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Morningstar | More Show Than Tell with Telstra's 5G Show and Tell, but Pleasing Transformation Progress

While Telstra's 5G investor day was informative (at times, even entertaining), it lacked the critical element that we are most interested in, namely, incremental revenue opportunity at a customer level for Telstra. All the futuristic applications that 5G wireless technology will enable are exciting. However, they are nothing but drawings on PowerPoint slides, without some quantitative indications as to how they result in higher average revenue per user, or ARPU.

Fortunately, we believe merits of Telstra's 5G investment are likely to stand on their own in terms of lowering operating costs (operating cost per gigabyte likely to be less than half of current levels), reducing network maintenance expenditure and boosting capacity. This is just as well, as mobile data usage volume has grown almost 15-fold over the past five years to around 5 gigabytes per month per average user, putting severe pressure on the current 3G/4G network. This is at a time when mobile ARPU is falling at low-to-mid-single-digit percentage rates, being the consequence of a maturing 4G wireless technology leading to pure price-based competition.

In the medium term, the key to closing the gap between narrow-moat-rated Telstra's current stock price and our AUD 4.40 fair value estimate remains successful execution of the AUD 2.5 billion cost-out program, as well as the group-wide simplification, productivity and fight-back plans for customers. To this end, the progress is satisfactory, especially in terms of reducing headcount (3,000 full time equivalent employees cut) and continued momentum in subscriber growth.

Critically, reiteration of the fiscal 2019 earnings guidance was important, as it lends credibility to management's claimed solid progress on the transformation projects to-date. It also provides confidence that Telstra has the capability to execute on the 5G rollout and monetise the longer-term incremental revenue opportunities from the technology upgrade.

Our current fiscal 2019 AUD 9.0 billion EBITDA forecast is within Telstra's reaffirmed guidance of AUD 8.7 to 9.4 billion, while the unchanged free cash flow guidance of AUD 3.1 to 3.6 billion is also in line with our expectations. Management did warn free cash flow split for the first half of fiscal 2019 will be less than the historical average of 30%, as capital expenditures are brought forward, along with incurring higher working capital for the period. We do not see anything alarming in this composition shift, especially as full-year capital expenditure guidance has been maintained at AUD 3.9 to 4.4 billion range.

Circling back to potential 5G opportunities, management appears confident the technology upgrade will boost ARPU. The key reason, as far as we can decipher, is its view that every wireless generation upgrade to-date was accompanied by higher ARPU as customers were willing to pay more to access the technology, in order enjoy the benefits of greater speed, features and functionalities. We concur and believe Telstra, as the market leader with the best network quality and coverage, will benefit more than competitors from the transition. It is certainly well-prepared for 5G, given the recent incremental AUD 3 billion investment program (finishing in fiscal 2019) to digitise Telstra's network infrastructure and put in place a 5G-ready platform.

Where we find the picture a little fuzzier is the longer-term revenue opportunities management speaks of. For instance, gamers apparently will be willing to pay telecom operators more per month for 5G's superior latency (in layman's terms, speed and responsiveness when you are playing heavy-graphic, multiplayer, online games). The argument extends to the automotive, healthcare, mining industries, and even robotics and virtual reality spheres, where millisecond response rate is critical. However, management was unable to put in its presentation slides any concrete overseas evidence of these customers willing to pay more per month for these 5G benefits. Having said that, we recognise it is still early days in the 5G evolution and quantifying the revenue opportunities is difficult at present. We are merely making the point that, with every previous wireless generation upgrade, the ARPU uplift was temporary and most value in the chain accrued to exploiters of the improved network (think Netflix, Facebook, Youtube and other application or services providers). As such, for the investments they are making, investors should hope that telecom network operators such as Telstra do better at monetising the 5G upgrade.