Why Bennelong sold its telco shares

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Bennelong Australian Equity Partners was a big supporter of the Australian telecommunications sector for a number of years and was rewarded with strong performance from stocks such as TPG Telecom.

However, its view of the sector changed last year, as it saw the emergence of a more challenging competitive environment, and it started to reduce its exposure.

According to the latest monthly performance update for Bennelong’s Concentrated Australian Equity Fund, TPG Telecom was one of its largest positions and in late 2015 it accounted for 7.5 per cent of the fund portfolio.

“It had been a strong contributor to the fund’s performance but six months ago we sold out of the stock,” Bennelong says.

For five years, until last year, the telecommunications sector was one of the strongest performing sectors on the ASX.

The industry giant, Telstra, gained from having a low starting valuation. Its shares traded at just over $2.60 in late 2010. Since then Telstra shares have been as high as $6.55 and are currently around $4.30.

There was a growing attraction to its full franked dividend, as part of the yield trade that accompanied lower and lower interest rates.

Telstra has a strong mobile business, particularly as offshore-owned Vodafone and Optus were having troubles with network reliability.

Elsewhere in the sector, broadband focused players such as TPG Telecom and Vocus Communications also delivered strong returns, Bennelong says.

Both benefited from industry consolidation. Each acquisition they made over the years added customers and came with costs that duplicated what was already being incurred and were therefore easily cut out.

As a result, both enjoyed strong growth in scale and profitability.

“More recently, the industry has started to suffer as the level of competition has lifted. The aggregate pool of revenues in the telecommunications industry is resilient but grows only slowly,” Bennelong says.

“To grow faster, one must take it away from a competitor.”

In mobile, Vodafone and Optus are now trying to recover from past difficulties that saw them lose meaningful market share.

Meanwhile, Telstra is looking to defend the gains it made at their expense. This is causing greater competition, best seen through higher capital investment in mobile networks and pressure generally on mobile plan pricing.

The industry’s profit pool, as measured by EBITDA, has basically flatlined for the past four and a half years.

Last month, TPG announced that it was entering the mobile market, having bid successfully for spectrum auctioned by the Australian Communications and Media Authority. The spectrum cost $1.26 billion and the company is proposing to build out a new network for $600 million that will only cover 80 per cent of the Australian population.

“TPG’s move will cause even greater competitive pressure, which in turn will put further pressure on revenues and margins,” Bennelong says.

In broadband, Telstra, TPG and Vocus are also dealing with quite intense competition. They are also facing higher network costs as they transition to the National Broadband Network.

“Partly as a result of these factors, we are of the opinion that the market is overestimating earnings for their broadband businesses,” the fund manager says.

“The industry changes will likely benefit customers at the expense of shareholders. In April, Telstra, TPG and Vocus made up three of the worst performers in the top 100 stocks, each falling between nine and 21 per cent.”


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