Gattung takes axe to costs as Telecom's revenues shrink

By Shoeshine

Friday 15th November 2002

The way things are these days, any company that reports lower earnings or "guides" over-optimistic analysts just has to be in big trouble.

And so it has been with Telecom. If you believe everything you read in the papers, chief executive Theresa Gattung is inches away from being sacked and a takeover, "probably by Telstra," is just around the corner.

Neither of these is a likely eventuality. Telecom is struggling mainly because of its purchase of AAPT, which was announced in September 1999. At that time Gattung had been CEO for only a month, and she didn't join the board until a month later.

As for the Telstra takeover, it doesn't take a competition law expert to predict what the Commerce Commission would have to say about the country's second biggest fixed line operator buying its only competitor.

Even a third party would have to get around the Kiwi Share, which requires ministerial approval for any shareholding above 10%. This is unlikely to be forthcoming from the present government.

Even though nobody sensible believes Gattung is under any threat, her track record bears some examination, particularly in the light of the latest share price setback.

This came about largely because Telecom "corrected" analysts' profit expectations, which had been for June 2003 net earnings of $676 million to $760 million. The first quarter came in on Tuesday at $146 million, down 3.3% on the previous year.

The headline number, however, doesn't do justice to the improved quality of the underlying earnings.

Earnings for the 2001 first quarter were boosted by two one-offs gains on the prepayment of a cross-border lease ($23 million in the full 2002 year) and sales of international network capacity ($19 million for the year).

This quarter was boosted by a lower amortisation charge following the $850 million writedown of AAPT. Taking all these one-offs out, net earnings were up 8.1%.

The bad news was revenue, down 7.1% at $1.3 billion, but the picture was mixed.

Earnings before interest and tax rose, and expenses were cut, in five of the six business groups. Only International saw all three measures fall following the capacity sales.

The revenue losers were the biggest division by far, New Zealand Wireline, the second biggest, Australian Business and Internet, and the fourth biggest, Australian Consumer. Only the third-ranking New Zealand Mobile and the relatively small Internet and Directories lifted sales.

The falls at the two biggest divisions are a bit of a worry.

At the workhorse, NZ Wireline division was down 2.7% to $692 million.

What can't yet be factored into forecasts is what regulation of access to Telecom's network by its competitors might cost the company.

The matter has been the subject of a flurry of press releases and intense lobbying of the Commerce Commission, which houses telecommunications commissioner Douglas Webb.

At issue is how much the Kiwi Share obligation to provide free local calling and the CPI cap on line rental charges are costing the company and how much competitors should contribute to that cost.

Telecom has revised its original $425 million a year to $408 million, prompting an outraged howl from TelstraClear, which thinks 1% of revenue, or about $55 million, is more like it.

The commission is doing its own work and expects to rule on the cost, and how it should be shared out, early next year.

As if that wasn't worry enough, Telecom seems to have bought itself a fight with the government over the connection fee it proposes to charge to people who choose to build a house halfway up the Southern Alps. The government, without making any coherent case for doing so, has threatened to intervene.

At Australian Business and Internet revenue fell 5% to $210 million, while the Consumer division fell 22% to $187 million.

These two contributed ebitda of $38 million between them, not much of a return on the $1.6 billion spent buying AAPT.

Gattung's challenges are to protect the New Zealand earnings base and to wring enough money out of Australia to at least cover the cost of the capital spent buying AAPT.

While there's a long way to go yet, it's hard to criticise her record so far.

Largely because of the AAPT cost, Telecom's gearing since she took over in 1999 has risen from 69% to 80%.

Interest cover has halved, from 6.8 times to 3.4, and the return on assets employed has fallen from 29.8% to 17.4%.

Despite these burdens ebitda has grown every year, from $1.96 billion in 1999 to $2.26 billion this June year, or an average 5.5% a year. Not too many telcos around the world can claim as much in the tough environment of recent years.

Telecom is now going to have to work extra hard on investor relations.

The exit last month of Verizon removed an overhang on the stock that saw the shares rise well above $5. Verizon's shares went all over the world, but mainly to the US, at $4.50.

The new investors shouldn't be too worried about the latest fall, some of which has already been recovered.

But the patience of a bunch of mostly Australian institutions that took a $500 million placement at $5.50 last May might be starting to fray.

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