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The Shoeshine Column: Thorny issues for Telecom spin-off

Friday 24th March 2000

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Theresa Gattung needs to make one and one equal more than two. It won't be easy

As Australia's Telstra this week unveiled its long-awaited internet strategy Telecom's Theresa Gattung will have been watching closely.

Of late the parallels between the two companies have been so close one could almost suspect they are copying one another. Each has launched a major attack on the other's home turf. Telstra said on March 9 it would sell its NDC network building arm. Last week Telecom put Connectel up for sale.

Likewise the rollercoaster movements in their share prices.

Telstra ran up to $A8.71 earlier this month on hopes it would announce a spin-off that would unlock the value of its "new economy" operations. When it reported on March 8, investors got no announcement and a flat result from the old-economy tolls business - and savaged the stock, wiping $A6.4 billion from its market value.

Telecom had its corresponding run-up in mid-February, climbing from $8.25 to $9.50 after hinting at new economy spin-offs. Telstra Saturn ruined the party a few days later with news it would build a local broadband access network, sending the shares back below $8.50. Recently they have rocketed through $9.

Chief executives like saying they manage the company not the share price. But for Telecom's Gattung, the decisions on whether, when and how to spin-off her company's new activities are all about the share price.

Despite short-term fluctuations Telecom stock is now about where it was two years ago. At the results briefing in February chairman Rod Deane explained the company was "paying the price for investing in the future." He handed out a table showing the non-traditional businesses - the Southern Cross cable, mobile, AAPT, internet service provider Xtra and the "esolutions" e-commerce marketing alliance - were worth $13-19 billion, as much or more than Telecom's entire market capitalisation.

The question is, how do you get the market to recognise the value both of the old economy tolls business and the sexy new stuff?

The answer, for Telstra and probably for Telecom, is to split the two and hope the sum of the parts will be worth more than the whole.

As Telstra's Ziggy Switkowski explained two weeks ago, the most obvious option - hiving off, say, internet assets into a separate listed company with public equity - has unobvious but serious drawbacks on the operational side.

Customers like their landline, mobile, and internet charges bundled together on one bill. But if a company is split, that single, seamless shop-front service becomes almost impossible.

Arguments inevitably arise between the two companies on issues of cost allocation and transfer pricing. These are more important than they sound. They have torn many an organisation apart.

So the value lost in customer service may outweigh any additional value recognised as a result of the split.

Telstra's solution emerged on Monday. It is merging two listed affiliates, Sausage Software and Solution 6, into a single listed company and tipping in $A237 million worth of online commerce assets.

In theory that will establish a market value - hopefully at sky-high new economy multiples - for the 40% of the new e-business Telstra owns. Usefully, it will also provide Telstra with some highly-priced e-paper, in the form of Sausage/Solution scrip, with which to finance acquisitions and alliances. Buying inflated assets with inflated paper beats diluting its earnings by issuing vast chunks of low-price "old Telstra" shares.

Telstra's strategy looks elegant - a little too elegant, for the market, which chalked the shares up by a meagre 15Ac the day after the announcement, although Sausage and Solution 6 shares rocketed.

Now it's Telecom's turn. If the Telstra experience is anything to go by the market will punish the shares if Telecom fails to announce an e-business spin-off when it reports on May 16.

Some observers on this side of the ditch believe it will opt for a "letter stocks" structure, with an overarching company holding the assets of separate listed entities operating in different fields.

Forget it. That strategy has been so debased by the Fletcher Challenge experience that nobody in their right mind would consider it.

Lacking a handy listed affiliate like Sausage/Solution into which to shift assets, Telecom is left with a separately listed vehicle with public equity. What will go into it?

Not esolutions - Telecom doesn't "own" it. Nor Southern Cross, of which it owns only half, unless it can convince the co-owners to play along.

AAPT, of which Telecom has 81%, already has a separate listing. Thorny issues surround a float of "Telecom Mobile" because it would want the value of AAPT's mobile operations, and especially its CDMA service, to be included.

That leaves Xtra - which accounts for only $1 billion to $1.5 billion of the value in "independent analysts' estimates" of New Telecom's worth - as the prime candidate for a spin-off.

One problem is that any e-currency based on Xtra has already been devalued by the markets.

Of late the e-bubble has been changing shape. While the US high-tech Nasdaq index has held up overall, investors have been piling into some sectors - such as business-to-business e-commerce, biotech, semiconductors and broadband communications - and bailing out of others - notably, ISPs.

Then there's Ziggy Switkowski's loss of value in customer service. With its biggest competitors building one-stop bundled services Telecom won't want to damage its own shopfront.

The carrier can afford the country's best brains and it is no doubt engineering its own elegant solution. Hopefully it won't be so elegant the market can't understand it.

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