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Opinion: Telecom may hang up on AAPT

By Simon Louisson of NZPA

Friday 14th October 2005

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Telecom appears poised to hang up on its Australian unit AAPT, or find a partner to share the bill.

It's been a costly and largely unproductive call, not dissimilar to The Warehouse's Crazy Clints foray.

Abandoning AAPT would mean Telecom has had two failed strategies in Australia following its ill-starred plan to grow organically through Pacific Star in the 1990s.

The strategy seems logical enough - if you are a titan in New Zealand and want to grow, find a suitable company across the ditch, buy it, and expand your market five times.

A couple of fish-hooks are that the company those tricky aussies sell you may not be quite what you thought; and secondly, as a few of our sporty types have found, the environment there is quite tough and competitive.

As well as encountering both of the above problems, Telecom concocted a couple of its own including a $225 million blunder two years after buying AAPT in 1999, when it rolled out a cable network but abandoned it during construction.

Telecom bought then-listed AAPT six years ago at the height of the telecommunications boom in a hostile takeover. It initially only wanted half of the company but got swamped with acceptances to end with 80%. It later bought out the minorities to take the price to $2.2 billion.

Theresa Gattung had just taken over Telecom and she aimed to transform Telecom from a boring old utility, into a "growth stock", in similar vein to other telcos.

However, despite restructuring AAPT virtually continuously, Australia's number three telco has never delivered an adequate return. Earnings have always been inferior to New Zealand operations.

Year after year Telecom has tried to put a positive gloss on AAPT's results - talking about such things as "positive free cashflow" - trying to mask the fact that when cost of capital is taken into account, it was losing money.

The fact that Telecom was looking to sell AAPT or ally it with another player was flushed out in Wednesday's Australian Financial Review.

Telecom said it had been approached by other parties and "hadn't hung up our shingle", but BBY analyst Mark McDonnell reckons Telecom has been looking to sell AAPT for at least a year amid continuing erosion of its market share.

"AAPT may not be much of a business on its own, but it could help deliver critical mass to another third-tier carrier," he said.

The smart money is on Optus, a rival bidder in 1999 when it was Cable & Wireless Optus. Optus is now owned by Singapore giant SingTel, which AFR mentioned, almost parenthetically, could gobble up all of Telecom without affecting its credit rating.

Whether the aggressive Australian Competition and Consumer Commission (ACCC) will allow the number two and three players to get together is unclear. It knocked Optus back in 1999 and Sydney Morning Herald columnist Stephen Bartholomeusz today argued the same result is likely this time around.

Optus has around 14% of Australia's fixed line market and AAPT has about 4%. UBS analyst Tony Wilson said combined the two should not create competition concerns.

While the words of Telecom's statement on Wednesday admitting it had been in talks on AAPT's future were non committal in terms of a sale, and it was stated no proposal was on the table, the language used suggested a sale or merger was on the cards.

Investor relations manager Philip King repeatedly talked about a "dynamic" market characterised by change. He said the proposals were "not inconsistent" with Telecom's commitment to an Australian presence and that much of the company's future growth would come from Australia.

AAPT was written down in Telecom's books in 2002 but is still valued at $1.4 billion. Analysts reckon that's about double its maximum value and one even reckoned the company was worthless.

Wilson said the market had not valued AAPT "at anywhere near book value for years".

If Telecom is forced to make a similar sized write-down to 2002, possibly tipping the bottom line into a loss, it should not greatly affect the share price, because it has already been priced in. Wilson notes AAPT is essentially a fixed-line business, which he valued at $500-600 million, or 4-4.5 times forecast 2006 earnings before interest, tax, depreciation and amortisation (EBITDA).

Most analysts welcomed the news that AAPT may be given the flick.

"It has been a drag and over the history of AAPT, it has had to run hard to stand still," said Goldman Sachs JBWere broker Murray Rutherford.

He said Telecom was budgeting to spend another $140 million in capital expenditure in AAPT plus $20 million on revamping the consumer division in the current year.

"This is capex and op-ex being spent on an operation that is struggling to succeed," he said.

Craig Brown, fund manager with Walker Capital Management, selling AAPT would force Telecom to rethink its business model. It had consistently argued having an Australian arm was critical, particularly in allowing it to provide full service to their trans-Tasman customer base,

"Any move away from that would be a significant strategic change."

As far as cutting off growth options, Brown said analysts were not factoring in much growth from AAPT anyway and Telecom itself is only budgeting on incremental growth.

"It's a tough and competitive market over there and at this stage Telecom hasn't shown much success in growing and making a lot of money out of that business."

In part, Telecom's desire to move on AAPT has been motivated by a more aggressive stance taken by new Telstra boss Sol Trujillo who has apparently decided to make it harder for rivals to buy services wholesale.

Interestingly, here at home, the positions are reversed and Telstra late last month announced it was retreating from providing a full national local phone service. Incumbent companies such at Telecom in New Zealand and Telstra in Australia seem very adept at manipulating regulators and politicians despite so-called market deregulation.

Brown believes shareholders would prefer Telecom quit any non performing asset and return any spare money to investors.

He said Telecom was pushed into AAPT when the market was saying Telecom needed to grow.

"Well, it hasn't proven to be the right strategy.

He said he hoped that, despite what the company had said in the past about its need to grow in Australia, if the climate had changed then the strategy had to change.

"A boring old utility that spits out reasonable yield is one investment that has some appeal to investors.

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


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