Management of AE Portfolio Conservative Holding Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY) announced its plan for the estimated AUD11 billion it will receive to transfer its copper-wire network and the customers who currently use it to Australia’s National Broadband Network (NBN).

Rather than announce a specific action, management instead detailed a “capital management strategy” focused on maximizing shareholder returns through both dividends and capital growth, maintaining financial strength and retaining financial flexibility.

The market had hotly anticipated a share buyback in recent weeks, though some held out hope for a special dividend or a payout increase. But, as I noted in a Feb. 28, 2012, AE Weekly, management’s clearly stated preference has been preserving balance-sheet strength and financial flexibility as it continues to invest in its wireless network and adds customers and services.

And this will remain the priority.

The market has reacted positively to Telstra’s announcement, sending the shares up about 0.7 percent by midday in Sydney.

In practice, Telstra aims for a balance sheet worthy of a single-A credit rating. The longer-term objective remains to grow dividends–and to make sure these dividends are fully franked for its broad Australian shareholder base. Management has declared its intention to pay AUD0.28 per share per year for fiscal 2012 and fiscal 2013.

Management is working with the following guidelines: a debt servicing ratio between 1.5 and 1.9 times; “gearing,” or net debt-to-capital ratio, between 50 percent and 70 percent; and an interest cover of greater than seven times.

As of Dec. 31, 2011, Telstra is at the lower end of these ranges, though management expects modest increases over the next 18 months as it funds its share of 50 percent owned FOXTEL’s acquisition of rival cable TV company Austar United Communications Ltd (ASX: AUN) and spectrum payments due in late 2013.

Payments from the NBN transaction are expected to help offset a reduction in free cash flow Telstra will suffer as it gives up its fixed-line business. But the timing of the NBN payments will result in “excess free cash flow” of AUD2 billion to AUD3 billion over the next three years and an “excess capital position” of AUD500 million to AUD1 billion by the end of fiscal 2012.

Management stated in its presentation today a “preference for returning capital to shareholders is via growth in franked dividends.” As things stand, however, Telstra doesn’t expect to have the franking capacity to increase the dividend before 2014.

(Australia-based companies accumulate “franking credits” as they pay tax to the Australian Tax Office [ATO].  A specific company’s “franking account” is only a record of what was paid; it doesn’t contain actual money. The company’s ability to frank its dividend will depend on the balance of this franking account. If the franking credit contains a surplus, the company may declare a fully franked–or 100 percent franked–dividend. If the franking account isn’t large enough, perhaps because it pays tax overseas, then the company may declare a partially franked dividend.)

Management determined as well that a share buyback at this time would not be “efficient.”

Although this announcement didn’t pack the immediate gratification many shareholders were hoping for, it does set the stage for Telstra to further cement its dominance in Australian telecommunications. The NBN will also play a part in growing two of Telstra’s growth portfolios, primarily its Network Applications and Services (NAS) segment, where the company’s “cloud” initiatives take shape, and its media businesses, including the combined FOXTEL-Austar.

In the first half of fiscal 2012 (ended 12/31/11) Telstra realized AUD579 million in revenue from “strategic growth driver” NAS, 19.4 percent above the prior corresponding period. Offerings within Telstra’s NAS segment include cloud computing, unified communications and intelligent networks, which allow numerous services to be offered across its networks. Managed network services revenue grew by 24 percent, or AUD75 million, to AUD387 million, on strong video conferencing demand. The March 2011 acquistion of iVision drove this growth; it contributed AUD34 million to revenue.

Some analysts have forecast Telstra will be able to generate AUD2 billion in revenue from NAS within five years; it’s already on a better than AUD1 billion annualized pace. Last June CEO David Thodey unveiled an AUD800 million spending plan to build out Telstra’s cloud capabilities even further, the first major step of which is construction of a 2,000 square meter data center in Melbourne that will come on line in 2013. The center will boost Telstra’s data capacity by about 40 percent.

The company inked new deals with AE Portfolio Aggressive Holding Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY) and South Australia Health, a government agency, during the period. The new contracts were significant contributors, as was rising business demand for video conferencing and managed data networks. As of early February Mr. Thodey saw about AUD1 billion in potential contracted services available in the market, business for which Telstra will be very competitive.

Right now Telstra is a wireless company: Domestic Mobile delivered revenue growth of 10.9 percent in the half of 2012 to $4.4 billion. But NAS was its fastest-growing segment, and the company is making it a priority.

Management didn’t rule any ideas out over the last several months while it considered its options. A dividend increase, which would have been the company’s first since 2004, never seemed likely, while even a one-time buyback or special payout to shareholders didn’t really square with management’s priority of winning market share based on its leading technology and infrastructure position.

As I wrote in February, “We like Telstra because of its dominant position, its attention to weak spots such as customer service and proven ability to fix same, and the prudence management has shown in focusing on preserving that which makes it a compelling long-term wealth-building story: its scale advantage. A robust network will keep Telstra’s wireless subscriber rolls growing and its data revenue share expanding.”

We will have to wait for a dividend increase. But, with the NBN agreements finalized, Telstra is in great position to grow.

Telstra is a buy on the home Australian Securities Exchange (ASX) and the US over-the-counter (OTC) market using the symbol TTRAF up to our increased target of USD3.50, where it would still yield 8 percent.

If you buy Telstra’s US OTC-traded American Depositary Receipt (ADR) trading under the symbol TLSYY, which represents five ASX-listed shares, don’t pay more than USD17.50.