Where Are We On Telstra?FN Arena News - September 20 2006 By...

Where Are We On Telstra?
FN Arena News - September 20 2006

By Greg Peel

"Confusion abounds regarding industry outlook, the competitive landscape and scant detail on how the Government will structure the divestment of at least $8bn of stock." – Citigroup today.

In our last episode, Deutsche Bank had just upgraded Telstra (TLS) to a Buy rating. Deutsche had previously predicted a "sluggish" FY07, but by thinking outside the square, the analysts had decided that if one was to take into consideration the retail potential of Sensis, broadband, mobile, and cable TV, things weren't looking quite so dreary after all.

This meant Telstra had scored only its second Buy rating in the FN Arena database, alongside a very lonely Credit Suisse. CS upgraded Telstra to Outperform in October last year when the stock was over $4.00. The analysts have held the rating, and a $4.78 target, ever since. Visionary? Or a touch of Rinker-itis?

Our exalted editor immediately poured a large bucket of cold water over the Deutsche upgrade, noting that (a) Deutsche is one of a handful of investment banks pitching for the last spots on the lucrative T3 panel and (b) Deutsche's previous telco analyst – who had maintained a Hold rating and a dim view of fixed line revenues – had mysteriously disappeared with nary a trace, while the new boy was suddenly bullish.

Previously I had noted that on the announcement of the T3 go ahead, little enthusiasm was sparked (except from CS of course) despite the average target in the database being $3.97 and the stock trading below $3.50 (The CS target drags the average up considerably). Citigroup (Sell) even suggested institutional buyers would be looking for a price of $2.80-3.00 before being interested.

The market response was, however, more positive. A lot of the problem with Telstra has always been the T3 "overhang". Was a partial T3 sale going to solve the problem? The market thought so, and the stock traded quickly up to $3.60. One of the reasons given for the rally was the fact that many fund managers were underweight Telstra, and the new sale would increase the telco's weighting in the index. This meant a bit of an index catch-up.

The "overhang" problem has not been solved in the eyes of the Citigroup analysts. (Citi is obviously not pitching for a spot on the panel). The parcel allotted to the Future Fund for a minimum two year escrow is still a spectre the analysts view and is not priced into the current market.

Citi believes mobile margins will dictate the medium term outlook for Telstra, capping the upside price potential to between $3.80-4.25 unless there are "massive" capex reductions. Operating leverage won't be achieved until the first half of FY09, says Citi, which happens to coincide with when the Future Fund can start selling.

Citi is happy to stay with a Sell rating.

JP Morgan (Neutral) had another spin on things last week. The analysts zeroed in on the Network Seven (SEV) announcement of the acquisition of a stake in VoIP operator Engin (VoIP is where you use the internet as a phone instead of the old fixed line). Morgans noted that any threat from VoIP had been largely ignored so far, given little financial backing had been afforded the new technology to date. The Seven endorsement changed all that, the analysts decided.

Hence, along with problems on ULL, broadband and mobile competition, VoIP would simply be another thorn in Telstra's side. VoIP aside, Macquarie (Neutral) summed up the situation in a report today thusly:

"…we are increasingly cautious on the outlook for Telstra in an environment where structural issues, intense competition and regulatory outcomes continue to pressure core revenue streams and operating margins. The impact on broadband and Public Switched Telephone Network revenues is only one example of this."

Indeed, and Macquarie used this morning's report to note that both Optus (SGT) and iinet (IIN) are expected to launch wholesale broadband services before the end of the year. (Macquarie is not pitching for part of the T3 action either).

So as it stands, the FN Arena database shows the current brokers included in the sales team maintaining a Hold (ABN Amro), a Neutral (UBS) and a gutsy Underperform (GSJB Were, hope that analyst isn't "disappeared" as well), and out of the sales team so far, brokers are maintaining an Outperform (Credit Suisse), a Buy (Deutsche Bank), two Neutrals (JP Morgan and Macquarie) and two Sells (Merrill Lynch and, of course, Citigroup).

Aspect Huntley rates the shares Accumulate, but it has been a while since that view has been updated.

Telstra closed today at $3.57.