The recent string of outages by Telstra is putting the company’s profit margins at risk and will see customers disappear because the no longer see value in the premium the telco charges, Morgan Stanley believes.
The Morgan Stanley research team, led by Mark Goodridge, argues that while Telstra’s network was previously seen as more stable and reliable than its rivals, the market leader was able to charge a premium of around 10-15%. But Goodridge and his team believe the recent multiple outages have dragged Telstra’s service levels back to the pack and the effective premium is now jumped up to 40%.
That, the analysts say, means Telstra (TLS) will lose margin, customers, or both.
“We forecast 1ppt of share loss for the next two years,” Morgan Stanley says.
The latest major outage, on Thursday, May 19, saw Telstra’s NBN and ADSL voice and data services knocked out. While the company said most services were returned on Friday evening, problems and complaints continued until Monday, with another failure occurring on the Sunday.
“We understand this has been frustrating for affected customers and we will be providing them with some additional data. We will contact them directly and provide more details,” the company said in a statement last week.
But many customers took to social media to complain that the company wasn’t keeping them properly informed about what was happening.
That failure came just 24 hours after CEO Andy Penn delivered a major speech pledging to do better and improve the company’s customer service, saying “whilst no network operator in the world can guarantee that disruptions won’t occur from time to time, what we can do is reduce the likelihood and the impact”.
Australia’s biggest telco incurred the wrath of customers with four prolonged outages to its mobile network during February and March.
The company is spending $50 million to upgrade monitoring and improve recovery times on the network following a series of embarrassing failures that led to two free data days for customers.
At its May 2 Investor Day presentation, Telstra announced it would spend $25 million on monitoring equipment and a further $25 million on “increasing our capacity to handle a large number of re-registrations occurring simultaneously”.
Telstra blamed the earlier outages on a range of issues, from human error to problems with its international cable, and offered free data on two Sundays as compensation, but even that led to further complaints from customers as the telco admitted it “throttled” the network during its second free data day in April.
Last week CEO Andy Penn took to Twitter to declare he’s reading “all” the comments of customers frustrated with the company’s repeated failures.
But Morgan Stanley’s view is that perception and reality are starting to collide around Telstra’s previously “reliable” network and customers are less likely to swallow the company’s premium pricing. Goodridge and his team also see the market beginning to open up, with the current quasi-monopoly fading and an oligopoly emerging.
As a result, Morgan Stanley says it favours buying Vodaphone and TPG over Telstra and is now overweight these stocks relative to index.
As Goodridge points out, Telstra’s May 2 investor day revealed a $2-3 billion hole in EBITDA when the NBN is completed, but he can’t see how the company will adjust effectively and needs to find between $600 million and $1.6 billion in savings:
Our view is Telstra will struggle to fill this hole as we forecast incremental mobile EBITDA of ~A$100m, incremental NAS/International NAS EBITDA of ~A$800m, incremental ~A$500m EBITDA from acquisitions (assuming a 10% ROIC on ~A$5bn excess capital).
This totals to A$1.4bn and means there is a lot of heavy work for TLS from cost out to fill this EBITDA hole.
Morgan Stanley’s research team also took aim at the company’s growth strategy, saying that while Telstra had reduced some of the riskier aspects of its capital allocation strategy, it needs to spend at least $1 billion annually over the next five years on a share buyback to solve the telco’s “biggest issue in our view, a declining ROE (ex-NBN payments) profile”.
Here’s what Goodridge says:
A$1bn share buyback per annum would shrink TLS’ capital base and see its ROE (ex-NBN payments) rise to 29% in FY21 from 28% today, rather than falling to 24%. Telstra would be a smaller company but just as profitable.
We maintain our UW TLS because TLS remains more focused on growth rather than adopting this more conservative strategy.
Telstra is currently down around 0.4% for the day at $5.64.
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