Telecom prospects baffle brokers

By RICHARD BRADDELL utilities writer

The investment community is in three minds about Telecom with the stock sagging as conflicting recommendations to buy, sell or hold its shares are matched by equally diverse views on their valuation.

Telecom dipped to $4.95 on Tuesday as Salomon Smith Barney's sharp downgrade from outperform to underperform last week sank in.

But the cruellest blow was its valuation of only $5 a share, contrasting with between $6 and $7 by most analysts.

Although Telecom has since recovered slightly, to close at $5.10 yesterday, it still has investors scratching their heads.

BNZ Investments head of research Selwyn Blinkhorne says there is equally strong evidence on which to value Telecom at $4 a share as there is at $7.

And although the year is over, analysts' forecasts for the 2001 year profit, due to be reported on August 14, are spread between $570 million and $625 million after tax, excluding the $221 million net dividend from the Southern Cross cable.

One said the wide spread might in part be due to the migration of much of New Zealand's research community across the Tasman, and a gradual loss of connection with Telecom.

But while analysts are not particularly concerned at dispersion in this year's forecasts, their lowering of future years' forecasts to below this year's expected profit is more troubling.

In part, Telecom's weaker performance will be due to increasing competition from Vodafone, TelstraSaturn and Clear. And while a merger between Clear and TelstraSaturn would benefit Telecom by eliminating a competitor, that is seen as unlikely to happen.

Investors are also worried about uncertainty about Telecom's mobile profits, slower than anticipated data growth as well as the impact of Australia where margins are thin.

Appraising Telecom is made more difficult because there is no full-year experience of AAPT's dilutionary impact on margins.

"Slight variations in your margins and slight variations in your capital expenditure can cause quite large swings in your valuation, and that's the bit we are struggling with," one fund manager complained.

"It's very hard to get a clear steer from the company what their strategy in these respects is going to be."

On the capex front, Salomon Smith Barney is also concerned that Telecom could be sucked into a fresh round of spending on mobile should Vodafone move to regain the technology lead through a rollout of third- generation mobile.

Already, the money Telecom has spent on Australia has suggested that it will be some years before the company that was once feted as one of the few New Zealand majors to consistently achieve "economic value added" will again achieve returns that cover its weighted cost of capital.

The Salomon Smith Barney downgrade is also expected to be the first of many.

"The brokers are slowly bringing down their valuations as the price falls, which is a bit self-serving," a fund manager said.

Nevertheless, a rumoured reappraisal by normally Telecom-positive JBWere did not materialise, with a note on Monday recommending the company as a buy since its valuation had slipped to the lower end of its international peers.

The JBWere note recognised concerns raised about Telecom's management of its recent $500 million share placement and continuing scepticism over the outlook for its Australian strategy. But it maintained that Australian growth was continuing and costs were being curbed in New Zealand operations.