Talking telco trends

27 Feb 2017

By Shadforth Financial Group

Over the years, we have witnessed a number of changes in the telecommunications industry due to technological advances. The key trend has been the steady decline of fixed line voice services. The chart below shows the decline of fixed line voice services versus the steady rise of mobile voice services due to an on-going shift to mobile-only households.

Research by the Australian Communications and Media Authority (ACMA) found a correlation between age and fixed phone use. Mobile-only consumers tend to be between 25-34 years of age while those over 65 are least likely to make voice calls on a mobile-only basis. The decline in fixed voice services is set to continue as the population goes through a generational change.

Another trend is the increasing inclusion of unlimited voice calls in mobile phone plans. As a result, telcos are now differentiating themselves through data allowance and driving revenue through excess data charges instead of excess call minutes.

A big driver of data usage trends is the younger generation’s constant engagement with their mobile phones through applications such as Facebook and Instagram. The chart below shows the significant increase in data usage over the past few years.

Other drivers of the demand for increased data include the rapid growth of video on demand services such as Netflix, Presto and Stan as well as Foxtel Play, Foxtel Go and ABC iView, which allow consumers to catch up on free-to-air television programs.

There is the potential for telcos to make further investments in their fixed and mobile networks to satisfy consumer demand for video streaming services. Some have even acquired content deliverers. In the future, pricing around data will be based on broadband speed and data allowances.

The five main players

Telstra, TPG and Vocus are listed on the Australian Stock Exchange. Optus is owned by Singtel, a Singaporean telecommunications company listed on the Singapore Exchange, while Vodafone is jointly owned by Hutchison Telecommunications (Australia) Limited (listed on Australian Stock exchange) and Vodafone Group (listed on London exchange and NASDAQ).

The NBN

The National Broadband Network (NBN) has been rolling out across the country over the past several years. It was built to provide Australians access to fast broadband at affordable prices and its introduction has caused major changes to the telecommunication industry.

The network was designed to be offered on a wholesale level to all telecommunication companies. The company NBN Co has no ability to directly generate retail demand. It can only generate demand based on functionality and pricing.

As part of the plan to make the NBN Australia’s only broadband network, Telstra and Optus were paid a large sum of money to hand over their network infrastructure and move their customers onto the new network.

Since the NBN operates as a wholesale only-network, it has provided industry players a more balanced competitive environment. Telstra and Optus no longer have the infrastructure advantage and are forced to participate in the same pricing model as other competitors such as TPG and Vocus.

However, while the NBN was designed to provide consumers with fast but affordable broadband, this hasn’t yet come to fruition. The current base NBN plans are priced between $30 and $70 a month depending on data allowance, while ADSL and cable internet offer unlimited data for less than $80 a month. Cable internet currently provides consumers faster speed internet at a comparable price, making the NBN a less attractive option in terms of functionality and pricing.

The NBN also charges a fixed connection fee to all retailers and varying fees based on data usage. The average revenue per user on the NBN is currently $43 per month, higher than the $33 per month Telstra charged as part of their wholesale prices on the old copper network. This increase in fees has led to margin erosion for broadband retailers such as Telstra, Optus, TPG and Vocus.

As the demand for data increases, costs will increase and we will see companies having to either absorb further margin erosion or re-price their broadband plans higher.

Given this inefficiency in the NBN, the current pricing model is under continuous review and we believe the NBN charge to retailers will decrease over time to ensure the NBN remains a viable option.

The impact for Telstra: a case study

To get a sense of the overall impact of technology trends and the NBN on telcos, we’ll look specifically at Telstra.

Telstra’s fixed line products saw a gradual decline in revenue from $4.3bn in 2013 to $3.4bn in 2016 as the current trend of mobile only households continues.

While data usage has been steadily increasing, mobile broadband revenue declined in 2016 from $1.3bn to $1.2bn as a result of increased competition in the mobile segment. Telcos are now offering higher data allowance as a form of differentiation from competitors, lowering the amount of revenue they generate from excess data usage as it lowers the likelihood of users exceeding their data allowance.

Management has estimated that at the conclusion of the NBN rollout in 2020, Telstra will face a negative $2-3bn EBITDA impact. Management are looking to make up for the lost earnings by increasing capital expenditure on investment from 15.6 per cent of sales to 18 per cent over the next three years.

There appears to be a high degree of uncertainty in Telstra’s outlook post-completion of the NBN, as the current business does not present many viable options to plug the forecasted earning gap. Telstra might be able to recover some of their lost earnings in the mobile segment, with acquisitions as an option. Telstra shareholders should look for further clarity regarding management’s strategy to combat the fall in earnings.

Overall impact and an outlook

As mentioned previously, the NBN is causing margin erosion for broadband participants. Companies such as Telstra, Optus, TPG and Vocus are now facing wholesale pricing pressure from NBN Co. In NBN Co’s corporate plan for 2017, they have forecasted that the average revenue per user will grow by 4.8 per cent per annum until 2020. This would lead to further margin erosion, assuming retail prices remain the same. The decline in margin witnessed and forecasted has resulted in investors re-rating the telecommunication sector lower, with a significant drop in the share prices of Telstra, Vocus and TPG over the last nine months.

The NBN headwind will continue until there are some changes to the current pricing model. NBN Co and the Communications Minister have both indicated that further changes to the pricing model will be considered to ensure the NBN is a viable option for retailers.

In the event that the pricing model does not change, we believe that telecommunication companies may consider building out their own fibre network or improve mobile broadband technology as an alternative to the NBN. TPG has already built a fibre to the basement network in metro areas in the major cities.

For a staple sector like telecommunications, rapid changes, government intervention, the need for instant gratification and data overload by today’s generation means the sector will remain in a state of flux and opportunities for the astute investor will present itself.

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