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What you need to know about Telstra’s (ASX:TLS) plan to split in two and sack 8,000 staff

Australia’s largest telco showed today that it’s serious about winning back investors after a painful de-rating of the stock that has left it at the bottom of the share price performance table for blue-chip stocks.

Telstra Corporation Ltd (ASX: TLS) is throwing everything bar the kitchen sink at this endeavour and announced a deeper cost cutting drive and a big restructure in its business that will set the scene for a potential spin-off of its infrastructure assets.

But the market was unimpressed and sold off the stock, which tumbled 5.2% at the opening bell to $2.76 a share as investors were disheartened by management’s FY19 underlying earnings before interest, tax, depreciation and amortisation (EBITDA) guidance of $8.7 billion to $9.4 billion.

This is around 15% below consensus estimates if the mid-point of the guidance is used.

Investors may also be unconvinced that the dramatic changes will position Telstra for growth in an industry that is increasingly being buffeted by competitive headwinds with an aggressive TPG Telecom Ltd (ASX: TPM) nipping at its heels and technological changes.

However, this dividend dog is on the right path, in my opinion, and I think Telstra should move back to investors’ buy list for FY19 as the radical changes will go a long way to protect the sustainability of its precious dividend stream.

Let’ face it, it’s not growth that investors should be after if they invest in Telstra. It’s all about the fat fully-franked dividend.

Telstra is the most widely held stock by retail investors who are drawn to its regular dividend payments. This makes the stock a hot favourite by SMSF and income-seeking investors.

Telstra bulls were hoping that management would announce a bigger-than-expected cost cutting drive, or split in the group into two entities – an infrastructure company and a sales company.

While Telstra’s chief executive Andy Penn knows he needed to make a bold move to save the slumping company and has embraced both ideas today at the telco’s Investor Day presentation.

Telstra announced it will squeeze an extra $1 billion in cost cuts to bring total savings of $2.5 billion by FY22. This will be achieved by flattening the organisation and removing 8,000 full time staff and contractors.

This is significant because Telstra is one of the most cost heavy telcos in the world and if Penn can bring its operating cost ratio towards the global average, it will unlock significant amounts of free cash that can be used to satisfy dividend-hungry investors.

I still believe management will cut its 22 cents a share distribution as Telstra will have to incur restructuring costs before it can reap the cost savings, but at least now there’s a light at the end of the tunnel!

Further, Penn has also flagged $2 billion worth of non-core asset sales to help streamline the organisation and unlock cash from its asset-heavy balance sheet.

Management has reaffirmed its 22 cents dividend for FY18 but said it will update the market later on the expected payout for the new financial year.

The potential split in Telstra is also exciting news given that past divestments have almost always created additional value for shareholders.

Some recent examples include BHP Billiton Limited (ASX: BHP) with South32 Ltd (ASX: S32) and National Australia Bank Ltd. (ASX: NAB) and CYBG PLC/IDR UNRESTR (ASX: CYB), or Clydesdale Bank.

Penn is putting all the company’s infrastructure assets into a new division called “InfraCo” that will have its own chief executive who will report to Penn.

The move is in preparation for a spin-out or sale of the business once the rollout of the national broadband network is completed.

Shares in Telstra have collapsed 40% over the past year when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is up 6%.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, CYBG Plc, National Australia Bank Limited, South32 Ltd, Telstra Limited, and TPG Telecom Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited and TPG Telecom Limited. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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