Telstra and Google investors have the same problem – big innovation spending means low dividends: Kohler

The nasty shock that Telstra shareholders got last week, leading to a 10% drop in the share price to an all-time low, was a version of what’s been happening with Google all year.

Google’s share price has fallen by more than $US250 as investors have been wondering whether they will ever get any cash out of this company. In the second quarter Google beat sales revenue forecasts but net profit fell short of analyst forecasts. Dividends? You’ve got to be joking.

The two companies are not too different at the top line. In the half year to June 30, Telstra made $12.9 billion in revenue while Google made $A14.9 billion. But for Telstra, just $2 billion of this, or 15%, fell to the bottom line, while for Google net profit for the half was $A4 billion, or 27%.

Telstra paid $1.74 billion, or 87%, of its half yearly profit out as dividends; Google paid out none, even though Google has a virtual monopoly of search and seems impregnable. The company has a start-up mentality and pours money back into the business to defend its position and grow its customer base.

Investors are now starting to get sick of Google hoarding its cash and have been slicing its share price, but with Telstra they have to start getting used to it, and don’t like the idea one bit.

In a way, last week’s statement from Telstra that its profit margin will be squeezed by customer growth and retention strategies is just a statement of the bleeding obvious. Did investors and analysts expect the directors to simply milk the cow until its dry?

The real question is whether cutting the cash profit margin from 44 to 40% will be anywhere enough to defend the empire. I doubt it. I don’t think shareholders or Telstra’s board and management for that matter have any idea of the bottomless pit of cash reinvestment they are entering.

For example, Google spent a fortune developing a Smartphone operating system called Android, which has now passed Apple’s iPhone in market share in the United States and will soon pass it globally. That’s because Google gives the software away to developers, while Apple packages its software with phones and sells them for big margins.

When asked how Google is going to make money from Android, CEO Eric Schmidt said recently: “You get a billion people doing something, there’s lots of ways to make money. Trust me. We’ll get lots of money for it”.

Maybe, maybe not, but that’s where Google’s profit is all going: Schmidt, Sergey Brin and Larry Page are pouring it into the future. These days they are trying to figure out the future of search and trying to defend Google’s position.

This is the world that Telstra is now entering. The NBN has accelerated what would have happened anyway, which is Telstra becoming a company that lives or dies by how well it serves its customers.

Will it have to cut the $3.5 billion a year dividend as a result? Of course. No company in a competitive business can pay out 87% of its profit and reinvest so little back into the business, and into retaining and growing customers.

This article first appeared on Business Spectator.