The share price of our telcos enjoyed another stellar run today with shares in Telstra Corporation Ltd (ASX: TLS) hitting a fresh five-month high following news of merger talks between its rivals. The stock jumped 2.1% to $3.34 while the broader S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index lost 0.2%. The gain is even more impressive if you consider that fellow telco TPG Telecom Ltd (ASX: TPG), which is exploring a merger with Vodaphone Australia, gave up its strong early gains to close 1.3% higher at $7.75. But the market is getting ahead of itself as the consolidation is no silver bullet…
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The share price of our telcos enjoyed another stellar run today with shares in Telstra Corporation Ltd (ASX: TLS) hitting a fresh five-month high following news of merger talks between its rivals.
The stock jumped 2.1% to $3.34 while the broader S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index lost 0.2%. The gain is even more impressive if you consider that fellow telco TPG Telecom Ltd (ASX: TPG), which is exploring a merger with Vodaphone Australia, gave up its strong early gains to close 1.3% higher at $7.75.
But the market is getting ahead of itself as the consolidation is no silver bullet for the ails of the embattled industry, according to Citigroup who is urging investors to sell Telstra into the rally.
Shares in our largest telecommunications company have surged 14.7% since TPG confirmed media speculation on the so-called merger of equals. Shares in TPG staged a more impressive 47% run-up but that’s nothing compared to the 86% gain by Hutchison Telecommunications (Aus) Ltd (ASX: HTA) – the 50% owner of the local Vodafone network.
Bulls believe that the consolidation of the industry to three players (Telstra, Optus and TPG/Vodafone) will bring price rationality back to the highly competitive mobile market. TPG’s impending entry foreshadowed big mobile plan price cuts and all-you-can-eat data.
The other advantage to TPG is that it doesn’t need to spend big to build out the rest of its mobile network if it was going at it alone.
But Citigroup noted that the merged entity will still have very high levels of debt on their balance sheet as TPG and Vodafone Australia are both over-geared. Then there is the question of regulatory approval, although I don’t see this as being a big issue given their market position.
However, the time it could take to get the green light from authorities could complicate the upcoming 5G spectrum auction in November.
The benefits to Telstra look even less certain to the broker. Citigroup’s “sell” recommendation on the stock stems from the NBN and the associated margin pressure from transferring customers to the national broadband network.
The broker also believes that industry consolidation won’t arrest Telstra’s mobile earnings decline and that the market leader will still struggle to right-size its high cost base.
“While a TPM-VHA merger would be a clear positive for TLS in that the mobile market would remain at three operators, in our view, the bigger issue in mobile is that TLS is currently over-earning with an unsustainably high market share in mobile already,” said Citigroup.
“TLS’ expects mobile industry revenue to fall 2-3% in FY19e; this is not due to TPM, it is a reflection of intense competition for market share in an industry that has stopped growing. TLS mobile will likely still decline, just not as much.”
I bought shares in Telstra as the stock collapsed well under $3.00 as I thought too much bad news had been priced into the stock. I believe the run-up in Telstra’s share price is warranted but clearly the valuation argument doesn’t hold out at current levels, even though I don’t think the stock is expensive.
Having said that, those sitting on handsome gains may want to consider taking some profit off the table. Regardless of the fundamentals, industry consolidation won’t cure the share price volatility.
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Motley Fool contributor Brendon Lau owns shares of Telstra Limited and TPG Telecom Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited and TPG Telecom 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.