Telstra (ASX:TLS) has been one of the better performers among Australia’s large caps over the past year, and we see more upside ahead. There are two good reasons for our optimism.
First, we expect that over the medium term, Telstra stands to benefit from strong growth in the number of devices connected to the internet via mobile networks, due to a confluence of improved mobile technology (5G), and evolving use cases including things like autonomous vehicles and a host of other applications yet to emerge.
The second part of our thesis is that the economics of Telstra’s fixed broadband business will improve over time. Currently, resellers likeTelstra earn close to zero margins reselling NBN services, and our assessment is that this is not sustainable.
What is less clear is what path might be taken to arrive at a more sustainable level of fixed broadband industry economics. The possible paths include:
While the end result (improved broadband profitability) should be beneficial toTelstra regardless of the path taken, the way that end result is achieved should make for some fascinating corporate strategy in the next few years.
The government has historically viewed wireless as not being a close substitute for NBN, due to lower speed and capacity. However, Optus has been conducting limited trials of a 5G alternative, and if company announcements are to be believed, the results have been very encouraging. In parts of the market at least, Optus appears ready to offer a superior service at a comparable price. What is yet to be determined is how readily this might be translated into a broad market offering.
To the extent that 5G wireless can be proven to be a viable alternative for a large percentage of the NBN’s user base, the government/NBN Co may have a difficult choice to make: either lower wholesale prices materially (and accept the resulting write-down to the value of NBN Co) to discourage investment in the 5G alternative, or accept progressive erosion of the customer base over time (resulting in a write-down to the value of NBN Co).
Telstra has been relatively quiet so far on the potential of 5G as an NBN substitute, and this may reflect the particular circumstances of the agreements Telstra entered into with NBN Co in 2011, including an obligation not to promote a wireless NBN alternative for 20 years. However, Telstra has been very clear that it intends to invest early and at scale to ensure 5G leadership, so will likely have the capacity to provide such a service even if it is restricted in promoting it.
For now, Optus appears to have put the ball into the government’s court. We await the next developments with interest.
The Montgomery Fund and Montgomery [Private] Fund own shares in Telstra. This article was prepared 13 November with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Telstra you should seek financial advice.