Telstra singing right tune, in wrong key

David Thodey may have some good ideas about where Telstra needs to go, but his direction requires hard change — and more sacrifice than many shareholders seem willing to afford. Yet as Telstra's dividends-at-any-cost strategy nears its breaking point, can Thodey keep guiding the good ship Telstra through its hard U-turn without losing key passengers overboard?

Of all the sound bites from Telstra's marathon Investor Day presentation, the comment that stuck with me most was David Thodey's comment that "if you don't have a fixed broadband service, you can't sell a compelling IPTV solution".

He's right: given the importance of networked services, it's premature for anybody to totally give up on fixed broadband just because copper is hitting the wall. However, with analysts nearly unanimous in their "meh" reaction to the day, it seems Telstra's biggest problem is not its innovation, services or market position, but its continuing attempts to rationalise its business while mollifying vampiric investors with cash bribes disguised as dividends.

Investors want one thing from Telstra, but how long can Thodey keep supplying it?
(Screenshot by David Braue/ZDNet Australia)

It's hardly contentious to argue that Telstra is a company in crisis. Increasing competition has put it on the defensive, forcing it to retreat from unapologetic premium pricing even as a shift from fixed-line phones has sucked revenues dry. The company faces looming competition from NBN Co, regulatory uncertainty that's being drawn out by the Coalition's new culture of opposition-at-any-cost, and is beating a path away from speculative investments such as its SouFun Chinese venture.

These things are understandable, and Telstra is to be commended for its attempt to innovate its way around competitors and into the future. Its Next G network, Next IP backbone project, and even novel customer lock-in strategies like its T-Box and T-Hub all represent more innovation than Telstra's competitors have been able to muster (although even that is rapidly changing as Foxtel, FetchTV and others mount new challenges).

Yet good ideas only go so far; all this innovation counts for nothing when key executives promise investors to maintain arbitrary dividends — representing an increasing percentage of the company's languishing share price. These dividends are being supported not by profits alone, but by dipping into the cash the company keeps under its mattress. This makes them less of a reward for good performance than a bribe to stick around for the next, presumably-better, act.

Eventually, the pool of resources from which Telstra can draw these incentives is going to run dry. That could be sooner rather than later, and Thodey knows it: "sustaining of shareholder returns is only possible if we make the transition in 2011," he said. "Telstra's performance could be better if we did not change strategies, but the benefits would be short-lived. We will simplify our business and grow new revenue streams to offset the PSTN impact."

I recently re-watched the film Jerry Maguire, in which Tom Cruise's mid-life crisis sports-agent protagonist struggles to explain to star client Rod Tidwell why he isn't securing megabucks contracts. These things are complicated, Maguire explains, but Tidwell isn't interested in the whys and wherefores: "I hear that you hear what I'm saying," he says to the manager who will do anything not to lose his star client, "but do you truly hear what I'm saying?" The classic "show me the money" scene ensues, but Maguire is exasperated when he hangs up the phone because he knows it's all a lot of hot air.

Dividends are being supported not by profits alone, but by dipping into the cash the company keeps under its mattress. This makes them less of a reward for good performance than a bribe to stick around for the next, presumably-better, act.

Substitute Thodey for Jerry Maguire, and Telstra's collective investor base for Tidwell, and you have a pretty good assessment of the company's current situation. Thodey is playing along with the investors by showing them the money — and, in some measure, he has to so as to avoid a massive flight of capital from the company. Yet at the same time, he knows things have to fundamentally change for the company to reshape itself effectively. He's clearly someone with a lot of ideas about what this future might look like, but his entreaties are falling on deaf ears because investors are only interested in numbers — and Telstra's are shifting with tectonic certainty.

But if this is how Telstra's shares are performing even with artificial dividends in place, how would it go if those props were removed? The mind boggles.

It's worth noting here the success of Apple, which is an undeniable innovator and market success, but does not pay any dividends to its shareholders. Investors are none too happy about this, mind you, but they keep funnelling money into the company. The value for Apple investors is not in getting cash handouts, but in owning an ever-appreciating piece of a company that has developed a sure-fire strategy for printing money. Apple has tens of billions in the bank, the goodwill of the investor community and an innovative product pipeline that is running rings around its competitors. People want to be part of the revolution Apple is perpetuating because Apple is creating new value — not just rearranging deck chairs on the Titanic so everybody can get a nicer view of the water.

Telstra is also an innovative company and it is rightfully trying to innovate its way out of the hole it's in. There's no reason Telstra can't sustain a strong market presence as a fixed-fibre player (as opposed to its previous fixed-copper monopoly): you will never, as Thodey pointed out, be able to deliver pay TV or other high-bandwidth services over wireless. But Telstra can supply both, and build its strategy around that dual-delivery model.

But it can't do this without both fundamentally shifting its models — and investing heavily, both here and in fast-growing overseas markets. Telstra is, simply put, a blue-chip share that needs to innovate like a dotcom to survive in the dog-eat-dog telecoms market. Is this really possible by throwing good money after bad and laying off employees in their thousands while executives let investors suck the company's coffers dry with unsustainable dividends?

Telstra is walking a fine line between harsh realities and necessary compromises to mollify a self-interested group of investors that isn't interested in the Telstra That Could Be, but is baying for maintenance of the Telstra that the Howard Government created when it priced Telstra shares well out of their sustainable range. Instead of shouting "show me the money", these investors should be shouting "show me the execution" and allow their share-market darling to be judged on its own merits, as Apple has. Dividends may follow later, but for now that money should really be going to help deliver the change Telstra needs — and, perhaps, even keep a few people actually working for the company.

In the end, Telstra's current strategy will leave it a shell of a company with lots of great ideas but nobody to execute them, and no investors willing to fund them because they've become so accustomed to Telstra-the-cash-cow that they have no interest in Telstra-the-telecoms-innovator. Thodey may sing the praises of Project New and the company's push to improve customer service like it's some sort of revelation, but he's simply singing in the wrong key until the company can muster the will to make some very hard, very necessary decisions.

What did you think of Investor Day? Is Telstra singing the right tune? And can it turn itself around while keeping all of its stakeholders happy?