KEY POINTS:
Results this month from Telecom, Telstra and Fletcher Building have an important bearing on the domestic sharemarket because the two New Zealand companies represent 25 per cent of the benchmark NZX-50 Gross Index and Telstra's performance is a benchmark for New Zealand's largest listed company.
In another development Elliott International has nominated Mark Tume and Mark Cross for the Telecom board, an unwelcome distraction in light of Telecom's dramatic upheavals in recent years.
The first point to note about Telecom, Telstra and Fletcher Building is their earnings before interest, tax, depreciation and amortisation (ebitda) performance (see table).
Telecom's ebitda has fallen steadily from $2.344 billion in 2004 to $1.891 billion in the latest year through a combination of increased competition and poor management. In addition the company tried to protect its monopoly position under the naive view that the Government would not interfere with its property rights.
This strategy was shattered on May 4, 2006 when Communications Minister David Cunliffe announced a number of initiatives including the accounting separation of the group's operations, the opening up of its network to competitors and increased monitoring by the Commerce Commission.
Since then, chairman Rod Deane and chief executive Theresa Gattung have left and been replaced by Wayne Boyd and Paul Reynolds with the latter taking up his position at the end of September 2007. There have also been a number of other changes at board and senior management levels.
Investors responded negatively to Telecom's June 2008 year results for a number of reasons including:
* The company continues to have ongoing issues with mobile, including a delay in the roll-out of its new network.
* Management indicated that there would be a large increase in depreciation in the years ahead and this would have a negative impact on net earnings after tax.
* The dividend payout will continue to fall from a peak of 48.5c in the June 2004 year to 24c in the current year with the latter payout carrying no imputation credits.
Analysts believe that ebitda will continue to fall in 2009 and 2010 and only one of the six major broking houses has a buy recommendation on the stock. Telecom is fairly loveless at present and its poor share price performance has had a negative drag on the NZX-50 Gross Index.
Telstra's June 2008 year result was more positive although its share price fell immediately after the announcement. This response was difficult to understand although a number of analysts were disappointed with its cost-savings guidance.
Analysts expect Telstra to achieve further ebitda growth in 2009 and 2010 and the consensus forecast is for a dividend of 31c for the 2010 year, fully franked for Australian investors, compared with 28c for the 2007 to 2009 period.
Four of the six major brokers have a buy recommendation on Telstra.
The two major Australasian telcos have a great deal in common because three years ago Telstra was also a poorly managed, inflexible and highly regulated organisation offering an unattractive outlook for shareholders.
The Telstra revolution began on July 1, 2005 when Sol Trujillo, the current chief executive, started at the company. A few months later, on November 15, he released a five-year growth strategy that was greeted with disbelief and derision by many analysts.
This strategy has been largely successful with Telstra's share price outperforming the benchmark ASX index and Telecom, the latter by a wide margin, over the past two years.
Reynolds is trying to bring about the same transformation at Telecom, albeit with a more low-key approach, but he started two years and three months after Trujillo. It is early days yet but if Reynolds is successful Telecom's shareholders can look forward to a more positive sharemarket performance in the medium to longer term.
However the announcement by Elliott International that it is nominating two new candidates for the board of directors is the last thing the company needs.
The current board comprises Boyd, Reynolds, Michael Tyler, Murray Horn, Ron Spithill, Patsy Reddy and Rod McGeoch. The latter two are due to stand for re-election at this year's annual meeting.
The company's constitution states that the board can have up to 12 members but the directors have a long-standing resolution that it will be capped at seven.
According to Elliott International, Tume and Cross have "considerable strengths in the finance and investment industry" that "will be of particularly value to the board".
Telecom needs more directors with telecommunications, marketing and corporate management expertise, it doesn't need any more individuals with a finance background given Boyd and Horn's expertise in this area.
Elliott is also proposing a structural separation (splitting Telecom into different listed companies) instead of the current operational (accounting and managerial) split.
There are a number of reasons why this proposal would have negative implications for the group including:
* The current separation plan has been agreed with the Government and approved under the Telecommunications Act 2001. A full structural separation would require a complete renegotiation of the regulatory framework and there is no guarantee that this would benefit Telecom
* The renegotiation of the separation plan would incur considerable management time during a period when the company is undertaking a number of major capital expenditure projects
* A total separation of legacy assets would incur substantial one-off costs and there would be a duplication of corporate overheads and regulatory compliance costs under this proposal.
Telecom has gone through considerable upheaval since May 2006 and the last thing it needs is another change in direction. Shareholders should reject Elliott International's proposal and leave Reynolds to focus on turning Telecom around and, hopefully, repeating Trujillo's success with Telstra.
Structural separation can be put on the agenda once Reynolds' transformation programme has been completed.
Fletcher Building has had a much better profit performance in recent years but the atmosphere at its result presentation was less relaxed than it has been in the past because of the headwinds the company is now facing. Ebitda has risen consistently from $582 million in the 2004 year to $966 million in the latest 12 month period with the dividend increasing from 25c to 48.5c.
However Fletcher Building operates in a far more cyclical environment than the telcos and its immediate outlook is uncertain because of the huge downturn in residential housing markets.
Four of the six broking firms have "buy" recommendations on the company even though they all expect earnings to decline in the current year. Ebitda forecasts for 2009 range from $776 million to $910 million and net profit after tax from $284 million to $414 million with all but one analyst expecting June 2010 earnings to be higher than the current year.
Fletcher Building is a well run company with a $1.3 billion construction backlog and a strong geographical diversification. However, it will be adversely affected by a decline in residential housing construction and the poor performance of Formica, which was acquired on July 1, 2007.
The group's business model, and its $1 billion Formica buy, will be fully tested in the current downturn but shareholders can take some comfort from the dividend increase announced this week and the company's relatively high, fully imputed, gross dividend yield of 10.4 per cent at $6.99.
Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management which holds shares in Telecom, Telstra and Fletcher Building on behalf of clients. He also holds Telecom and Fletcher Building shares in his own name.
