The Inbetweener

Friday 9th March 2001

HIGH GROWTH: The extent of the change under way in Telecom did not really sink in until the changeover to Theresa Gattung

'The risk for Telecom now is that maybe they have left it a bit late. They will now have to pay more than they would have three years ago. They've got a large job ahead of them in Australia whatever happens' - Analyst

Telecom management will be on tenterhooks next week as Cable & Wireless Optus Australia board members begin reviewing final bids for the sale of that company. But what is Telecom's overall strategy?
ROB HOSKING investigates

There used to be a class of rugby forward in New Zealand known as the inbetweener. These were the types who were not quite tall enough to be a first class lock and not quite fast enough to be a top rate loose forward.

They might hover on the edge of All Black status, often warming the reserves bench for a season or two, with hopes simmering, before falling back into the ruck of provincial players.

In the maul that is modern telecommunications, the inbetweener is New Zealand's largest company, Telecom.

By local standards a behemoth, Telecom has faced the danger of being the perennial inbetweener as it has moved to being a regional telecommunications player.

Not large enough to take on the Telstras and the Optuses of this world, Telecom in its role as the incumbent carrier in New Zealand also struggles to be nimble enough to foot it with the new entrant telcos springing up around the region.

Telecom is one of the three bidders for Australia's C&W Optus - the others are Singapore Telecommunications and Vodafone - but sentiment appears to be swinging behind SingTel, according to reports from across the Tasman.

Vodafone is seen as the least likely successful bidder, after Australian competition regulator Alan Fels made it clear last month the company would have to sell off large parts of its business to comply with the country's competition laws.

With Telecom's share price still languishing below $6 - when many analysts a year ago were picking a rise above $10 by now - and with the Optus bid looking increasingly likely to go sour, where is Telecom heading?

The underlying issue throughout the Optus bid saga has been that, for Telecom's size, Optus is a huge bid - and that Telecom is not in a position to pay top dollar for it.

This was why there was a prolonged period of speculation last year that Telecom was linking up with Japanese carrier NTT DoCoMo to buy the Optus mobile arm. That fell through and Telecom has had to hang in there alone. Once seen as the favourite, Telecom has waned in status as the company's bottom line realities became clearer.

"Part of the problem is that the buyer is going to have to - initially - buy the whole of Optus," one analyst said.

"That's quite an outlay. They would then have to onsell it to various buyers, and in Telecom's case, they would probably have to form a separate mobile company in Australia, retaining a controlling or cornerstone stake."

That would have been a big challenge for a company of Telecom's size even if the market had been booming.

But of course it is not. Telecommunications stocks are not flavour of the month any more and investors are even less keen on mobile telco stocks.

The reason is mostly debt. Carriers around the world leveraged themselves to the hilt building new networks, and then went further when various governments began auctioning off spectrum for the next generation of mobile applications. That happened at the same time many dotcom firms reached the end of their credit limits.

"There's not a strong appetite for mobile stocks right now - it was always going to be hard for Telecom and that makes it much harder," another analyst commented.

How important is Optus to Telecom's overall strategy? Important, but not vital, according to most analysts.

"I don't think it's critical," Forsyth Barr research manager Rob Mercer said.

"Their overall Australian strategy is a combination of organic growth and growth by acquisition. The most important thing for Telecom going forward is that their capital spending gets a commensurate return."

Analysts compare Telecom's Optus bid to Air New Zealand's acquisition of Ansett across the Tasman - a transaction the airline's chairman, Sir Selwyn Cushing, admitted was too expensive.

"If you think you must make that sort of move, you have to be very careful that the cost of that growth is not too high."

Telecom's Optus bid had been run in an exceptionally prudent way in terms of how it has been played publicly, he said.

"They haven't run it as a 'must have.' Whether they believe that or not actually doesn't matter - but it makes sure they are less likely to overpay for the asset." It also means the company is less likely to face a backlash from investors if it dips out on Optus.

If, as expected, Optus goes with SingTel, that leaves Telecom requiring a Plan B.

One of New Zealand's most notable transtasman exports, John Clarke - of Fred Dagg fame - once defined Plan B as "Plan A executed with a slight edge of panic."

Telecom's Plan B does seem pretty similar to Plan A but the edge of panic is yet to be seen.

The most likely option for the company is to look at snapping up some of Australia's smaller carriers - and it is not a bad time to be in that market.

"If they missed Optus there are a number of other areas of the Australian market that are not being chased by other players at the moment," UBS Warburg analyst Paul Richardson said.

One.Tel and PowerTel are two companies Telecom executives are said to be eyeing up if they are needed.

One other option mentioned is for Telecom to pull away from building networks in Australia and instead form partnerships with existing network owners - ironically a strategy not dissimilar from that of Telstra on this side of the Tasman.

"Should they not get the part of Optus they're after, there are any number of other opportunities in Australia," ABN Amro analyst Jeremy Simpson said.

"They could surprise us over the next 12 months."

"In some way or other, they really do need to partner with someone else in Australia," another analyst said.

Another option is a linkup with the most likely successful Optus bidder, SingTel, involving some sort of carve-up of the Optus Mobile services.

Mobile is the key area for Telecom at present, and not just in Australia.

The company is spending $200 million on a new mobile network using the CDMA technology, set to go live in July this year. This tied in with a similar network its Australian subsidiary, AAPT, was rolling out and should mark a crucial turning point in perceptions of the company, Mr Mercer said.

"We should know by the December quarter how well that is going. The key thing CDMA gives them is roaming in Australia, and that is going to give them the ability to claw back some corporate customers."

That CDMA investment and the AAPT purchase are two of the three big investments undertaken by Telecom over the past couple of years.

The third, the Southern Cross cable, of which it owns half, looks set to make considerable returns already.

Telecom was told by partners Alcatel and Fujitsu just before Christmas that capacity on the cable could be increased fourfold, chief executive Theresa Gattung said last month.

That capacity can be added within the company's existing budget.

Telecom is already expecting a dividend of $US100 million from its investment in the cable in the coming financial year.

Those two facts explain why talk of Telecom selling off its holding in the project - speculation that raged through much of 1999 and 2000 - has faded away in recent months.

Since Ms Gattung took over from former chief executive Roderick Deane there has been a perception that Telecom's whole focus has shifted from a maniacally cost-cutting, bottom-line-focused, high-dividend-paying company to a firm in highly geared, major-expansion mode - one that is taking on debt rapidly.

The cost of servicing debt in Telecom's last result was $56 million for the last six months of 2000 - much of it on the AAPT purchase.

The perception is that the shift is largely driven by a change at the top - reflecting the personal style of the chief executive.

In fact the major shift for Telecom began in the mid-1990s, when it was one of the first incumbent carriers in the world to start its own internet arm, instead of regarding the whole online world as a kind of insurgency.

The move to take on greater debt began in 1998 with the issue of Telenotes in New Zealand and restricted capital securities overseas. These were not included in the company's reported interest-bearing debt, but if they had been, it would have been clearer to the company's investors that Telecom was moving away from its conservative leverage policies of its early years.

From 1997 on, Dr Deane talked enthusiastically about Telecom moving New Zealand online, of the need for the company to change from being a high-return to a high-growth company, and of the mind-blowing potential of the Southern Cross cable investment.

But to many it was still the flinty, bottom-line-driven Dr Deane talking, and the extent of the change under way did not really sink in until the changeover to Ms Gattung.

The main area of residual caution over that time appears to have been offshore investments of the type Telecom is now so prominent in.

Burned by its earlier Australian foray into Pacific Star, Telecom was perhaps over-careful, many analysts now maintain.

"The risk for Telecom now is that maybe they have left it a bit late," one analyst said yesterday. "They will now have to pay more than they would have three years ago. They've got a large job ahead of them in Australia whatever happens."

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