Digital transformation can reinvigorate telecoms but will it pay dividends?
Communications service providers (CSPs) are moving from talking about digital transformation to engaging in real projects. However, these aren’t cheap and investor demands for uninterrupted dividends could cause momentum to stall, writes George Malim.
The telecoms industry is caught in the cleft stick of a no-win situation. If CSPs can’t reduce the dividends they pay, they can’t free up cash to invest in digital transformation and generate revenues from new services. This means they can’t move up the value chain to provide more profitable services and relegates them to a business model of managed decline. Within this, their businesses will become similar to traditional utilities except they will be hampered by being in an industry where commoditisation and market saturation mean all paths lead to zero growth.
For some – typically conservative – investors, that low single digit return will be acceptable and meet their goals but even this is under threat. Telecoms essentials, such as investing in 5G networks and even more fibre, will continue to afflict even pipe businesses’ dividend performance. Doing this in addition to investing in new services and digital transformation requires a radical rethink about investor returns.
A brave few are making this case. Telstra in Australia, for example, has announced a significant reduction in dividends starting from its 2018 financial year. Previously, the CSP typically paid close to 100% of earnings, reported the Sydney Morning Herald, which added that shareholders will have to: “wear a 30% cut in the total dividend to A¢22 per share.”
“Whether we like it or not, we have to accept the world around us has changed dramatically and Telstra is having to change just as dramatically as well,” John Mullen, the chairman of Telstra, told the newspaper, noting that tech giants such as Amazon do not pay out dividends because they reinvest to grow market share, reduce prices and enhance product offerings.
“We would never consider not paying a dividend … but if one hadn’t and had behaved the same way as some of those other companies we would have a war chest of A$50 billion,” Mullen said in the Sydney Morning Herald article, illustrating the scale of CSP cash apportioned for investor dividends.
It’s a brave move to tell investors to take a longer term view, drawing less return in the short to medium term in order to back the digital transformation strategy of a CSP. “A lot of operator CEOs feel they’re already on the naughty step so they may not feel emboldened to say: I know what you want but if I don’t invest I can’t compete,” said Angus Ward, the chief executive of digital platform solutions at Bearing Point.
Much will rest on the investor composition of CSPs – and those investors’ attitudes. “I think it’s about understanding practicality and being clear about what the transformation goal is,” said Gordon Rawling, the vice president of marketing at Huawei’s carrier software business unit. “If you’re 65% owned by pension funds they’re not going to be particularly happy about reducing dividends to increase investment. Therefore you have to understand whether digital transformation is an achievable journey to go on.”
“The dividend point is really important,” added Rawling. “As an industry we’re not talking about the pace at which we’re driving efficiency to liberate free cash. Dividends are not going away, so it’s about driving 20-30% efficiency into the business.”
The only viable equation to fund a digitally-transformed CSP therefore seems to be to invest – hopefully modestly – in technologies that result in efficiency gains that create sufficient free cash both to keep investors happy and to enable investments in digital transformation.
“This is the next five-to-ten year battle for the survival of what we think the telecoms industry is,” said Martin Creaner, a consultant and former president of TM Forum who has recently authored a book entitled ‘Transforming the Telco – Developing the Instinct for Survival in the Digital Economy’.
“In the other corner is the hyperscale over-the-top model, so are we willing to see the traditional model fade or are telcos capable of doing things that ensure their survival?” he added. “Will telecoms be an industry that is capable of feeding the ultimate shareholders?”