Tuesday, 05 September 2017 07:30

New Magellan listed trust - with a loyalty bonus

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Magellan Financial Group have announced a new listed investment vehicle, the Magellan Global Trust.

This ASX listed trust will commence trading on 18th October 2017, targetting an income yield of 4%pa and will be invested similarly to the Magellan Global Fund which has been established since 2007.

Existing investors in Magellan funds (both listed or unlisted) can apply for units in a priority offer and receive 6.25% worth of bonus units on the first $30,000 applied for.  Bonus value is up to $1,875, and to be eligible the Magellan Global Trust must be held until 11 December 2017.

The Priority Offer is open to any person who has a registered address in Australia or New Zealand and who, as at 5.00pm (Sydney time) on 1 August 2017, was a direct or indirect holder or investor in any one of the following (each an "Eligible Vehicle"):

  1. a)  Magellan Financial Group (ASX: MFG);

  2. b)  Magellan’s Active ETFs: Magellan Global Equities Fund (Managed Fund) (ASX: MGE), Magellan Global Equities Fund (Currency Hedged) (Managed Fund) (ASX: MHG) and Magellan Infrastructure Fund (Currency Hedged) (Managed Fund) (ASX: MICH);

  3. c)  Magellan’s unquoted registered managed investment schemes: Magellan Global Fund (ARSN 126 366 961); Magellan Global Fund (Hedged) (ARSN 164 285 661); Magellan Infrastructure Fund (ARSN 126 367 226); Magellan Infrastructure Fund (Unhedged) (ARSN 164 285 830); and Magellan High Conviction Fund (ARSN 164 285 947); and

  4. d)  at Magellan’s discretion, any fund or investment strategy for which Magellan is the investment manager or adviser.

 

GEM Capital will be flagging this issue to its clients directly, but in the meantime we attach a fact sheet about the offer.

 

Download Magellan Global Trust Fact Sheet

 

Download Magellan Global Trust Product Disclosure Statement

 

Thursday, 31 August 2017 09:44

Company reports can mislead investors

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We tracked how investors read company reports and here's how they're misled

File 20170828 27564 jnov8i The study used an eye-tracking device to ensure that all information included in the management report was read and considered in light of judgment formation. www.shutterstock.com Andreas Hellmann, Macquarie University

Investors would have spent a fair amount of time over the last few weeks poring over financial documents, as listed companies report their earnings and plans for the year to come. But our research shows they could have been misled just by the order of information in these reports.

We found that investors place more emphasis on the last piece of information in the management report included in company documents. Non-professional investors also ranked the performance of the company higher on more occasions, if the last piece of information is positive.

We invited 66 non-professional investors in our laboratory to read a management report of a fictitious mining company containing a short series of complex and mixed information. The positive information contained in the report told of increases in financial profitability and a strong operating cash flow. Negative information included a declining share price and increases in costs.

We randomly assigned the participants to two groups. The first group read the textual information included in the report in a sequence of positive information first and negative last. The second group read exactly the same information, but for them it was presented in the opposite way, negative before positive. We used an eye-tracking device to ensure that all information included in the management report was read and considered in light of judgement formation.

The investors we studied actually used the fictitious information in their investment decisions. Over 60% of participants were less inclined to invest in the fictitious company when negative information was presented last.

Easily mislead

Research into the behaviour of investors shows that the presentation order of financial information influences their judgements on company performance.

Because of the limited attention span and working memory capacity of the human mind, investors give more weight to information received later in a sequence.

So although financial information is often regarded as objective, neutral and value-free, the deliberate presentation ordering of information is able to influence non-professional investors. Companies could use this to try and hide negative information in the middle sections of a narrative and disclose positive information at the end of a sequence for the greatest effect.

Presentation ordering is not the only trick companies may use to influence the perceptions of annual report readers.

Graphs can attract investor’s attention and can be more easily retained in their memory than other narratives. Because of this, companies use significantly more graphs highlighting favourable rather than unfavourable performance.

One concern that arises from our findings is that readers of financial information may be mislead into believing there is more objectivity in practice than actually is the case. With regulatory efforts largely related to quantitative information, companies have much more flexibility in terms of how they present narrative information accompanying the financial statements in their reports.

Perhaps further guidance on the presentation of the management commentary is required by the global regulators to restrict the possibility that companies may influence the impressions conveyed to users of accounting information.

The ConversationMaybe next reporting season investors should take another look at what information companies include in their reports.

Andreas Hellmann, Senior Lecturer in Accounting, Macquarie University

This article was originally published on The Conversation. Read the original article.

Tuesday, 22 August 2017 14:09

Driverless vehicles are here

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The question is how quickly they become mainstream

(written by Magellan Financial Group)

 

Milton Keynes is a UK town about 75 kilometres to the northwest of London where many streets are reserved for pedestrians and bicycles. That made it a suitable place to test driverless cars, one of the great possibilities tied to the rise of artificial intelligence.

In what was declared a successful experiment, ‘pods’ with radar, lidar (that uses pulses of light to measure distance) and cameras feeding data into a central computer drove two passengers through the town during testing in 2016. The robocar travelled along the digitally pre-mapped two-kilometre route from the railway station to the town centre at a maximum speed of 15 kilometres an hour.1

The testing is part of a three-year government-funded program begun in 2015 run by the UKAutodrive consortium of businesses, governments and academics. The trials seek to overcome the technical, safety, legal, insurance and social challenges of using driverless or automated vehicles in cities.2

Such testing is happening the world over as driverless driving represents one of the most-touted aspects of artificial intelligence. Almost every developed country including Australia is hosting pilot studies on automated vehicles. The big technology companies such as Alphabet, Apple and Uber and the largest car companies including Ford, Honda, Tesla and Volvo are investing billions of dollars into driverless technology. US-based CB Insights tallies that 44 companies3 are developing autonomous technology and many of them are road-testing prototypes. The US research company estimates that global investment just in auto-tech start-ups topped US$1 billion in 20164 and reached US$1.6 billion in the first six months of 2017, more than double that of a year earlier.5 Those investing hope to profit from a leap in transportation as significant as the bound from horses to cars was a century ago. 

The promise of driverless cars, delivery bots and self-propelled buses and trucks is safer, faster, cheaper and more comfortable travel, especially for the disabled, the elderly and those who never learnt to drive. Robocars are poised to revolutionise travel within cities by promoting car sharing (what’s called transport as a service). Driverless proponents push the safety aspects the most because human error causes most of the world’s 1.25 million road deaths a year.6

The technological advances in automated driving are as impressive as any of the artificial-intelligence revolution. The breakthrough to fully autonomous cars has been made, cars are including more autonomous features, robocars that require human backup are for sale, self-driving taxis (with a safety driver) have picked up passengers and automated driving with no safety driver on public roads has occurred.7 Boston Consulting Group this year forecast that by 2030 a quarter of all miles driven in the US could be done in shared, self-driving (and electric) vehicles, and by that year more than 4.7 million autonomous vehicles will have displaced five million conventional cars.8 Research firm IHS Automotive predicts the take- up of driverless cars to accelerate from 2030, such that 21 million robo-vehicles will be sold annually by 2035.9 (In 2016, for context, about 92 million vehicles were sold worldwide.10)

But driverless cars are a while away from meeting the expectations of their biggest advocates such as Elon Musk who said this year that by 2019 the technology would allow people to sleep while being driven11 The largest obstacles to the mass uptake of driverless cars may prove to be challenges away from the technology. These issues include safety, legal and insurance liabilities, cybersecurity risks and making roads suitable. Above all this sits the unanswerable question of whether or not the public will feel safe being propelled at great speed by software. Enough people will surely be willing. Driverless vehicles are coming in some form – the technological advances so far, the amount of money being invested and the greater commercial viability of the technology will ensure a driverless world of some description. 

To download the complete article - click on the link below.

 

 

Wednesday, 02 August 2017 12:51

SA Bank Levy might be legal, but politically unviable

Written by
Joe McIntyre, University of South Australia

South Australia’s new bank levy, projected to earn A$370 million over four years, seems to be constitutionally valid but it remains hostage to political machinations.

While precise details are sparse, the Major Banks Levy will target those institutions liable for the Commonwealth bank levy (Commonwealth Bank, ANZ Bank, Westpac, National Australia Bank and Macquarie Bank). It will impose a state levy of 0.015% per quarter of South Australia’s share (about 6%) of the total value of bank liabilities subject to the federal government levy.

By making Commonwealth grant payments conditional on the removal of a levy, the federal government could force South Australia to abandon its bank levy.

It’s here that South Australia can benefit from the cover provided by the federal government’s bank levy. The federal government would be forced to tread a very tight line if they try to argue that it is fine for them to tap the banks’ honeypot but not for the states to do it too.

With new sources of state funding rare, South Australian treasurer Tom Koutsantonis has exploited this political opportunity, potentially signalling a shift of power back to the states. Unsurprisingly, the banks have reacted with fury, mounting their own attack campaign and threatening reprisals.

Taxation powers in Australia

The constitutional validity of South Australia’s bank levy rests on the distribution of taxation powers in the Australian federation. The power of the states has been eroded over time as the Commonwealth gradually came to dominate the federation.

The Constitution assigns almost equal power over taxation to the states and the federal government. Under Section 51(ii) the federal government is granted a power to enact laws with respect to taxation, but “not so as to discriminate between states or parts of states”.

However, Section 90 grants the federal government the exclusive power to impose “duties of customs and of excise”. So a state tax will generally only be constitutionally invalid if it’s characterised as a duty of custom or excise, or if it is incompatible with a Commonwealth Act.

Back in 1942, the federal government used its power under Section 96 to gain an effective monopoly on income tax. Under the scheme, the federal government levied a uniform tax on income, then gave a grant to the states equal to the income tax they had collected on the condition they cease collecting income tax.

In South Australia v Commonwealth (1942), the High Court upheld this effective takeover of income tax. While states retain the right to levy income tax, the risk of losing Commonwealth grants (together with administrative cost and competitive pressures) has made the proposition unattractive.

The federal government has consolidated more power through the expansive definition given by the High Court to the meaning of “duties of excise” in Section 90. For example, in the court case Ha v New South Wales (1997) a majority of the court held that duties of excise are taxes on the production, manufacture, sale or distribution of goods. As this is an exclusive federal government power, the states are effectively prohibited from taxing goods – such as sales tax.

The states have instead been forced to rely on a range of relatively inefficient transaction taxes (that is, stamp duties on certain written documents), on land taxes, and on payroll tax (levied on the wages paid by employers). The narrow base of these taxes has seen the federal government come to dominate taxation revenue – collecting more than 80% of tax revenue in 2015-16.

This “vertical fiscal imbalance” leaves the states dependent on federal government grants, together with any conditions attached to such grants. As Professor Alan Fenna has observed, the states are left:

…scrounging for revenue in economically inefficient or socially undesirable ways and going cap in hand to the Commonwealth.

With opportunities for the states to introduce new forms of taxation being so limited, the proposed South Australian bank levy is something of a game-changer.

The legality of South Australia’s bank levy

The levy’s structure doesn’t appear to involve the taxation of goods in a way that would go against Section 90 of the Constitution. The banks are being taxed on the basis of the value of an asset class they hold – in a way that is comparable to land tax.

Given the small percentages involved, this levy does not seem to interfere with the federal government’s levy, and would arguably not be incompatible with it. While relatively novel, the tax appears on its face to be constitutionally valid.

However, the politics of the issue is far more vexed, as the dark shadows of the federal government tied-grants scheme loom over all matters involving state tax. As Western Australia has learned, raising state taxes can have catastrophic unintended consequences. After that State raised mining royalties during the mining boom, the Commonwealth Grants Commission drastically reduced its share of GST payments - down to 34 cents in the dollar.

The fate of the state levy remains uncertain, with the politics very much in flux. What is clear is that the other states are taking notice.

The ConversationWith growing frustration over fiscal dependence on the federal government, it seems we may be entering a new phase of innovation in state taxation. Perhaps the federation is not yet dead.

Joe McIntyre, Senior Lecturer in Law, University of South Australia

This article was originally published on The Conversation. Read the original article.

Thursday, 13 July 2017 16:46

Platinum Quarterly Report - a great read

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Platinum Asset Management's quarterly report is always full of insightful information about the world economies and financial markets.

The most recent quarter considers the imbalance of investment capital around the world, comparing the economies of US, UK and Australia who all are spending above their income levels (running deficits) versus economies in Europe and Asia who are spending less than their income.  It is indeed thought provoking from the perspective of an Australian investor.

While quite a detailed read, we thoroughly recommend investors take the time to run through this excellent document that is put together by the professional investors who manage the money at Platinum rather than marketing spin doctors.

You can download your copy of the report by clicking on the image below.

 

The Spanish property market was materially over valued and fell spectacularly following the GFC, causing significant damage to the Spanish economy.

We recently spoke with Clay Smolinski about the similarities of the Spanish Property to the current state of the Australian property market, to determine whether investors can learn anything from the lessons of history.

 

 

Wednesday, 28 June 2017 06:39

Australian economy hits rough patch

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Despite numerous forecasts for an “unavoidable” recession following the end of the mining boom early this decade, the Australian economy has continued to defy the doomsters and keep growing. However, recently it seems to have hit a bit of a rough patch. After contracting in the September quarter, the economy bounced back in the December quarter only to falter again in the March quarter. While there was relief that we didn’t see another contraction, as had been feared, and the economy has now had 103 quarters without a recession, it would be wrong to get too excited. March quarter growth was just 0.3% quarter on quarter and annual growth slowed to 1.7% year on year, its slowest since the global financial crisis (GFC).


Source: ABS, AMP Capital

Bad weather and bad wages growth – the negatives

Cyclone Debbie and its aftermath disrupted housing construction & trade in the March quarter and this will pass. But before it does, the weather impact on trade will worsen in the current quarter – as indicated by a 45% collapse in coal exports in April, which is unlikely to be made up for in May and June – resulting in another quarter of poor growth. More fundamentally though:

  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">Consumer spending is heavily constrained by record low wages growth and high levels of underemployment resulting in real household disposable income growth of just 0.4% over the last 12 months. While real consumer spending grew more strongly than income at 2.3% over the last year, this was only possible because of a fall in the household savings rate to 4.7% from 6.9% a year ago. Rapid increases in the cost of electricity, talk of an increase in the Medicare levy and high debt levels are probably also not helping. All of which is showing up in relatively low levels of consumer confidence.
  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">The housing cycle is starting to slow. Falling building approvals point to a downtrend in housing construction activity (see next chart). Similarly, the wealth effects from home price gains are likely to slow if, as we expect, Sydney and Melbourne property price growth has now peaked under the weight of bank rate hikes, tighter lending standards, rising supply and poor affordability.


Source: ABS, AMP Capital

The impact of the housing cycle on the Australian economy is regularly exaggerated. Last year it contributed around 0.3% directly to GDP growth (via housing construction) and indirect effects look unlikely to have been more than another 0.3%. In other words, not a huge amount. But nevertheless it will be a drag on growth when it slows.

Offsetting positives

However, while the consumer and the housing cycle look like becoming a drag on Australian growth in the year or two ahead, several considerations will provide an offset:

  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">The big drag on growth from falling mining investment is nearly over.Mining investment peaked at nearly 7% of GDP four years ago and has been falling at around 30% per annum, knocking around 1.5% pa from GDP growth (and a lot more in Western Australia). While it’s still falling rapidly, at around 2% of GDP now, its weight in the economy has collapsed reducing its drag on growth to around 0.5% for the year ahead and it’s getting close to the bottom.


Source: ABS, AMP Capital

  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">Secondly, public infrastructure investment is rising strongly, up 9.5% over the last year, in response to state infrastructure spending much of which is financed from the privatisation of existing public assets.
  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">Finally, net exports or trade is likely to return to contributing to growth as the impact of Cyclone Debbie fades, resource projects including for gas complete and services exports continue to strengthen.


Source: ABS, AMP Capital

Recession avoided, but growth to remain subdued

These considerations should ensure that the Australian economy continues to grow and avoids recession. However, the drag from soft consumer spending and an end to the east coast housing boom will likely leave growth stuck around 2 to 2.5%. This is below Government and RBA expectations for a return to 3%, posing downside risks to the inflation outlook.

In an ideal world and given the declining potency of monetary policy (and the fear of reigniting home prices gains), this would be the time to consider income tax cuts (or “cheques in the mail”) to help shore up consumer spending. The Government could consider financing this by dropping/delaying the cuts to corporate tax for large companies that are stalled in the Senate. However, since the corporate tax cuts were due to kick in much later, the budget deficit would still blow out in the short term and it’s doubtful the Government would want to allow this given the risk of a ratings downgrade.

As a result, the pressure to do something if growth remains sub-par and underlying inflation stays below target will fall back to the RBA. As such our view is that the chance of an interest rate hike in the next 12 months is very low and the probability of another rate cut has pushed up to around 40-50% (well above the probability implied by the money market of 11%). Yes, the RBA remains reluctant to cut rates again and showed no signs of an easing bias in its June post-meeting statement, but then again it’s been a reluctant rate cutter all the way down since 2011. Key things to watch for another rate cut are: a softening in jobs data; continued weak consumer spending; another downwards revision in RBA growth and inflation forecasts; significant cooling in the Sydney and Melbourne property markets; and the Australian dollar remaining relatively resilient.

Implications for investors

There are two major implications for Australian based investors. First, continue to favour global over Australian shares. While US and global share indices are hitting new record highs, Australian shares remain well below their pre-GFC peak. In fact, Australian shares have been underperforming global shares since October 2009. See the next chart. This reflects relatively tighter monetary policy in Australia (the US had money printing and zero rates and Australia had neither), the commodity slump, the lagged impact of the rise in the $A above parity in 2010 and a mean reversion of the 2000 to 2009 outperformance by Australian shares. While the underperformance has reversed half of the 2000 to 2009 outperformance, it looks like it has further to go reflecting weaker growth prospects in Australia. We see the ASX 200 higher by year end, but global shares are likely to do better.


Source: Thomson Reuters, AMP Capital

Secondly, maintain a decent exposure to foreign currency. A simple way to do this is to leave a proportion of global shares unhedged. Historically the $A has tended to fall against the $US when the level of interest rates in Australia relative to the US is falling. See the next chart. With the Fed likely to continue (gradually) raising rates and the RBA on hold or potentially cutting rates again, the risk for the $A remains down.


Source: Bloomberg, AMP Capital

 

Article by Shane Oliver - Chief Economist AMP

Tuesday, 27 June 2017 15:31

SA Bank Levy - Fact or Crap

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With SA Treasurer, Tom Koutsantonis announcing in the budget recently, a state based bank levy, we examine his assertions in a game of "Fact or Crap"

1. Tom Koutsantonis asserts that a new tax on the banking sector will ensure 'the sector contributes their fair share'.  

The fact of the matter is that last year alone, the banking industry paid over $14bn in tax.  In terms of tax paid, it is banks first, daylight second.  Banks make the highest contribution by far to help governments at all levels fund essential public services such as hospitals, schools and roads, and income support for those in need.  In fact, banks paid 55.3% of all tax paid by Australia's top 200 listed companies.  Food and Staples retailing paid 5.4% and the Metals and Mining industry paid 3.8%.  Source of this information is special report published by Australian Bankers Association.

Therefore we declare Tom Koutsantonis' first assertion is CRAP.

 

 

2. Tom Koutsantonis asserts that banks are earning super profits and therefore should pay more tax.

 

If banks in Australia truly were earning 'super profits' investors would clearly be able to see a material increase in financial ratios such as bank margins, and return on equity.  The first chart shows return on equity over the past 30+ years.  If banks were earning super profits this graph would show an increased return on equity, whereas the fact of the matter is that return on equity has been relatively stable over the past 30 years.  And while Australia's banks are profitable, this is something that Australians actually benefit from not only in their superannuation fund investment returns, but also having access to credit from a stable financial system to purchase houses, cars, businesses etc.   

The second chart shows the journey of bank interest margins over the last 20 years.  If banks were making super profits, margins would not be decreasing which is clearly what the chart demonstrates.

Tom Koutsantonis' second assertion is also CRAP.

 

3. Tom Koutsantonis asserts that banks should pay extra tax as they have closed branches.

We sourced information from the IMF Financial Access Survey (2015) which outlined the number of Commercial Bank branches per 100,000 adults and some of the key results are as follows:

 

Australia 28.7 branches per 100,000 adults

Canada 23.6

Germany 14.1

Greece 26.8

Netherlands 13.9

Norway 7.7

North America 28.2

OECD Average 23.6

 

Arguing an organisation which rationalises its physical locations should pay higher tax liabilities would result in some interesting tax outcomes for the likes of Book stores, Record/CD shops and of course Video rental shops that have all changed materially at the hands of technology.

Australia has one of the highest rates of bank branches to populations in the world, and it is with this in mind that we declare that Tom Koutsantonis' third assertion is also CRAP.

 

And for further interest from the same IMF report, Australia has 164 ATM's per 100,000 adults, providing ease of access to cash.  This compares to OECD average of 75.9 ATM's per 100,000 adults, further demonstrating that banks provide an above average service to Australians.

 

GEM Capital believes it is poor policy to single out an industry and impose a specific levy in a particular geographic location.  This is likely to distort the integrity of the tax system in Australia and lead to poor economic outcomes for South Australia.

 

We conclude this article by quoting some interesting sources who have shown their concern about the proposal to introduce a state based levy in South Australia on the banks:

 

"My concern is that it will damage investment.  It's quite a different set of circumstances from the federal tax".  "A state based levy could make the region uncompetitive" - Nick Xenophon, who is opposing the SA Bank Levy.

"There is no justification for this state tax other than a grab for revenue.  It is clearly open season for governments attacking big banks, but it is their shareholders who will bear these added taxes"  Ross Barker - Australian Foundation Investment Company

"In the case of South Australia the tax is avoidable by not doing business there and that's a very bad outcome for bank customers of that state" - David Murray former CEO of Commonwealth Bank

 "Koutsantonis shows his lack of understanding of the profitability of the banks relative to their capital by quoting the annual profits number..... and he might get a shock when they start shutting down local operations in Adelaide in response to the tax, which woul be a rational response"  Tony Boyd Australian Financial Review

"Australia is becoming a laughing stock of global investment circles as erratic governments - state, territory and federal - carelessly undermine confidence by chop and changing the rules of doing business" Jennifer Westacott - Business Council of Australia

 

GEM Capital is concerned at the anti-business messages the SA Government is promoting in this levy and believes it is highly likely to result in reduced investment in South Australia which is likely to result in reduced employment over time.  From an investment perspective, actions of Australian Governments like this are materially increasing "Sovereign Risk" of investing in Australia which is also likely to negatively impact the Australian economy over time.  It very much validates our view to look to continue to invest outside of Australia in search of investment returns.

 

These opinions are my personal views and not necessarily those of the Dealer Group we are licensed through.

 

 

 

 

 

Mark Draper and Shannon Corcoran (GEM Capital) recently met with Clay Smolinski to discuss the frail Italian Banking system, and to determine whether it will be at the epicentre of the next crisis.

 

 

Thursday, 01 June 2017 07:37

Is Telstra good value after the dip?

Written by

Written by Tim Kelley - Montgomery Investment Management

 

Telstra (TLS) is not high on the list of businesses we would most like to own. Having said that, it is not a terrible business, and at the right price it makes sense to own it, particularly given its steady dividend stream. So, with TLS’s share price down around 20 percent over the past year, we decided to assess its value.

One of the appealing features of TLS is its stability. Over many years, the company has delivered consistent revenues at consistent margins for consistent earnings. On the face of it, this should allow us to value the company fairly readily.

However, for several reasons the future for TLS looks different to the past: Firstly, migration to the NBN will take a large bite out of TLS’s fixed-line business, offset somewhat by a series of one-off and recurring payments it will receive from NBN Co. for handing over its copper and HFC networks. Secondly, there is the matter of TPG Telecom (TPM) planning to become Australia’s fourth mobile network operator.

Given this, we think it makes sense to split the valuation into four components:

A “business-as-usual” valuation of TLS based on historical financial metrics; A valuation of the earnings “hole” left by the migration to NBN; The present value of payments TLS will receive from NBN Co; and An adjustment for the impact of increasing competition in mobile.

We consider each of these in turn.

“Business-as-usual”

As noted above, TLS has historically been a very stable business, and the “business-as-usual” valuation is a relatively straightforward extrapolation of historical financials. Using an 8% cost of capital and a 1.5% p.a. growth rate, we arrive at an estimated value of just under $50 billion for the equity in TLS, or around $4.20 per share.

NBN earnings hole 

We then come to the NBN earnings hole. TLS has provided guidance as to the EBITDA impact it expects when the migration is complete, and our “business-as-usual” valuation gives us an implied EBITDA multiple with which we can capitalise this impact. We estimate that this amounts to a fairly meaningful $17.4 billion of equity value, equivalent to around $1.46 per share.

Payments from NBN Co.

Happily, this earnings hole is largely compensated for by one-off and recurring payments it expects to receive from NBN Co. TLS has provided estimates of the value of these payments, but we believe the discount rate applied to these payments should be lower than the one TLS has used (which is generally 10%). We have evaluated TLS on the basis of an 8% WACC, and we see these payments as having somewhat lower risk than the overall TLS business, and so we apply a 7% discount rate. On this basis, we estimate the value of payments yet to be received from NBN Co at around $16.9 billion after tax – a larger figure than quoted by TLS, and one that substantially makes up for the value lost from TLS’s fixed line business.

Increasing competition

Finally, we consider the impact of TPM’s entry into the mobile market. As a point of reference, we note the impact of the 2012 entry into the French market by low-cost operator, Free mobile. In that example, ARPUs for the leading player, Orange, declined by 10-15% over several years, as the new entrant moved to take market share of 15%.

This sort of outcome would imply a very material loss of value for TLS. However, for a range of reasons, we expect TLS to experience a less dire outcome. These reasons include:

Free benefitted from a roaming agreement with Orange. However, the ACCC has indicated it does not support roaming in Australia. This is an important constraint on TPM which plans to spend relatively little on its network build and will achieve relatively limited population coverage; Approximately 53% of TLS mobile subscribers are outside the major cities, and therefore less vulnerable to competition, as TPM focuses its network spend on the major cities; A large part of TLS’s mobile revenues are derived from business subscribers, who would also be less susceptible to a TPM offering; and Across its entire customer base, TLS maintains a price premium position in the Australian market due to perceptions of coverage and quality. TPM’s low-cost offering will more directly impact Optus and Vodafone (and is thought to potentially be a strategy to pressure Vodafone into a consolidation).

Our valuation of Telstra

Taking these factors into account, we anticipate a couple of percentage points of lost market share for TLS, and perhaps a 5% decline to ARPUs. On this basis, we estimate that the value of TLS falls by around $4.3 billion, or around $0.36 per share – still a material impact.

We then assemble the different valuation components into an overall picture, as follows, to arrive at an estimated value for TLS equity of around $44.8 billion, which equates to around $3.77 per share.

Against today’s share price of $4.42, this makes TLS look around 15% expensive, although it should be noted that we consider large sections of the Australian equity market to be expensive, so this conclusion perhaps comes as no surprise. It is also worth noting that different judgements around discount rates might lead other analysts to a different conclusion.

The Montgomery Alpha Plus Fund – which is fully-invested and uses a machine learning model analysing many different variables to drive investment decisions – holds a modest position in TLS in its long portfolio. For the Montgomery Fund, however, we are particular about valuation and are happy to hold cash when value is scarce. Accordingly, TLS does not find its way into our long-only funds at the current price, regardless of its dividend-yielding appeal.