Options for Telecom
September 21st, 2009 at 11:00 am by David FarrarIn light of the Government’s fibre to the home proposal, there seem to be three distinct paths forward for Telecom. They are:
Structural Separation
If Chorus is sold off, then Chorus would be in a very strong position to effectively gain most of the $1.5 billion on offer, by partnering with the Government to set up many of the regional fibre companies – or even one national fibre company.
The likely sucess in gaining most of the $1.5 billion would increase the value Telecom would get by selling Chorus. Also Telecom might not have to sell all its shareholding in Chorus – it could, I beleive, still retain a minority stake as an investment.
This would leave Telecom with its wholesale and retail arms. They would probably immediately have most of the current obligations imposed on them, such as equivalence, dropped.
With much reduced capital expenditure needs, and a cash inflow from the sale, Telecom should be in a position to increase the dividends it pays.
The downside will the inability to leverage the advantages of also owning the existing infrastructure. They’ll be paying an outside company to utilise their lines – the same as everyone currently has to do to Telecom. They will also be more at the whim of the market. If they lose market share to competitors, they won’t have the compensation of the fact the competitors are still paying them access fees.
Infrastructure companies tend to be safer, but have lower dividend returns. Competitive companies are a more risky investment, but can produce higher returns.
Participate as a minority partner
If Telecom do not structurally separate, then they are deemed a “partner” that owns a retail operation. This does not preclude them in any way from full participation in one or more local fibre companies (or even to still propose they be a partner in a national fibre company).
The key restriction is that will not have the right to appoint a majority of Directors to the Board of the LFC, and the Chair of the LFC Board must be agreed unanimously by all shareholders.
I’m not sure how important control of the Board of an LFC will be to Telecom. The initial partnership agreement with CFH setting out terms of investment and how extensive a fibre build will be is arguably the more important factor.
It is quite possible Telecom could decide to participate and invest in one or more LFCs. This will also help protect their investment in current legacy assets.
Do not participate
The third option is for Telecom not to bid to be a partner for any LFCs, or they do bid and are unsuccessful.
If this is the path chosen, then Telecom will be in a fairly strong position to ask for some of the current requirements imposed by operational separation to be removed. There would be issues over timing, of course.
It is likely Telecom would not undertake any more major infrastructure investment (such as further cabinetisation or further upgrades to VDSL2) beyond their current commitment of $1.4 billion. This would save them money in the short term, and in the long term they would become a customer of the LFCs for their higher speed products.
Telecom could do quite well relieved of the need to keep rolling out faster and nearer infrastructure. For many of their customers, the current speeds will be adequate for some time.
It is possible that they might keep up an aggressive investment programme to try and compete with the local fibre companies, and even drive them out of business. That would be a very ballsy call though, considering the firm policy of both major political parties is that the future fibre infrastructure must be open access and not part of a vertically integrated monopoly.
Telecom’s decision is going to be one of those really big ones – on much the same scale as which mobile phone technology to go with. The wrong call can cost a lot of money. The senior staff and board have an unenviable task looking at their company, considering its strengths and weaknesses, and deciding on the best path forward.
Tags: Chorus, fibre, Operational Separation, structural separation, Telecom
September 21st, 2009 at 11:32 am
On the second or third options, they need to consider the impact to Telecom of keeping their legacy network at the same time that a new network is being rolled out. The problem with that network is that it is aging, and therefore needs a reasonably sizeable annual investment to keep running.
It is hard to run a business where your most profitable customers are moving to a new service, your least profitable customers are remaining, and you have a fixed maintenance cost that still has to be covered. You can jack up your prices, but that results in more customers moving to the newer faster service.
I think the structural separation and sale of assets into the network company is by far the best result for Telecom. As it also is in Australia for Telstra.
Vote:September 21st, 2009 at 1:29 pm
Very interesting. Telecom is going to be truly competing on an equal basis with other Telephony/internet providers.
I see them dropping adsl altogether at some stage – that will just not be competitive with a fibre network.
Telecoms main competitive advantage will be it’s size, intellectual property, and existing customer relationships. The local loop will no longer be a factor.
Woohoo!
Vote:September 21st, 2009 at 2:15 pm
At least Telecom’s share price hasn’t dived, as it did when Vladimir Cunliffe ordered Telecom to unbundle its copper network. Perhaps international investors have built into the Telecom share price the risk the company carries as the dominant player in a small, isolated left-wing archipelago.
DPF, you say if Telecom sells Chorus it would be in a position to increase its dividends. This would be a one-off boost to the company thus shareholders would likely benefit only from one capital return or one special dividend.
Unless, of course Telecom sold Chorus and ploughed the money into telecommunications with a smart partner in one of the *BRIC countries, where fast economic growth will increase. Or split the money received between this and boosting its hold on trans-Pacific fibre cables, where it can click the ticket of every internet bit that travels between NZ and North America, and that’s most of them. As long as they didn’t put all the money into Australia, where shrewd operators have already cleaned Telecom out once, and perhaps twice.
When it comes to Government interference with shareholders’ property rights, Telecom wouldn’t be in any more risk in a BRIC country than they are in NZ. Similarly with Pacific cables: it would be easy to keep these out of politicians’ hands.
*BRIC: Brazil, Russia, India, China.
Vote:September 21st, 2009 at 2:55 pm
Jack5: if I was a Telecom shareholder, I wouldn’t want them investing in BRIC. If I wanted to invest in a telco in BRIC I would do that directly – I would argue that an investment of this nature would likely be dilutive to Telecoms valuation.
On dividend, I think DPF was saying that the infrastructure bit of Telecom has a lower expected rate of return, and higher capital intensity, than the retail bit. Sell off the infrastructure bit and the remaining retail bit would have higher return on capital, and therefore higher dividends. Not as a one-off, but ongoing.
Vote:September 21st, 2009 at 4:19 pm
Whichever option transpires, I believe Telecom are going to struggle to compete on a more level playing field. The government department, monopolistic culture runs deep within that organisation (as it does also in Telstra in Aus) and they are going to bleed heavily once they loose their monopolistic position re infrastructure.
Vote:September 21st, 2009 at 4:39 pm
Re PaulT at 2.55
Assuming by dilutive you mean loss of dollar value rather than decreasing stake in the venture, it’s doubtful Telecom would be at risk of bigger loss by putting proceeds from Chorus in a couple of BRIC telcos than it suffered from the State decreed unbundling. That cost shareholders billions.
Personally I would prefer to invest in a BRIC company through an intermediary, and Telecom with expertise in telecommunications would be preferable to some fund run by an accountant-broker type. It’s difficult for an individual investor to hedge currency investment, too.
As for the retail side of Telecom having a higher return, some of that return stems from its ownership of infrastructure. And you can’t trust politicians who would confiscate shareholder wealth in infrastructure. They would just as likely impose price controls.
Of course a state has a right to restructure industry. However, when it does so at the cost of investors, such as Telecom shareholders, it steps into the world of Chavez and Putin.
Vote:September 21st, 2009 at 5:23 pm
Jack5: dilutive of shareholder equity. Same as most mergers – at the end of the merger the combined entity is usually worth less than the individual entities were before they started. The merger usually destroys shareholder value. On the plus side, the CEO and their minions now have a larger empire, and can therefore justify bigger salaries. This misalignment of the goals of managers and shareholders is one of the many agency issues with our corporate model.
My view is that conglomerates have lower share prices than the component parts when unbundled. There is a lot of evidence of this in markets around the world. Not everyone who wants to invest in Telecom (a moderately sized and boring telco in a small corner of the western world with solid if unspectacular returns) would want to have that investment come along with exposure to a telco in a BRIC market – which is an entirely different kettle of fish.
Telecom NZ have shown no particular aptitude for managing offshore investments, nor knowledge of their industry that would lead me to think that they will make better investment decisions over offshore companies than I would make myself investing directly. In fact, the evidence from Australia would tell me that Telecom investing offshore is more likely to destroy value than create it.
No, if the employees of Telecom NZ don’t like working for that boring telco with solid returns, then they should go and get themselves a job somewhere more exciting. The last thing I as an investor want is a surprise about what I’ve invested in – thinking I invested in a solid company only to discover that they go bankrupt because of some misplaced investment in a risky location.
The retail side of Telecom has a higher return on investment because it has to make so little investment, and it generates good profits. It is also riskier though, as it is more exposed to competition. This is pretty basic economics and business analysis…am I missing something?
Vote:September 21st, 2009 at 6:09 pm
PaulT: I agree with you on Telecom’s Australian blunder, as I acknowledged in my first post.
But if Telecom invested money raised from a sale of Chorus in a BRIC telco it would almost certainly have a minor stake, with no management role, except if it was lucky perhaps one seat on a board. In the view of many, the Australian disaster was partly or largely caused by Telecom imposing its institutional management style on what had been a lively, entrepreneurial small company.
I don’t see what the value of conglomerates has to do with it. Surely you wouldn’t call Telecom, a telco, a conglomerate? I’m not sure what mergers have to do with it either. No-one suggested Telecom would merge with a BRIC player.
Paul, if you can invest on your own in BRIC telcos and make a mint good luck to you. When you hit it big, float so we can coat-tail on your skill.
Vote:September 21st, 2009 at 6:27 pm
Jack5: my point was that I don’t believe Telecom would be any better at investing than I would be. Problem is, that isn’t very good
If Telecom’s managers were so good at investing in offshore telcos, they would quit Telecom and join an investment bank – the pay is much better. The reality is that most market participants know little more than you personally do, and there is no quick path to investing and making money. Relying on Telecom NZ on the basis they can invest better than you can is probably false security.
The company I work for regularly goes through phases where we think we’d be good at investing – because we’re so smart we must be able to do better than the markets. And to be fair, some of our people are pretty smart. We rarely beat hte market though, and so far as I can tell it is usually blind luck when we do. We usually end up divesting of all those investments, and either returning capital to our shareholders for them to invest themselves, or pursuing organic growth within our core business, which we are actually pretty good at. I suspect most other big corporates are the same.
Vote:September 21st, 2009 at 8:55 pm
Would they sell Chorus or just issue pro rata shares to existing Telecom shareholders?
Vote:September 22nd, 2009 at 12:11 am
This is certainly a conundrum as I doubt it is efficient for the country to foot the cost of a duplicate access network being built around the country when Chorus already has fibre going to cabinets in many places.
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