only, i.e. no longer have a fixed line connection, at around 19%. At the same time, Telstra continues to report an inexorable downward trend of fixed line customers. In 2003, the company recorded 10.46 million fixed access lines but has watched this decline by an average rate of 3% every year to an estimated 7.7 million lines over the 10-year period.

Where the customers go, so too does the revenue. Telstra now reports the mobile division as its largest revenue earner.

Australia is already close to saturation point in terms of the number of people using a mobile phone, but it is only just beginning to step up the pace on the services and devices for which mobile applications are ideally suited.

It is something that internet pioneer, Cisco Systems, tracks very closely and each year produces a must-read treatise on the state of global mobile traffic. Every year, Cisco gets its forecasts wrong because the pace of growth is just so rampant forcing the forecasts skyward.

The above chart says that by 2016, global mobile traffic is expected to grow by a compound annual average rate of 78.4%.

Most of the growth is driven by video, followed by data, but it is interesting to see the M2M (machine-to-machine) category only just appearing on the radar by 2015.

M2M refers to systems that communicate with each other such as vehicles capturing information about reaction times, which is sent to control centres and used to build better vehicles.

Eventually (probably sooner than Cisco and everyone thinks) M2M data traffic could swamp all other categories as the range of applications is boundless.

Social growth

One aspect that is difficult to measure is the extent to which the socialisation of the internet is generating traffic growth. Kleiner Perkins Caufield & Byers partner Mary Meeker conducts an annual survey of the internet and she says that the rate at which content is being shared has increased by nine times in the last five years. It is easy to believe this rate will only accelerate as applications like Facebook, Pinterest, Instagram, Tumblr, Snapchat, Twitter, and YouTube proliferate.

The amount of total mobile traffic is also increasing as a percentage of total traffic according to Meeker’s report. At 15% of total traffic currently, mobile will grow at 1.5 times the rate of total traffic, doubling to 30% by 2015.

The next chart shows how a plethora of devices is spawning the growth of mobile data but is mostly driven by human use of phones, laptops and tablets.

It is metrics such as these that have telecommunications carriers like Telstra in a frenzy of anticipation and excitement about the future of mobile communications and the potential earnings to be gleaned for shareholders.

Of course, fixed line broadband can do the same things and certainly much faster using fibre-optic cables, but the convenience of mobility is hard to beat.

In this regard, Telstra is probably secretly delighted that it is being paid rather well to hand over its fixed line customers to the government-owned National Broadband Network. Telstra will still have the opportunity to service these customers at a retail level but the company knows that there is more growth in mobile than fixed line communications.

No love lost on NBN

The NBN is, therefore, unwittingly facilitating faster growth for Telstra.

In May this year, Telstra paid $1.3 billion to secure another big chunk of spectrum that will be used to expand its 4G mobile network. Telstra will use this spectrum to expand the geographic coverage of its 4G network as well as lifting the speed of its service. The new spectrum also gives it more efficient coverage as the 700MHz capacity can travel longer distances and provide better in-building coverage.

Telstra recently said it was aiming to provide 4G coverage to 85% of the country by Christmas this year, up from 66% in June. That will provide a tempting carrot for many more users to join the 2.1 million customers already enjoying speeds up to 40mbps.

By the time the NBN finally rolls into town, there will be a solid core of customers, who will sniff at the pricing and simply carry on using mobile broadband instead.

Subject to the pace of the NBN rollout, Telstra is expecting to generate up to $3 billion of excess capital in the next three years. Its preferred strategy is to build up sufficient franking credits so that it can increase the dividend from the current annual 28 cents per share, possibly from FY15.

The prospect of higher dividends should entice even more shareholders aboard to enjoy the current 5.7%, fully franked dividend yield.

As a portfolio stock, Telstra is impossible to ignore.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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