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Belt-tightening pulls Telecom through

By Rob Hosking

Friday 9th May 2003

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Telecom investors will be looking for some indication for the company's future direction from today's quarterly result.

The telecommunications giant will announce its third-quarter result this morning. Analysts are picking a result somewhere in the $182-196 million range.

That is regarded as a fairly strong result but it is also likely to be driven mostly by lower costs rather than higher revenue.

And Telecom's third quarter is usually its strongest.

The onetime darling of the New Zealand sharemarket has faced tougher times in recent years, with telecommunications stocks going from swan to ugly duckling status and disquiet over the company's Australian expansion.

Telecom halved dividends in 2000 and increasing borrowings to fund the purchase of Australian carrier AAPT just as the gloss was coming off the international telecommunications sector.

It has since had to drop the value of its AAPT subsidiary.

However, analysts are now beginning to show some cautious optimism.

The sale of its stake in Independent Newspapers boosted Telecom's share price this week. Telecom has said it will use the proceeds from the sale to lower its debt, which may bring forward the date of its promised dividend increase.

The company has the declared aim of reducing debt to below twice its earnings before it lifts dividend payouts again. At present the debt level is 2.3 times earnings.

"A lot of things look OK at the moment," Forsyth Barr analyst Jeremy Simpson said.

"The Australian investment is not expected to contribute much value over the next few years but no one is expecting it to yet. The share price is basically the New Zealand business and that's not looking too bad."

Telecom is expected to place further emphasis on reducing costs over the next few years. The company has slashed back its capital spending in both New Zealand and Australia, and other costs have been under pressure for several years.

The reduced debt ­ and the consequent drop in Telecom's interest bill ­ will be a big factor over the next year or so.

How that affects the company's cashflow will determine when Telecom shareholders can expect to see dividends rise,

Macquarie Equities analyst Steve Hodgson said, "That will probably be towards the end of the 2004 financial year ­ higher dividends will probably come in 2005."

One of the main unknowns is the impact of the new telecommunications regulatory regime.

"The competitive environment in New Zealand is not too onerous for Telecom at the moment," Mr Simpson said. "But regulation is going to put a bit of a cap on the share price in the near term because of the uncertainty."

Several competitive issues are before the Commerce Commission's new telecommunications commissioner, Douglas Webb.

Earlier this year Mr Webb ordered Telecom to more than halve its interconnection charges for competitors.

That was a harsher ruling than many were expecting and there is a concern the new regime will be unnecessarily tough on Telecom.

The commission's decision on Telecom's wholesale charges is imminent.

The direct impact of the commissioner's decision on profitability would be comparatively limited, Mr Hodgson said.

"Indirectly, though, there will be a second round impact of improving its competitors positions ­ especially TelstraClear."

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