Sensis sale is part of Telstra's plan to shift revenue to clouds of silver linings Google, schmoogle. It was 2005, Telstra's directories business Sensis was estimated to be worth up to $12 billion and the telco's chief executive at the time, Sol Trujillo, was at his arrogant best. We're outgrowing Google in Australia. We're doing more, we're growing faster, and we have more capability, because we're more relevant. Future focus: Telstra CEO David Thodey. Fast-forward to 2014 and it is a very different story. Telstra offloaded most of Sensis this week at a price which valued it at $650 million - well below analyst valuations of up to $3 billion. Trujillo's successor, David Thodey, was not tying himself in knots over the incredible value implosion. "After the [global financial crisis], life changed," he told a conference call after the announcement. The huge destruction of value offers Telstra investors a stark reminder of how much things have changed over the past decade. But the sale also gives a clear indication of Thodey's determination to clear the decks and invest in new business areas to ensure earnings growth will not be swamped by the slow decline of Telstra's traditional telephony business, the fixed-line or public switched telephone network (PSTN). He has swept away several businesses over the past 18 months to focus on what he sees as the telco's future. In mid 2012 Telstra sold its New Zealand business TelstraClear for about $660 million; Trading Post would have gone later that year if the competition watchdog had not kyboshed the sale to News Corp-controlled Carsales.com.au. Just before Christmas, Telstra offloaded its Hong Kong mobile business, CSL. Combined with the Sensis sale, it will raise about $2.5 billion and remove distractions that management cannot afford. "This is a huge change in the willingness of Telstra under Thodey to reshape the business," says BBY analyst Mark McDonnell. It is opening up improved strategic options for growth, and for reshaping the business more towards growth assets. The implosion of Sensis may also offer management a lesson on what ambitions are feasible for Telstra - it may not be capable of building the next Gumtree, let alone the next Google or eBay. But the brave new digital world still offers plenty of opportunity, as an IBM veteran like Thodey would know. Telstra's growth plans rely on its building its corporate and government business, which has much more room for growth than its incredibly dominant retail business, and not just in Australia. In October last year Thodey told Telstra's Investor Day audience: "The reality for a company like Telstra is that we must become more and more involved in Asia. We just don't have an option. Now, the question is how. Thodey was quick to provide an answer. He anointed the Asian region and the company's push into Network Applications and Services, such as cloud computing, as two of Telstra's main growth vehicles. And there is a common thread between the two. With the sale of the Hong Kong mobile business, CSL, and the ramp-up of investment in cloud computing, the answer is clearly to leverage its investment in this new NAS business into Asia. It carries a very different risk-return profile to some of the telco's previous, often disastrous, ventures into Asia. "When you are looking at an international investment strategy, the sunk costs of rolling out cloud services versus the sunk costs of buying a physical network, there's just no comparison," says Ovum analyst David Kennedy. The risk profile of these new NAS services is much lower than investing in networks would be. However, he believes the future of carriers like Telstra lies close to what has always been the core of the business - the network. All of this stuff (Google, Apple, cloud services) requires someone to run a network. You can't do any of it without a network. It is obviously the telcos that are going to be running those networks; so that is going to remain a big part of their business," Kennedy says. Where they can leverage the network into areas like supporting enterprise services, supporting the big global consumer providers like Google and Apple, of course there are opportunities for them there. But the network is the foundation for all that. This is still all a new world for a telco like Telstra that in the past offered nothing more than dumb pipes to customers and must now demonstrate to the sceptics that it can become a technology solutions provider offering cloud computing services to corporates and more. This future cannot come fast enough for Thodey, who risks becoming a victim of the share price's recent success. He is now under pressure to show there is a growth story for the shares, which are now safely camped above $5 apiece for the first time since Trujillo was in charge. Clime Asset Management's John Abernethy says the shares, having posted gains of about 60 per cent over the past two years, are now trading at a price that does not equate to the telco's low single-digit earnings outlook. "Once you pay the sort of price you're paying now, you've got to assume Telstra can slightly accelerate its growth profile from low single digit to high single digit," he says of the stock, which is one of the most significant investments in Clime's portfolio. The problem is how you "move the dial on growth" - as one analyst put it - on a behemoth like Telstra when the high-margin fixed-line business generated $1 in every $4 earned before interest, tax, depreciation and amortisation (EBITDA) last year. The fixed-line and mobile businesses combined generate more than 60 per cent of Telstra's EBITDA. "Telstra is such a big beast that these individual things [such as Asia and NAS] might do well but they have a small impact," says CIMB analyst Ian Martin. Telstra chief financial officer Andrew Penn has offered an idea of how big these businesses need to be to move the dial. Penn says that in order for the new growth sectors like Asia, NAS and media to become "significant" for Telstra, they collectively need to generate more than $20 billion in revenue. Last financial year, these businesses generated about $5.4 billion in revenue, but these included the now-sold Sensis and CSL. The target of $20 billion is clearly a long way away, and part of Telstra's war chest needs to be put towards acquisitions that will help these nascent businesses achieve critical mass. "They do have a bit of a buffer there of a few years to get some of these new growth areas up, but of course it is a limited time frame ... which is why Thodey and the management are putting so much emphasis on investing in growth areas," says Kennedy. The NAS business received glowing reviews for its performance in Telstra's 2013 full-year results, but its current relative insignificance was demonstrated by JPMorgan analyst Paul Brunker. He offered a sober analysis of just how easily the shine of Telstra's result could have been tarnished by a slightly worse performance from either fixed line or mobile. Growth of 20 per cent from the NAS business would have been wiped out by a 0.6 per cent fall in the profit margin of its mobile business, or a 1.4 per cent fall in the fixed-line profit margin. "If mobile starts to feel the effects of competitor renewal at the same time as fixed-product margins succumb to NBN pressure, these divisions are not yet powerful enough to support earnings," says Brunker. It is one of the reasons why management has yet to commit to lifting the dividend on the widely held stock, although the uncertainty over the future of Telstra's $11 billion deal with NBN Co also holds great significance. "The rate and pace of the rollout of the NBN [national broadband network] does influence our free cash flow, which does influence our decisions in relation to capital management," Penn told analysts this week. Renegotiations with the national network provider and the new federal government are set to begin later this month. While Telstra says the value of its original deal is protected by its iron-clad contract, analysts and investors are mixed as to whether the prolonged negotiations, and rollout delays, are good or bad for Telstra. The contract guarantees cash payments for handing over the fixed-line, or PSTN, business, but it means sacrificing profit margins that rose to 63 per cent last year. Speaking of the long-running delays, Abernethy says: "It's good in terms of Telstra maintaining its market shares; the slowness of the government helps Telstra. On the other hand, the NBN proceeds aren't coming to Telstra quick enough, so we win and we lose at the same time. Ovum's Kennedy is more positive about the deal. "The NBN Co deal [allows] Telstra to cash out its incumbency advantage in PSTN through the mechanism of disconnection payments," he says. It puts Telstra in a pretty strong position to manage the decline side of the ledger in comparison to most incumbents around the world. Of course there are get-out clauses that mean the NBN may not get beyond first base. Under the current contract, NBN Co is obliged to pay Telstra up to $500 million "if, having reached a minimum of 20 per cent of NBN Co's fibre coverage target (93 per cent of premises), the rollout ceases." But one-off lumpy payments under the NBN deal are not enough to drive a long-term dividend increase in any case, as Telstra's management has made clear. So, the bigger question for investors is whether Telstra has effectively rebased its earnings to the extent that it can weather any further PSTN decline and confidently increase the current 28¢-a-share annual dividend. While the profit margins will change, there is enough growth from new businesses to keep Telstra's earnings growing, according to CIMB's Martin. "They are still above $10 billion of EBITDA once you take out Sensis and CSL," he says. And I think they can grow that at low single-digit rates while managing that PSTN migration. And I think they can do that well enough that the underlying cash flow will support some gradual increase in the underlying dividend. Clime's Abernethy says it is hard to get bullish on Telstra given the current share price and issues that need to be resolved, such as the NBN uncertainty, but he still sees positives in the stock. "There's not a lot of value in the Australian market full stop, and at the big end of the market Telstra probably stands out on yield," he says. Longer-term threats remain, of course. There is no guarantee Telstra will not face a Google-like threat over the next decade that could target the core of the business as opposed to a prized but peripheral unit like Sensis. We are seeing it in a whole lot of markets that virtually no business is safe in this new world. Players can come out of nowhere with new products," says Abernethy. I'm speculating there, but I just don't see the world in 2025 being similar to the world in 2015. We're massively transforming communications around the world.