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The Shoeshine Column: Too much bleating on Telecom spinoff

Friday 21st July 2000

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Breaking up is so very hard to do

If Telecom is taking some heat about its failure to announce a spinoff of its high-growth businesses it has only itself to blame. It should have kept its mouth shut until it had something definite to say.

Even so reports of bleating from the marketplace are overdone. There are many reasons for Telecom's recent slide from 970c down to 700c and spinoff disappointment is only one of them.

Shoeshine hears some overseas institutions that wanted to sell up late last year hung on in the hope a spinoff would eventuate. When it became obvious it wouldn't in the short term they bailed out, contributing to the share price slide.

Telecom and Fisher & Paykel find themselves in the same boat. A few vocal investors have managed to give the impression the whole market is seething with impatience.

Listening to them you could be forgiven for thinking it was just a matter of carving off a company, doling out some equity to Joe Blow investors and getting on with business.

In fact it's a mind-bogglingly complex set of decisions and Telecom would do its owners no favours if it succumbed to pressure to hurry things up.

For starters the directors and management have to decide what, if anything, to carve out.

The easiest, cleanest option is the Xtra internet service provider (ISP). But the window of opportunity there was well and truly closed by April's Nasdaq "tech wreck" which saw the price of just about anything to do with the internet heavily marked down.

Mobile comes next but that's far more complicated, mainly because Telecom owns 81% of Australia's AAPT.

AAPT's burgeoning mobile operations would need to be folded into the carve-out vehicle - let's call it Telecom Mobile - to give it scale but as things stand that would take a considerable feat of financial and operational engineering.

How to deal with the AAPT minorities? Buy them out altogether?

That wouldn't make much sense. Part of the rationale for carving out divisions is to provide their management with incentives in the form of equity in their own operation and to put a market value on the portion of the new vehicle the parent retains. That's the status quo and it would be lost if Telecom took 100%.

At current prices it would also cost Telecom around $A270 million ($342 million) and would take some time to complete.

Offer the minorities shares in the new vehicle? In that case Telecom Mobile's directors would be answerable to three different sets of shareholders - Telecom's, AAPT's and their own minorities, a prospect no director would relish.

Offer them cash for their share of AAPT's mobile arm? Again that would take time and Telecom would no doubt have to pay top dollar.

In fact as Telecom chief executive Theresa Gattung has already said Xtra, mobile and the 50% interest in the Southern Cross Cable would have to be included in any carve-out vehicle for it to be big enough to attract the attention of international investors.

Even if the market perception of ISPs improves dramatically and Telecom can hammer out a workable deal to get AAPT mobile aboard, the decision on whether to proceed will be fraught with complication.

The list of questions to be answered goes on forever. For starters, would Telecom be able to maintain its high dividend payout ratio if the capital-hungry high-growth businesses - let's call them T2 - were spun off?

If so, it might retain its yield investors. But would its share price collapse after the split, as has happened after other spinoffs?

How would the split be done? Options would be a handout of T2 shares to the existing shareholders or an initial public offering to raise fresh capital. Would the money go to Telecom or T2?

How much of T2 would Telecom keep? At least 51%, of course, to keep operational control and ensure T2 wasn't taken over by someone else. But if it sold "too much" - say, 49% - it could be accused of "selling its future." And if it sold too little there wouldn't be enough liquidity in T2 shares to attract the big investors.

Then there are value creation questions. If the cost of T2's debt rose as a result of the split would the economic value lost outweigh the extra value recognised by the market?

Then there are governance issues. For instance, T2's directors would be duty-bound to look out for the interests of all T2 shareholders, not just Telecom. How could they turn down another carrier if it offered Xtra better terms than Telecom?

And then there are thorny operational issues.

Problems can arise when brands and distribution are shared. For instance, high-growth "junior" companies tend to experiment far more with brands than their parents. How would Telecom be compensated if T2 damaged its brand?

Where would the shared costs of research and development, and sales and marketing be allocated?

How would transfer pricing for goods and services traded between the two companies be settled? Both sets of managers would want as sharp a deal as possible to make their company's performance look better and fights would be inevitable.

And how would the critical ability to offer a bundled package of products and services be affected?

Ms Gattung is well aware of all these questions. "We're not just going to make a premature decision and wake up one day and realise we can't operate and manage the companies," she told Reuters in May.

So enough bleating from the cheap seats. To paraphrase Rachel Hunter, it might happen but it won't happen overnight.

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