Huntleys' Stock of the Week

Recommendation: Buy

TLS's current stock prices

A peaceful solution or a bloody mess?

Investment Rating:

TLS is the leading telecommunications and information service provider in Australia with a full suite of services across voice, mobile, data and internet products and has either a dominant or significant market share in each service category. TLS also offers services including directories, advertising and Pay TV. It operates in a highly regulated industry where the extent of regulation penalises it due to its market position and historic ownership. The Strategic Review of November 2005 outlined a wide-sweeping transformation of TLS from the complex to the simple - from price-based to value-based competition with broadband anchoring the future direction. TLS is on track to deliver significant free cash flow in FY10.

Event:

• Stephen Conroy has issued an invitation - ultimatum - to Telstra. Structurally separate or else.

• The reforms to current telecommunications regulation addressed five issues but most important were issues of vertical integration and horizontal integration. Reforms to the competition regime (what about the banks and supermarkets?), strengthening consumer safeguards and the removal of unnecessary red tape are minor issues.

Impact:

• David Thodey has to negotiate in the best interests of shareholders. Telstra's communication assets have a book value of $21bn. Swapping relevant network assets for an interest in a loss making NBN is not in the best interests of shareholders. A cash sale - yes. Swapping relevant network assets and customers, which would provide revenue, cash flow and perhaps earnings for NBN, for cash and a holding in NBN - possibly. If enough cash can be extracted a slim Telstra could be conservatively geared after capital initiatives - a capital return or share buyback - with growth operations including mobiles - voice, data and broadband - advertising and directories, Pay TV and offshore activities.

• A degree of uncertainty has been removed. There will certainly be a reaction from Telstra and if it is a "win, win" situation for the public and shareholders as Conroy suggests then there is likely to be a palatable resolution.

• Until Telstra makes formal submission many more trees will be felled as speculation abounds. In the meantime the Telstra share price is not likely to collapse nor is it likely to surge. We retain our valuation at $4.45. Increased dividends and other shareholder benefits are possible.

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