Own Telco stocks? Read this.

Own Telco stocks? Read this.

As reported in the Sydney Morning Herald, iiNet (ASX: IIN) customers have reportedly experienced internet speed slowdowns from the later afternoon into the evening post the release of its Netflix offering. Note, watching Netflix doesn’t use up any of the users monthly data allowance.

So why is this occurring? Well, iiNet CEO David Buckingham has blamed Telstra Corporation Limited (ASX: TLS) for the issues. Telstra managing director Mike Wright on the other hand seems to think it’s because iiNet doesn’t have enough capacity on its own network to handle the traffic.

As an investment manager, we have little incentive to jump into this blame game but we are interested in the business ramifications of the issue. For instance, does Australia’s internet infrastructure have the capacity to meet the demands of the very near future?

The way Australia watches media has changed from a time when groups would huddle around a television screen to each group member having their own mini screen in the form of a laptop, tablet or smartphone (traditional television media may have its place, but it’s a space with many less eyeballs).

Online streaming can consume data at the rate of 300MB – 2.3GB per hour (depending on video quality) meaning that most of us will likely need a higher monthly data limit with our Internet Service Provider’s (if not unlimited). And yes, if consumers want more data and speed delivered with a reasonable amount of quality then they’re going to have to pay more for it.

The reasoning behind this is fairly straightforward. We have a telecommunications sector that has largely consolidated into a small number of large players (TPG Telecom Limited (ASX: TPM), Telstra, M2 Group Limited (ASX: MTU) and Singapore Telecommunications Limited (ASX: SGT) – we assume that iiNet is acquired by TPG). Couple in that barriers to entry are rising due to the dominance of these players and structural aspects of the NBN, for example, the capital costs of connecting to 121 points of interconnectivity across Australia. These factors naturally lead to less price competition.

If Australian consumers are downloading more data at faster speeds, they should theoretically begin moving up to plans with higher data allocations. But there’s no guarantee that the price of these plans will be lower than where they are today. In fact due to lower levels of competition and increasing costs, they may stay the same or even rise.

In saying this, I do not imply that we know of a Internet Service Provider that intends to raise prices – merely that the trend seems to point to stable or even increasing prices in the future.

This could mean that incumbent telecommunications may face a fairly favourable operating environment in the future where both the average spend per user is up and increased costs can be passed onto said users – a view in contrast to many others in the industry.

The Montgomery Fund and The Montgomery Private Fund hold and seek to hold positions in the telecommunications sector.

This article is for general advice and educational purposes only. Before you commit to any investment decision we strongly recommend you seek the counsel of a licensed investment adviser.

Scott Shuttleworth is an analyst at Montgomery Investment Management. To invest with Montgomery, find out more.