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Why I think the merger of Vodafone and TPG Telecom (ASX:TPM) is good news for Telstra shares

Shareholders in the major telcos have finally had something to be happy about over the last month.

Since the beginning of August, the share price of Telstra Corporation Ltd (ASX: TLS) has increased by 11%, while shares in Vocus Group Ltd (ASX: VOC) have jumped 24%.

But the biggest gainers have been TPG Telecom Ltd (ASX: TPM) and Hutchison Telecommunications (Aus) Ltd (ASX: HTA). Shares in TPG have surged 42% higher, while Hutchison (which owns a 50% stake in Vodafone Australia) are up an unbelievable 160%.

The big news that has sparked the rally in the telecommunications sector has been the announcement of a proposed merger of equals between TPG and Vodafone Australia.

According to the joint announcement, the new company would have an enterprise value of approximately $15 billion, annual revenues of over $6 billion and EBITDA of over $1.8 billion. It is hoped that the merger would create a new company with the financial strength to better compete with Telstra and Optus.

So why the resurgence in the share prices of the other telcos?

You’d think the merger would have Telstra and Optus shareholders shaking in their boots. A new telco with significant infrastructure and a customer base combining TPG’s 1.9 million fixed line subscribers and Vodafone’s 6 million mobile customers could pose a real threat to Telstra’s and Optus’s market dominance.

But the merger also has the effect of reducing competition and overall risk for all players in the industry. As was reported recently in the Australian Financial Review, Morgan Stanley analysts predict that the merger will “lower the risk profile of industry returns”.

Basically this means that with fewer players there is necessarily less competition, even in an aggressive price war.

The Vocus share price has also increased following the merger announcement. Vocus provides telecommunications services and network solutions to business and corporate clients and also stands to benefit from a smaller, less competitive industry.

Last month, Vocus CEO Kevin Russell told Fairfax Media that with TPG and Vodafone focussed on sorting out the finer details of their merger, Vocus had an opportunity to expand.

“If competitors are focused on transactions, rather than competing in the market against us, then we will be running even harder to take share from them,” Russell is quoted as saying.

So what does this mean for investors?

As pointed out by Morgan Stanley analysts, the TPG/Vodafone merger could change the risk/return profile of the telecommunications industry, and this could offer benefits to shareholders.

The short term gains observed over the last five or six weeks probably won’t be repeated, but investors picking up shares in any of the major telcos now could be locking in more dependable long term returns with lower risk.

Foolish takeaway

Personally, I think the big winners out of all this might be Telstra and its shareholders.

It used to be that Telstra was one of the most bankable companies on the ASX, with a high dividend yield and good long-term growth potential. But intense industry competition and the loss of some $3 billion in revenues to the NBN has massively eroded Telstra’s market dominance. Prior to the August resurgence, Telstra’s share price was at its lowest point in about 7 years.

I already thought Telstra had been oversold and was due for a rebound. But the possibility of easing price competition within the telecommunications industry as a result of the merger of TPG and Vodafone might see investors start flocking back to Telstra.

It still offers a dividend yield of close to 5%, which stacks up favourably against its competitors. And if the competitive forces that had been squeezing its margins are relaxed the company could start delivering renewed profit growth for its shareholders.

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Motley Fool contributor Rhys Brock owns shares of TPG Telecom Limited and Vocus Communications Limited. The Motley Fool Australia owns shares of and has recommended Telstra Limited, TPG Telecom Limited, and Vocus Communications 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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