Brian Gaynor: Telco difference is in the detail

The Australian Government has finally received approval to fully privatise Telstra.

The decision comes after weeks of mud slinging between the Howard Government and the telco's senior executives, a profit downgrade and intense debate over the regulation of the Australian telecommunications sector.

The high-profile saga has had an impact on Telecom's sharemarket performance because many investors believe that Telstra and New Zealand's largest listed company are fairly similar. That assessment is not entirely accurate.

The New Zealand Government sold Telecom to a consortium of American and New Zealand investors for $4.25 billion in September 1990.

In July 1991, the two major United States shareholders, Ameritech and Bell Atlantic, sold down 8.9 per cent each to facilitate a stock-exchange listing. Ameritech, Bell Atlantic and the original New Zealand consortium sold out several years ago after making a huge profit.

Telecom now has 52,400 shareholders with 25.5 per cent of the company owned by New Zealand individual and institutional investors, 22.3 per cent by Australian interests and 52.2 per cent by Northern Hemisphere investors.

Telecom's Australian-based ownership has risen from 6.5 per cent to 22.3 per cent since June 2002, partly because of Telstra's poor performance.

Telstra's privatisation began in November 1997 when the Australian Government sold 4.29 billion shares or 33.3 per cent of the company through an IPO process for A$3.40 a share (individual investors paid only $3.30 a share). The partial sale realised A$14.2 billion for the vendor.

The Commonwealth reduced its shareholding to 50.1 per cent in October 1999 when it sold 2.13 billion shares to individual and institutional investors at A$7.40 each. The share sale realised A$15.8 billion for the Government, giving a total of $30 billion for its 49.9 per cent stake.

The 1999 prospectus warned that the Australian telecommunications market had become increasingly competitive since open competition was introduced on July 1, 1997. It stated that Telstra had lost substantial market share in some key markets and had to lower prices in response. This trend was expected to continue.

Telstra now has 1.62 million shareholders with the Commonwealth of Australia holding 51.8 per cent, Australian investors 42 per cent, New Zealand 0.4 per cent and Northern Hemisphere 5.9 per cent. Under the Telstra Corporation Act, foreign shareholders cannot own more than 35 per cent of the non-Government held shares and individual foreign persons cannot control more than 5 per cent.

These figures demonstrate that Telecom and Telstra are totally different in terms of the privatisation process, foreign ownership rules and shareholding structure. The privatisation of Telstra has been a hot political issue for a number of years and it has been on the front page since Sol Trujillo became chief executive officer on July 1.

On June 30, the day before Trujillo joined, Telstra's share price closed at A$5.06 on the ASX and NZ$5.54 on the NZX. This was well below its all-time high of A$9.20 in February 1999.

The political debate over Telstra intensified after Parliament resumed sitting on August 8. The telco's full privatisation, its regulatory regime and provision of services to the rural sector were at the top of the agenda.

The next week, the Government announced that a A$2 billion Communications Fund would be established from the proceeds of the final privatisation and the annual income from this would be used to fund rural services.

In addition, the company would be required to separate its retail, wholesale and key network activities from an operational but not an ownership point of view. The objective of this is to achieve greater transparency and disclosure.

But Telstra entrenched itself on the front page of Australian newspapers when Trujillo indicated that earnings for the June 2006 year would be 10 per cent below the 2005 figure and Phil Burgess, a fellow American appointed to a senior executive position by Trujillo, announced that he would not want his mother to buy Telstra shares.

This started a slanging match between Prime Minister John Howard and Telstra's executives as the Prime Minister didn't want negative comments about Telstra when one of his top priorities was to sell the Government's remaining 51.8 per cent stake.

The outspokenness of Trujillo and Burgess is another big difference between Telstra and Telecom as Theresa Gattung is a low-profile chief executive who does not make controversial comments in public.

Finally, the Senate passed the Telstra sales legislation on Wednesday night and the 51.8 per cent stake will be sold around this time next year.

The initial reaction was that the sale of the Australian Government's Telstra stake, which would be worth A$28.7 billion ($31.1 billion) at yesterday's share price, would entice many Australian investors to sell their Telecom holdings and reinvest the proceeds in Telstra.

This will only occur if the outlook for Telstra is much better than Telecom or the New Zealand dollar is expected to weaken against the Australian dollar. Both companies face increasing competition and regulation but the earnings and dividends prospects of the New Zealand company are more encouraging. Dividends are becoming more important because the two telcos are perceived as income rather than growth stocks.

Telecom's earnings per share is expected to increase from 45.2c in the June 2005 year to 45.7c this year.

The company paid 38.5c a share plus a special 10c dividend and has indicated a similar 48.5c dividend for the year.

But what will happen to earnings and dividends from 2007 onwards? As one would expect June 2007 year forecasts are varied with about 50 per cent of analysts expecting earnings per share to be higher than the 2006 year and the remainder expecting them to be lower.

Telecom executives are giving strong hints that they wouldn't introduce a 48.5c dividend unless they were reasonably sure this could be sustained. Stockbroker analysts are more cautious with most believing the 48.5c dividend cannot be maintained beyond this year.

If Telecom continues to pay a 48.5c dividend beyond the 2006 year, then the stock looks attractive with a gross dividend yield for New Zealand investors of 12 per cent.

Most sell side analysts expect Telstra's earnings per share to fall in the June 2006 year and again the following year. This is because the Australian environment is becoming more competitive and the regulatory regime less friendly. Telstra's poor outlook is probably good news for Telecom because it reduces the prospects of the Australian company establishing a mobile network here.

Telstra paid a 40Ac dividend, including a special 12Ac, for the year to June 2005. Based on this, the company has a net dividend yield of 9 per cent but it is unlikely to continue to pay 40Ac a share when its earning per share for the current year is expected to be only 32Ac.

At this stage, the outlook for Telecom looks more promising than Telstra but New Zealand investors shouldn't be complacent.

The Telecom board of directors has too much investment banking, accounting and legal expertise and not enough retail experience.

Chairman Roderick Deane, who was appointed a director in 1992, is standing for re-election at the October 6 annual meeting. That is far too long for any director to remain on the board of a major listed company.

Disclosure of interest; Brian Gaynor is a Telecom shareholder and an executive director of Milford Asset Management