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By Andrea Fox

Monday 1st December 2003

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For Telecom chief executive Theresa Gattung, taking the temperature of the telco sector's recovery is a bit like trying to work out New Zealand's current weather. There are some signs of spring, some optimistic souls are seeing blue sky, but the facts don't support there being much of a summer.

New Zealand's biggest listed company turned in a profit of $162 million for the three months to September, with earnings up 11% on the same period last year. The result was ahead of analysts' forecasts of a 7-10 % improvement on flat revenue of $1.32 billion, but predictions that the first quarter performance would be solid rather than spectacular were proved correct.

The telco reduced its debt by $275 million in the quarter, meaning it now owes $4.4 billion. Earnings before interest, tax, depreciation and amortisation rose 2.4% to $554 million. Half-hearted market hopes that Telecom might this time lift its dividend from the 5c a share it has paid each quarter since 2000 were quashed.

In short, a respectable result but scarcely the dramatic turnaround the market is waiting for. But what of the nascent signs of spring in the international telco sector, such as Bell South's 46% jump in third quarter profit in October? Do they signal sunnier times ahead for Telecom?

The forthright Gattung clearly doesn't want to trample over such cheerful thoughts, but, she says: "I just think it's too simplistic to say we've turned a corner." She counters the Bell South example with the considerably less than rosy outlook in Goldman Sachs and Credit Suisse First Boston's latest global equity research on telcos.

"I was in the US about six weeks ago and you see a lot of activity, frenetic activity. It's great for customers but it's not clear to me from an investor perspective that any of those telcos have any traction in revenues."

So what's the bigger picture? "We are all in the multi-year transition from a voice world to a data world," Gattung says. "If you go back a few years, the market really did buy into data revenue growth. Broadband was going to take off and be great for telcos. That is true to some extent, but the price pressure is on voice, and that price is falling, and great competition in the data services area means that revenues in America tend to be flat, at best."

And Gattung says this transition could take some years. "Telcos can influence the supply side of it - like our deal with Alcatel [with which Tele­com has a five-year, $120-million deal for the management of the telco's network planning and development] - and we can clearly influence the demand side, but we don't control either. And we're not all as smart as we think we are. No one predicted that text messaging would be the killer application for mobile that it's been...

"What we are trying to do with Alcatel is, over time, migrate to a next generation network, to one physical infrastructure that supports voice, video and data. That's the vision."

In the meantime, Telecom has achieved 85% broadband coverage of New Zealand and, through its deal with state-owned transmission company Broadcast Communications Ltd, will have 95% by this time next year. But the spectre of regulation forcing Telecom to unbundle its copper line network - in other words open it to competitors - casts a chilly shadow. The possibility of having to unbundle its next generation networks too means its capital expenditure programme is in a state of flux, Gattung says.

Telecom chairman Roderick Deane also cites the prospect of unbundling - recommended by the Commerce Commission - as one of the key uncertainties on the horizon for the company. He says for Telecom's share price to rise "more sturdily", greater certainty is needed, along with stronger earnings growth. While the balance sheet is strong and costs have been pegged back 10% despite increased volumes, he says there are still intense pressures on the business. "Regulatory pressures, competitive pressures, pressures on international business, on our mobile business from our very able competitor, on our fixed wire business from unbundling ... So it's not quite fair to say we have a turned a corner. We are in solid shape, but we'd like to be doing better."

And what about Telecom's Aussie albatross, AAPT? Deane: "We are generating a bit under $100 million in cash out of Australia now, so that business is improving but it's still very demanding." AAPT has 6% market share in Australia and it posted a slight drop in the first quarter operating revenue from $A334 million to $A331 million, but Gattung is positive. "A few months ago we said, 'Right, we have good disciplines in there now, we need this business to be an irreverent attacker and we need to reinvest in the brand to build people and capability'."

But the Australian experience has clearly been hard yakka.

"New Zealanders expect everyone to play fair, and no one else I do business globally with expects it to be anything but tough-as out there. There's something really nice about the Kiwi psyche and the fair play thing, but where it feels hard doing business in Australia is that they really do look after their own. I get frustrated with that dichotomy.
We've tried to get traction by pointing out that Telstra is much bigger than us, and helped by Australian government ownership, but no one cares. And perhaps they shouldn't, but in Australia they really do care about companies that are their own."

Meanwhile, email has become mission critical for Telecom - just as mobile threatens to cannabilise the fixed line service, particularly in Europe, so email has begun to cannabilise voice services. Email, which started life as a low-cost service to contact your friends at the weekend, is now an integral business tool, says Gattung. "We expect instantaneous email, secure and reliable. People expect - and I'm not saying they don't have a right to - the 24-hours seven-day-a-week reliability they get from the [phone] world.

"That's what broadband really is, convergence - an overworked word - but it's a melding of those two worlds, where people expect it to work perfectly all the time."

Telecom's opportunities lie in getting revenue growth through that big picture transition from voice to data, she says. That means achieving growth in the mobile business, where most customers have yet to be transferred to the 027 network. It also means capitalising on the current positive economic cycle and population growth, but at the same time finding ways to make the business simpler and to take out costs.

"We have had a really good track record in the past couple of years, of sensibly making decisions that take out chunks of costs by challenging sacred cows. Who says a telco has to employ the people who install the phones? But it's not a slash and burn mentality. We don't sit around and say how can we be mean buggers today."

Roll on summer.

Bond Offer: Infratil Ltd, 7.2 year & 10.2 year unsecured unsubordinated bond


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