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Opinion: Will Telecom's cash go to shareholders or on expansion?


Saturday 30th July 2005

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Market commentators are talking up the prospect of healthy capital repayment when Telecom reports its annual result next Friday.

Shares in the telco have risen sharply in recent weeks in anticipation that it will return as much as $400 million to shareholders in special dividends or a share buyback.

But as competition in the mobile phone sector -- the only segment of the market that Telecom has struggled to dominate -- intensifies, the question has to be asked: would Telecom be wise to hold onto some of its spare cash as a guard against an onslaught of competition?

On Thursday, Telecom -- the country's biggest listed company -- touched an intraday six month high of $6.42, and has been a key driver in the benchmark NZSX-50 index chalking up record gains on an almost daily basis lately.

The shares lost their early shine on Thursday afternoon, however, after new TelstraClear chief executive Alan Freeth gave his strongest indication yet that TelstraClear has firm intentions to build a third mobile network in New Zealand.

"Our intention is to build a mobile network. The business case is under review," he said.

Freeth's comments saw Telcom's shares wilt to $6.27 on Thursday afternoon before recovering to $6.32 on Friday.

"The market's view is that that would be fairly damaging for Telecom," Goldman Sachs JB Were broker Joe Gallagher said.

"You'd have a big pickup in competition in mobiles, and you'd see prices drop."

Telecom is expected to post a healthy $800 million plus profit for the June year -- up from $750 million a year ago.

After accounting for agreements with ratings agencies to keep its ratio of gross debt to earnings in check, and with no plans to use the surplus cash for any offshore expansion after its less-than-successful foray into Australia with AAPT, Telecom will have a healthy stash of cash to return to shareholders.

"We think they could probably pay up to 20c per share in special dividends," one local analyst said.

"There will be a special dividend and there may or may not be a share buyback as well."

Some analysts think TelstraClear is bluffing about building a national mobile network, and that its Australian owner, Telstra, would baulk at the estimated $600 million cost.

But Goldman Sachs JB Were analyst Andrew White says TelstraClear could build a network in Auckland for much less and strike a commercial deal with Vodafone to use its network in other places. TelstraClear currently resells Vodafone's service.

Either way, the opening move has been played, and with Vodafone set to launch its high-speed network by Christmas, Telecom may choose to build up its armory -- rather than deliver the cash back to its largely offshore shareholders.

"The market would love it if we just paid more cash back," Telecom chief executive Theresa Gattung told Reuters in a recent interview.

Currently capital expenditure is forecast at $750 million for 2005/06, roughly matching last year's annual profit.

Ms Gattung says Telecom isn't necessarily thinking of spending $50-$100 million more each year in the foreseeable future -- as it has done in previous years, "but it is probably true that the level we're spending at now is likely to continue, it's not likely to go backwards and down again for a while."

In the third quarter,Telecom outpaced global giant Vodafone for the first time, gaining a 51 percent share of new mobile revenues.

Telecom launched its "T3G" network in November 2004 -- an upgrade of its existing digital network. Some analysts view the system as closer to "2.5G" than "3G" and believe it will be superseded by Vodafone's wideband CDMA.

Goldman Sachs' broker Gallagher said one option for Telecom would be to partner up with TelstraClear to build a new mobile network.

"Telecom currently has an EV-DO network. If Vodafone, which is expected to launch its 3G network any month, comes out with an extremely good consumer offering, Telecom -- through competition -- might be forced to go down the UMTS or wideband CDMA network route, and maybe Telecom and Telstra will get together."

New Zealand has been described as "the land of the long white telco monopoly" -- a reference to Telecom's defensive grip on the local loop, which has survived several attempts by TelstraClear to get competition regulators to unbundle the copper wire network.

That has seen TelstraClear so far stay out of wholesaling high-speed Internet services from Telecom.

The national uptake of broadband has been slow, and telecommunications commissioner Douglas Webb is promising to wade into the fray.

Earlier this month he told angry Internet service providers (ISPs) that a big move is imminent regarding Telecom's wholesale broadband regime, and has recently threatened regulation to separate Telecom's wholesale and retail broadband businesses.

Meanwhile, innovative broadband players like Woosh Wireless are snapping at Telecom's heels, with offerings that circumvent Telecom's local loop.

Woosh said this week its customer base has grown by 50% in the past five months to 15,000. Within its network coverage it has an average market share of 30% and is currently rolling out its services to Auckland, Wellington, Christchurch and Southland.

Trials of phone services are also "very advanced".

Beyond the regulatory and political niggling, analysts say there are strong commercial reasons for Telecom to invest in its broadband capacity.

"There is a strong commercial imperative encouraging Telecom to increase its uptake of broadband and improving technology in that they can use it as a pipeline for other service offerings," a local analyst said, creating a one-stop-shop for cable TV -- through its partnership with SkyTV -- land lines, and mobiles.

That sort of expansion doesn't come cheaply -- and is something that investors should consider before popping the cork on a potential cash repayment.

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