Telstra, the robot farming company? Surely that can’t be correct. Yet it was the topic of an interesting article in last Friday’s Australian Financial Review.
This got me thinking. Surely such a project is a distraction for Australia’s largest telecommunications company. Why would management be throwing resources at robot farming equipment? And for that matter, why does Telstra employ a chief scientist?
The Looming Earnings Hole
Telstra knows a lot about digging holes. By far the biggest hole the company faces relates to future earnings. Once NBN payments start to wind down in about five years’ time, Telstra will need new earnings streams to replace declining fixed line profits.
How big is the potential size of this earnings hole? Let’s look at Telstra’s disclosure of earnings before interest, tax, depreciation and amortisation (EBITDA).
Fixed line EBITDA declined by $158 million in 2016 and is showing no signs of leveling off.
Data & IP EBITDA declined by $101 million in 2016. This division contains legacy technology that is being used less and less (similar to dial up modems).
One-off NBN EBITDA grew to $558 million and will presumably keep growing over the next few years. But this will disappear once the NBN roll-out is complete.
Adding these up, we can see that close to $1 billion of annual EBITDA will need to be replaced. And that’s just to enable Telstra’s EBITDA to stand still, yet alone grow. These are big numbers.
Can New Business Ventures Fill the Void?
Which brings us back to robot farming. Telstra clearly needs new earnings streams. But why invest in this seemingly unusual project?
I didn’t have to look far for the official answer. Page six of the 2016 annual report states that its “vision is to become a world class technology company.” That sounds like a sensible strategy. Telecommunications and technology seem to go hand in hand.
But where in the annual report could I find Telstra’s robot farming revenue and even more technology revenue from other projects?
Nowhere. That’s where.
Of Telstra’s $27 billion of revenue, $26 billion comes from telecommunications services. Then there’s a small division called “Other sales revenue.” This includes the payments Telstra receives for allowing the NBN to access its infrastructure. It also includes “new business,” which refers to ventures, software and health. Telstra shareholders needn’t worry about the latter. Management haven’t diversified into pathology or aged care. Its health business provides software and IT solutions for the healthcare industry.
I couldn’t find any more information about this eclectic division in the annual report so I turned to Telstra’s 2016 financial results presentation. Out of the “Other sales revenue” division’s $1 billion of revenue, over three quarters comes from the NBN. The rest comprises “new business” revenue, roughly of $229 million. This is less than 1% of group revenue.
But perhaps it is highly profitable? Unfortunately not. New business ventures lost $246 million in 2016. In other words, its costs were more than double its revenue. And that’s costs before interest, tax, depreciation and amortisation.
Perhaps new business ventures will turn profitable by the time NBN revenue dries up. Why else would Telstra spend around half a billion dollars on ventures that aren’t close to making a profit?
A cynic might suggest that Telstra can partially fill its earnings hole by closing down these ventures, saving $246 million.
Therein lies the problem ahead for Telstra. New business initiatives like robot farms just won’t move the needle for a business that generates $10.5 billion of EBITDA. Neither will the cost savings generated by closing them down. But they do provide a distracting diversion in the meantime.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.