Brian Gaynor: Australian adventure hobbles Telecom

Telecom's interim result is usually the first major NZX announcement of the year, and this year was no exception. Thursday's results presentation gave investors one of the first opportunities to assess how the economy, the country's largest listed company and the benchmark NZX-50 gross index will perform in 2006.

Telecom is tremendously important to the sharemarket. It represents 20 per cent of the market's value, 24 per cent of the benchmark NZX-50 gross index and, on most days, more than 40 per cent of the value of all shares traded on the NZX. No other company dominates a stock exchange as Telecom does the NZX.

The Wellington group also has a huge impact on the NZX's performance because of its high index weighting.

In January, the NZX ranked bottom of the 50 sharemarkets included in the MSCI indices with a negative return of 2.6 per cent. The only other sharemarket with a negative return was Denmark, which was down 0.4 per cent.

The NZX's poor start to the year was mainly due to a 5.8 per cent decline in Telecom's share price in January.

When chief executive Theresa Gattung, chief financial officer Marko Bogoievski and chief operating officer Simon Moutter fronted up to analysts in Auckland on Thursday morning, they were in an upbeat mood. (Fronting up has a different meaning these days as no more than four or five analysts were present but another 50 from New Zealand, Australia and Asia were on the teleconferencing facility.)

Gattung's first good news was the economy. She said that Telecom was seeing no signs of an economic downturn, staff recruitment remained a problem and the company added 135,000 mobile customers in the December quarter while Vodafone had 68,000 net additions.

How could the economy be softening if the country's two mobile operators added 203,000 customers in the latest quarter?

Gattung glossed over the full interim result, which was a loss of $466 million, including an $897 million writedown of its Australian assets.

The announcement of the Australian write-off on January 20 allowed Gattung and her executive team to focus on the positive issues because the group's transtasman problems would have completely dominated this week's presentation if they hadn't been disclosed two weeks earlier.

Moutter, who runs the New Zealand operations, opened his presentation with the declaration that he was "feeling upbeat". That is an extremely rare comment from a Telecom senior executive.

He said the mobile division was doing well and the group was "back in the game". He was particularly pleased with broadband growth and the group had added 38,000 connections in the December quarter, including 35,000 residential connections.

Bogoievski drew the short straw and had to describe Telecom's dreadful performance in Australia. The company has written off nearly $2 billion across the Tasman. The remaining book value of these operations is A$628 million ($686 million).

The CFO said that there was more downside than upside to the revised Australian 2006 year ebitda forecast of A$85 million to A$95 million and a strategic review of these operations would begin next week. No decision had been made on whether to retain or sell the Australian operations.

After Gattung, there was time for questions from seven analysts.

The presentation ended quickly, the analysts left, eight media representatives took their place and Gattung, Moutter and Bogoievski repeated the same positive addresses.

Analysts ask questions about costs and capital expenditure whereas journalists are more interested in product and sales issues. Most of the questions were directed at, and answered by, Moutter and Bogoievski at the analysts' presentation whereas Gattung replied to the media.

Gattung concluded that the company was comfortable with the June 2006 year adjusted net profit after tax forecasts, excluding the Australian write-off of $830 million.

She seemed visibly relieved there were no questions from hard-nosed and persistent Australian journalists.

The upbeat presentations had a positive impact on the sharemarket, with Telecom's price rising 16c to $5.82 and the NZX-50 gross index leaping 1.3 per cent while the ASX fell 1 per cent. Just over $61 million of the group's shares were traded, representing 64 per cent of total NZX turnover.

Thursday was a clear example of the importance of Telecom to the NZX.

Although Telecom's interim result was better than expected, the group faces major medium and long-term challenges.

It operates in a dynamic industry where most companies are trying to maintain the profitability of their major traditional services (fixed-line rentals and national and international toll calling) while desperately trying to convince customers to use their new services.

Fixed-line rentals and toll calls now represent 43 per cent of Telecom's revenue, compared with 60 per cent in 1997, but the group's Australian acquisition has been a major setback to its new services development.

A former Telecom director said Rod Deane was determined to make an acquisition in Australia but the board, which was dominated by representatives of the two major US shareholders at the time, wanted him to focus on New Zealand. When Deane moved from chief executive to chairman in 1999, after the US shareholders had sold out and their board representatives had resigned, Telecom launched a bid for AAPT.

Meanwhile in New Zealand, Vodafone acquired Bell South in November 1998 when the latter had only 20 per cent of the domestic mobile market, with Telecom holding the remaining 80 per cent.

With Telecom focusing on Australia, Vodafone raised its share of the domestic mobile market from 25.5 per cent in June 1999 to 43.3 per cent in June 2001 and subsequently went above 55 per cent.

A former Vodafone chief executive said Telecom was a soft competitor in those early years.

Moutter is correct to say that Telecom is "back in the game" as far as mobile is concerned, but aggressive pricing has played a big role in this. The group has 1.81 million New Zealand mobile customers, a rise of 23.6 per cent in the past 12 months, but mobile revenue increased only 10.8 per cent over the same period.

The money lost in Australia could have been used to upgrade the domestic network, which is now extremely slow and expensive for many broadband users. There may be a significant switch to Telstra Clear when the Australian-owned telco offers broadband services in the next month or so, particularly if its rates are attractive.

Telecom also faces threats from VOIP (phone calls over the internet) and the prospect of a significant number of fixed line cancellations. Can the group expect another 12 months where it has 345,000 new mobile connections and a net loss of only 1000 fixed residential lines and 1000 fixed business lines?

Telecom's interim result was encouraging, but it still has a long way to go before it gets over the Australian debacle. It will also have to run hard to switch customers to its new services and maintain the profitability of these divisions.

When asked about this on Thursday, Gattung broke into a broad smile, shuffled her feet and declared that Telecom has to run exceptionally fast just to stand still.

It is vitally important, as far as the NZX is concerned, that the chief executive and her executive team are up to the challenge.Disclosure of interest: Brian Gaynor is a Telecom shareholder and an investment strategist and analyst at Milford Asset Management, whose clients hold Telecom shares.