Telstra dials up cost cuts as big business puts it on hold

Telstra’s chief financial officer, Michael Ackland, has attributed the falling sales to weaker business confidence and a “lull” in big infrastructure deals such as a contract the company signed with the Tasmanian government in 2020 to upgrade emergency radio communications.

Although Telstra is still making money selling cloud computing services, these have lower profit margins than professional services and dragged margins in the broader fixed enterprise group down by almost 8 percentage points to 4.1 per cent.

Telstra previously warned investors that the company was experiencing “headwinds” in data and connectivity services, telling shareholders at its November investor day that growth in the professional services arm would be “less than expected”.

But the extent of the earnings decline has astonished management and analysts as well as investors, and forced Telstra to shrink its full-year underlying earnings guidance.

Surprised by speed of the fall

As she delivered Telstra’s results on February 15, Brady – who is at Barcelona’s mobile world congress, an annual trade show for mobile products – said she was surprised by how quickly sales of professional services had fallen, citing “a very significant drop off” at the end of the calendar year.

She told investors that Telstra would tackle falling sales of calling and professional services immediately. Analysts at Morningstar have been blunter, forecasting Telstra will be taking “the knife to its cost base”.

Telstra hasn’t disclosed the extent of the additional cost cuts. The telco group has already pledged to get rid of about $500 million in costs by fiscal 2025 as part of its T25 strategy but is struggling to meet that target due to continuing inflation in expenses such as utilities.

The overhaul of the enterprise business comes as rival Optus warns of “churn and price erosion” in its fixed enterprise operations and the big telcos encounter more competition from Aussie Broadband and Superloop, which make most of their money selling home internet services.

The so-called “challenger” telcos are still minnows compared with Telstra and Optus but are pushing into the business and enterprise market, forcing the telecoms giants to be more competitive.

Aussie Broadband’s acquisition of software group Symbio allows it to expand the kinds of connection services it can offer to businesses, including helping them make and receive external calls when they are using applications such as Microsoft Teams.

Shares of Aussie Broadband and Superloop surged last week after they each reported strong growth in broadband customers.

Telstra’s share price, by comparison, has slid 3 per cent since it delivered its half-year result and is down 6 per cent over the past 12 months, underperforming the 5 per cent rise in the S&P/ASX 200 Index.

Review in hand

Telstra has already started what Brady says will be “a detailed review” of the company’s enterprise business, which includes Telstra Purple.

Telstra Purple was created in September 2019 and pitches itself as delivering “digital transformation”. It has expanded through acquisitions, buying Melbourne-based cloud computing specialist Versent late last year, and employs about 2000 people.

Its projects have included providing extra mobile infrastructure and services to the town of Exmouth, Western Australia, during a solar eclipse last year.

For the past year, Telstra Purple has been run by Oliver Camplin-Warner, who previously ran Telstra’s international business from Singapore. Camplin-Warner will replace the head of Telstra’s enterprise division, David Burns, when he leaves at the end of this month.

But he may find it tough to convince investors that he can turn the enterprise business around.

While Telstra has acknowledged that structural changes have hurt its data, connectivity and call businesses, it argues that the downturn in professional services is “cyclical”.

But revenue from professional services in previous years has been bolstered by acquisitions, and some analysts have questioned whether it makes sense for Telstra keep services.

Jefferies analyst Roger Samuel asked Brady at Telstra’s interim result to explain whether the company actually had a “point of difference” in professional services.

Brady conceded Telstra needed to focus on products where it had “an advantage” but said the Versent purchase would help Telstra sell cloud and security services.

Telstra remains in favour with analysts thanks to its buoyant mobile phone services business, which delivered $2.5 billion in earnings over the half, up 13 per cent. Most analysts have buy ratings on Telstra’s stock, and like its strong balance sheet and solid infrastructure returns from mobile towers.

But some have questioned what will propel the valuation from here. “The potential issue for investors is Telstra appears to be lacking catalysts outside of CPI-linked pricing performance,” said JPMorgan analyst Mark Busuttil.

Telstra added 344,000 new mobile services over the half, including 63,000 “postpaid” services. It teed up 99,000 “prepaid” services for people who pay their bills and advance, and 182 wholesale services, which are sold through third parties such as Aldi.

Earnings from mobile services were boosted by price increases on postpaid plans and new prepaid and wholesale customers.

Price rises expected

The resumption of international travel following the pandemic and ongoing immigration help prepaid growth, although analysts worry some new customers may be trading down from the more expensive postpaid plans.

Telstra offers a range of postpaid phone plans, using budget brands such as Belong to offer cheap plans such as $29 per month for 25 gigabytes of data.

The cheapest plan under the Telstra brand is $62 a month for 50 gigabytes. Analysts expect the company to announce further price increases by the middle of the year.

Competitor Vodafone, which is owned by TPG Telecom, is increasing prices on many existing postpaid mobile plans by $4 a month. Vodafone will increase customers’ data allowances at the same time.

While Telstra executives admitted to an “uptick in churn” in mid-2023 when the company raised prices on postpaid plans, they say customer turnover (which is running at about 11.5 per cent annually) stabilised after people were offered other options.

Telstra says customers will stick with it because it has a reliable telecommunications network, good cybersecurity, and retail stores that people can walk into.

The brand damage experienced by competitor Optus after its national outage in November has also helped boost sales. Telstra estimates it has picked up tens of thousands of Optus customers over the past six months.