Following the government’s announcement of its commitment to sell $8 billion of its Telstra (TLS) holding in October/November, made late on Friday, three of Australia’s nine leading stockbrokers have produced reports outlining their views this Monday morning.

There have been no changes to the brokers’ recommendation ratings. As at today, of nine brokers, three call Telstra a Sell, five a Hold and one a Buy.

Through all the ups and downs of Telstra’s battle with the ACCC, abandoning of FTTN, and downgrade in profit guidance, Credit Suisse has remained the telco’s sole champion. Citi rates Telstra as Outperform and has maintained a 12-month target price of $4.78 since early this year. That target is 16% above the next high mark of $4.11 and 33% above the low mark of $3.60.

Averaging broker targets (from those who provide them) results in a figure of $3.97, which currently seems a world away. It also seems lofty compared to the estimates as to what price the government will need to offer in order to complete the sale.

The Sydney Morning Herald this morning suggested “brokers expect the retail offering to be priced at $3.10 to $3.30”. SB Citigroup is the low marker amongst the nine brokers, and suggested institutional demand is likely to rest between $2.80 and $3.00. Citi provides the lowest target of $3.60 and rates Telstra a Sell.

The reason the government provided for going ahead with the sale was to alleviate the “overhang” of stock, such that the Telstra price would never be able to improve while the market knows half the company is yet to be sold. The question is: does proceeding with the sale now remove this barrier?

Credit Suisse believes so, suggesting it “now clears the way for the market’s focus to return to Telstra’s operating fundamentals”. Other brokers agree that the overhang will now be crystallised. The other significant commitment made by the government is that the remaining $14.5 billion stake will be transferred into the Future Fund and escrowed for two years. This means that while further overhang will remain, there is a two-year window of opportunity to exploit a weakened stock price and an extremely attractive yield.

T3 will be sold in two instalments, and Citi assumes that if T2 is a guide, the first instalment will priced at $1.80 for retail investors and $2.00 for institutions. As investors receive all of the dividend in the first year despite having only made one instalment, Citi calculates the effective yield to retail investors is 14.7%

This is a figure unheard of for an equity instrument of Telstra’s size. If it were a debt instrument it would be afforded “junk” bond status at that sort of yield. But Telstra is unlike most global equity instruments.

In order for investors to crystallise the yield, the Telstra stock price must not fall from its issue price at the end of twelve months (as T2 did — significantly). Investors are obliged to make the second payment after 18 months. Otherwise they must at some point sell their first instalment which would thus crystallise any loss occurred. Will Telstra rally from its sale price?

Broker’s targets suggest it should. However, most brokers warn of entering into Telstra shares ahead of the issue, believing the overhang will provide its last influence before $8 billion worth of stock can find a buyer. The most significant effect of the first T3 sale is that the government will no longer be a significant shareholder. Regulatory problems aside, brokers agree the removal of government majority influence will provide Telstra with the opportunity to remove inefficiencies from within the company, particularly in labour. Across broad metrics, notes Credit Suisse, Telstra is 40% less efficient than its regional peers.

On the other hand, SB Citigroup points out that a sale below $3.00 only brings Telstra into line on a price earnings ratio basis (9x on FY07 estimates), with European telcos. Not all of the detail has been divulged as yet, and brokers will wait till after the sale has proceeded before confirming their next calls. In the meantime, share price weakness is the expectation.

Of the three brokers so far listed as co-ordinating the sale, UBS rates the stock as Neutral with a target of $3.66. The analysts have questioned Telstra’s long-term earnings sustainability. ABN Amro similarly rates Hold, but its analysts are far more optimistic with a target of $4.11. Goldman Sachs JB Were’s analysts are concerned that Telstra will need to price its services aggressively in order to maintain market share, and as such have maintained an Underperform rating on the stock in the short term. Weres does not set targets, but it values the company at $3.62.

It’s a wait and see game for retail investors, with the attraction of the yield the obvious impetus to go again on a company that has provided so many Australians with grief. Not even the government will comment on the value of the offer, and brokers, in general, are not expecting any fundamental changes in value in the medium term.

Peter Fray

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Peter Fray
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