The NBN is a complete disaster

  • My Republic is moving into a crowded telco market that is dropping prices to protect market share
  • 50% EBITDA margins on ADSL, will fall to 15% on NBN
  • In 5 years’ time we are saying that the earnings for Telstra is going to be 30% lower than it is today

David Spotswood of Shaw and Partners says the view of the market is that the NBN is costing five times more than the equivalent in the UK and US.

That cost is putting the squeeze on the earnings of the telcos and there’s still new players moving into the market. As a result, not only are future earnings at risk, but internet speeds are frozen at ADSL speeds because there’s no profit in offering higher speeds.

David Spotswood tells Alan Kohler that he would invest anywhere but in telcos.


Will anyone make money out of the NBN, do you think, or is the NBN a complete disaster for listed telecoms?

The NBN is a complete disaster. We actually had a meeting with a new player in the Telco market, they are from Singapore and they have come into the Australian market and their kind of view is…

This is My Republic, I presume?

Yep. Their view is, and I think it is the view of everyone in the market. They said that the NBN is costing five times as much to roll out in Australia as the equivalent in New Zealand, Canada, the UK, and the US. It is five times as expensive. The NBN is a really expensive monopoly and so the government just took the monopoly away from Telstra and has created another inefficient monopoly. They have got these access prices and charges, which is basically about $42 to use the NBN, depending on the speed, the telcos are all charging about $60. So their margins are very low and that is at a very low speed. So the NBN is exactly the same speed as copper, you are getting 12mbps or 25mbps which is basically the same speed as ADSL, the same speed as copper. The reason for that is because the telcos, the retail service providers won’t go up any higher speed because they won’t make any money. My Republic is going to have 100mbps which is whatever that is, 5 times as fast, and [based] on our work it is unprofitable. The NBN, the way the pricing is structured doesn’t work. It is a complete waste of time. You might as well not build it. Either of two things has to happen. Either the telcos have to charge more, and for some reason, I don’t know why they refuse to charge more. It is a land grab, it has lowered the barriers to entry, everyone wants to get as many subs as they can over the next 3-4 years. It is the biggest churn event, it is what they all quote, it is the biggest churn even in the history of the telco market. It is just a land grab, let’s get as many subs as we can. The profitability is not going to be great, it is 10 to 15% margin, but we are not going to put up prices at the moment because new entrants are coming in, you have Amaysim coming in, you have My Republic coming in, you have Kogan coming in so there are a lot of new entrants. Everyone is going for market share, everyone is going for subs. No one is going to put their output prices up and no one is offering higher speeds either, because the margins are wafer thin. So there is only thing that can happen is the profitability of the telcos that do offer higher speeds, then their earnings get hit, which is what My Republic are doing. Or NBN, and this is obviously not going to happen overnight, needs to be written off and restructured and they drop the access charges so that you can offer higher speeds.

The market share that all the new entrants are going after is Telstra’s, isn’t it?

Yes, and Telstra is saying there is no way that you are taking our market share, so everyone in the market was saying that this is the biggest churn event and everyone is going to eat Telstra’s lunch, and Telstra has said “No you are not”. So Telstra has actually taken market share in NBN. Telstra’s market share on NBN is higher than its share on copper.

But that is going to cost us earnings, isn’t it?

It is $2-3 billion. That is the number that they have put out there. Their 50% EBITDA margins on ADSL, on copper their NBN margins are going to be whatever, 15%. They have a number out there in the market that is saying that it is going to cost them $2-3 billion. We put out a report on Telstra yesterday and we have sustainable EPS and DPS for Telstra of about 24c and at the moment they are 36c and the dividend is 31c, so that is over 5 years. In 5 years’ time we are saying that the earnings for Telstra is going to be 30% lower than it is today. And I think everyone in the market agrees with it.

What is going to happen to the dividend then.

25c

Right. And is that 25c sustainable?

You know, plus or minus 2 to 3 cents, yeah. The industry is so dynamic, so your certainty on anything is not high. This is an unstable industry at the moment. You have got a 4th player coming in in mobile, as we are saying, in TPG. Building a network which will roll out in 2019 and 2020 and you have got NBN which is lowering the barriers to entry and destroying everyone’s earnings. Where it actually ends up, you can’t have a high degree of certainty with anything, but at the moment I think Telstra’s earnings are going to be lower in 5 years’ time than they are today, and significantly lower. Telstra have given you the numbers. They have $11.2 billion of EBITDA they are going to lose $2 to 3 billion through NBN then whatever TPG are going to do in terms of impacting their revenue and profits by having 4 players instead of 3. They have a billion dollars cost outs strategy. You put all those numbers together and you get the EBITDA from 11 to 9 billion down 20 or 25%. On a share basis, it spits out 23, 24 cents EPS. That is what the dividend is going to be as well.

Vocus has had a terrible time, and they recently had an investor day.

Vocus is a bit of a cautionary tale over the last 12 to 24 months. You obviously had a merger from the old Vocus business which was run by James Spenceley. That was the infrastructure business which basically just dealt with businesses and then they merged with M2 which was a retail business, which resold copper, ADSL and also had the Commander business, which is a small SME business as well. They merged. There was obviously a clash of personalities and a clash of culture. There is a lot of staff that have left, a lot of board directors have left and they have lost business from it. They are still dealing with losing contracts, losing staff and losing customers. They had a downgrade earlier in the year.

Did you come away from the investor day feeling like they have turned it around?

No. The investor day was a bit of a ra-ra day on how great they are going. If you hadn’t seen their share price or their profit downgrade you would have thought they are doing well. So the investor day was just basically how the outlook for the business is great, the outlook for the Vocus infrastructure business is great, the outlook for the retail business in terms of their reselling NBN for the Dodo business, for the iPrimus business was all good. Everything was great and it was all kind of systems go and everything is going great. In my opinion, it was a lot of spin and not a lot of substance. There were no numbers given at all from the investor day. The board and the CEO are fighting for survival. You obviously know that there is a bid on the table from KKR to take over the company. The profit downgrade was only 3 months ago, or 2 months ago before the investor day, so the chance of them stabilising the business and having turned it around in a couple of months is pretty unlikely.

Do you think that KKR will get it?

I don’t think they will get it at $3.50, I think they will need to bump the bid. In my view, the job of Vocus board and management now is to extract a higher bid from KKR. You don’t put in your highest bid to start with, so I think it is the job of management to get another bidder to come along. Apparently there was a lot of people looking and a lot of private equity looking at it. They had spoken to the previous CEO, James Spenceley and Tony Grist who was the previous CEO of Amcom that got bought by Vocus in terms of how to run the business and how to run the business better and get it on a more even foot. I think there is more than one bidder out there, and so it is the job of the board and management to extract another bid. So I don’t think they will get it at $3.50.

It could be a buy for that reason then.

Yeah, the only downside is, and which I am sure you are aware and you have seen it happen again and again is basically where the management are going to reject any price. The investor day was all about how the long term outlook for the company is very, very rosy. If you take a 3-5 year view then the earnings will be significantly higher and the revenue will be significantly higher and they have got these teething problems at the moment and there is an opportunistic private equity bid come in at the moment and therefore you know we shouldn’t sell the business at this time because it is a low point in the earnings. If we are allowed to manage it then the earnings will be significantly higher. The risk in saying that you should rush in and buy it at $3.50, which is what it is trading at today and which is the bid price, it did get up to about $3.68, is that we have seen this happen before, where the management are saying no, it is opportunistic, we can extract value from that, and then the stock has never traded anywhere near the bid price again. That is your risk in rushing out any buying it.

What do you think of TPG at the moment and their strategy?

The market is completely confused and doesn’t understand the TPG strategy. If you talk to any of the other telcos, Vodafone, Optus, Telstra, about how they are going to make the mobile network work, no-one seems to understand, so I think it is very high risk strategy for TPG. David Teoh is held in very high regards in the market, he has been one of the smartest guys in the telco industry so people are basically giving him the benefit of the doubt that he will make it work. But our view is just to stand aside from TPG until we can work out the capex and when they are actually going to turn a profit from it, which I don’t think is going to be for a fair few years. They spent $1.3 billion on spectrum, they are going to spend $600 million in capex, so it is $1.8 billion. The return profile from that is highly uncertain and the time period is highly uncertain. I am not sure I would be rushing out and buying that at the moment.

It sounds like you’d say that investors should give the whole industry a wide berth?

Yeah, I think Westpac looks like a good investment.

Westpac?

That’s a joke, yeah, that’s what I am saying. Invest it outside the industry.

Yep

It needs to settle down and competition is only getting worse. Optus and Vodafone dropped $10 to $20 off their mobile plans last week, that is 10 to 20%. Telstra hasn’t moved yet. There was a view of the market that TPG wouldn’t affect Telstra because it has got the best network and TPG is only 80% and it will be low quality, but the other mobile providers have already dropped their prices to try to squeeze out TPG. Amaysim, which is a reseller, dropped their prices on one of their products by 60% in the last 2 weeks, so prices are falling. Telstra hasn’t moved yet, but chance of Telstra being immune to a fourth player coming in to the mobile market. I would have thought would have been zero.

Great to talk to you David, thanks very much.

OK, no worries.