Telstra investors looking to Ziggy Switkowski to deliver

By FRANK FERNANDEZ

Monday 17th July 2000

Since the inception of Stocktake, I have written about two stocks - GDC and PRG. GDC has done extremely well rising from an opening listing price of $1.75 to a high of $3.98 over the subsequent weeks. PRG, on the other hand, has been extremely disappointing with the share price dipping from $1.70 to $1.52 at last close. However it does appear that because of market conditions, expansion plans for the company have been placed on the backburner in the interim - and this has seen the stock punished accordingly by shareholders. However, if the issue of some 370,000 shares @$1.68 to PRG executives not so long ago is any guide, there is obviously no shortage of confidence (at management level at least) in the stock's future.

In recent times, I have been following Australian stocks as I believe that the bigger market (population and number of stocks), greater availability of market information and market depth, and the more stringent regime run by the ASX makes for a more favourable investing environment. Lucky enough to be able to spend some time across the ditch recently, I found myself immersed in a riveting stockmarket scene -one which was rife with takeover rumours and the constant ramping of stocks on investor web sites. Almost all of those rumours came to nothing - except to make a lot of money for those lucky enough to jump on and off the bandwagon at the right time.

In the last few months, there has been a large sell-off in global telecommunications companies as the sector fell out of favour with investors worldwide. In New Zealand, we have seen our own Telecom sinking to new lows ...and remaining there. However in Australia in recent weeks, there has been a renewed interest in telco stocks with Telstra especially coming back into favour. Telstra has long been a favourite whipping toy for a bored Australian news media and hence why the company, on more occasions than not, ending up at the wrong end of the media's gun barrel.

To be fair to Telstra, over the three years to 1999, the company has been driven with an emphasis on restructuring, efficiency and initial cost cutting (current management believes much more can be achieved). Revenue in the period rose by 6% a year compound to A$17.6 billion, and profit before depreciation, interest and tax (PBDIT) by 11.5% to A$8.35 billion. PBDIT rose from 39.5% to an outstanding 47.5% of total revenue, and profit on this measure in 1999 was A$0.65 a share. Net profit rose at a rate of 18% a year in the three years to A$3.5 billion, or A$0.27 a share, giving comfortable cover for a A$0.17c a share dividend.

In the half year to December 1999, Telstra's sales momentum was maintained at 5.3% to A$9.3 billion. PBDIT (perhaps the best measure of underlying performance) increased by 9% to A$4.6 billion (A$0.35 a share). Net profit was up 15.6% to A$2.1 billion (A$0.16 a share) assisted by a reduced tax provision and lower interest.

Ziggy's formula

While Telstra's management strategy may have appeared to be confusing in the past to Australia's news media, CEO Ziggy Switkowski (who took over the reins in March last year) does appear to have a winning formula for the company. Telstra, over the past 12 months, has embarked on a series of expansion moves deliberately designed to position it to achieve Switkowski's vision of expanding globally and being more than a telephone company.

A big part of Switkowski's strategy is to tap into the vast and seemingly bottomless and extremely lucrative Asian markets. A fortnight ago, Telstra achieved the first step in this direction when shareholders of Cable & Wireless Hong Kong Telekom voted overwhelmingly to be acquired by Telstra's intended pan-Asian partner, internet company Pacific Century CyberWorks (PCCW) which is owned by mega-entrepreneur Richard Li. [PCCW is in the process of completing an A$42 billion takeover of Hong Kong's former monopoly telephone carrier]

For Switkowski and Telstra shareholders, the CyberWorks deal (which will see Telstra invest A$5 billion to give it a 2% stake in PCCW, currently valued at A$35.25 billion) is extremely important. If it works long term (and there are no reasons to suggest otherwise), Telstra will emerge as a significant player in high growth businesses in one of the world's highest growth areas. Short- term, it could quite quickly add to Telstra's worth - by getting markets to put a significant value on the blue sky in the two joint ventures which form part of the deal.

The joint ventures comprise a panAsian mobile phone operation (with Telstra taking a 40% stakeholding) and a global "internet protocol backbone". The plan of the panAsian mobile phone operation is to hunt down and acquire mobile phone businesses all over Asia. It will also include the distribution of internet content produced by PCCW's production houses, the development of software and electronic commerce products for corporate customers, and the establishment of data-hosting centres across Asia.

The IP operation is a 50-50 joint venture which both companies hope will corner a major role in delivering voice, data, internet and interactive services such as online banking and shopping to the masses of Asia (including China). This will consist of the likes of undersea telephone cables and satellite capacity to which Telstra will contribute assets.

It has generally been agreed by analysts that because HKT does not have the carrier assets or the technical expertise of Telstra, it is more than likely that Telstra will take the upper hand in managing the business (although the carrier joint venture will be headquartered in Hong Kong). The next step in the takeover of Cable & Wireless HKT by PCCW will require the deal to be ratified by Hong Kong courts on July 25. And if all goes to plan, as almost everything has so far, the complicated mergers and alliances mapped out by PCCW and Telstra will take effect on August 10.

Inroads into m-commerce

While the PCCW deal will allow Telstra to enter and establish itself in Asia in a significant way, Telstra has in recent times (and probably not known by many investors) also been attracting a lot of attention in the world of finance. Credit card and payments companies such as MasterCard International and Visa have been watching Telstra's every move - mindful that the telecommunications carrier stands at the gate of electronic commerce.

And this is what it is all about. Telstra directly benefits by carrying billions of e-commerce transactions on its wireless and cables network. And through its surprisingly successful Qantas/Telstra Visa card - which has dramatically eroded MasterCard's share of the credit card market in Australia - it has developed a deep understanding of some of the critical payments issues that are dominating thinking about the new world of online transactions.

Indeed, senior executives of MasterCard accredit Telstra with helping solve one of the
biggest riddles in e-commerce - how to make the mobile phone the essential tool for e-commerce. MasterCard believes mobile-phone technology will underpin the trillions of dollars in global e-commerce turnover that United States-based research companies such as Forrester and Gartner Group have been predicting for years.

While Forrester estimates e-commerce revenue will top $US7 billion ($A12 billion) by 2004, the expected surge certainly has not happened yet. MasterCard estimates e-commerce transactions represented only about 1.5% of its 5.4 billion authorisations last year. Indeed, some delegates at a MasterCard conference in Malaysia recently were quietly sceptical about the forecast growth rates that have telecommunications companies and banks salivating.

At the conference, Miyuki Suzuki of Brokat (a German-based company that supplies payments software to banks and businesses) said e-commerce so far had failed to live up to consumers' expectations. She noted that only one in three customers who log into the Internet with a plan to buy something actually execute a deal. The rest drop out because the transaction process is too complicated, or they are concerned about who else might be reading their credit card information, and because financial institutions and retailers so far had not provided a great choice of payment methods. Most demanded credit cards.

Ms Suzuki nevertheless remains confident about the growth of e-commerce, saying while customers would use personal computers to surf the Net, WAP (wireless application protocol) and higher-speed wireless technology will make mobile phones the preferred device for conducting transactions.

At the same conference, Gareth Hill of United Kingdom-based FlexiCom, which supplies payments processing systems to banks, suggested the big switch to e-commerce would emerge in 2003 when most mobile phones will use WAP systems. Until now, the single biggest hurdle has been customer concerns about security. It seems that despite sophisticated encryption technology, Internet users are wary about giving their credit card details.

MasterCard's chief executive Robert Selander believes that while chip-based smartcard technology overcame the security problem, the cost of installing terminals that could decipher the information on the chips would run to well over $US20 billion - and that bill would be passed on to retailers.

And this is where it appears that Telstra might have a future edge. What Telstra is doing, as part of its ongoing work alongside Hitachi, Motorola and Keycorp in the global MULTOS consortium, is to help find a way to put smartcard technology on the SIM card inside the mobile phone.

If the mobile phones also used the revolutionary Bluetooth technology (which helps mobile devices activate or talk to other devices using infra-red technology), customers need only, in the future, to point their phones at vending machines or cashier terminals.

Until recently, smartcards were considered an expensive way to solve problems of fraud. But as retailers realised how much information could be stored on chip-based cards - up to 100 times more information than traditional magnetic-strip cards - the economic rationale swung back in their favour.

All of this of course makes Telstra's proposed foray into the hot mobile phone markets of Asia particularly interesting. Customers throughout Asia are expected to be the most enthusiastic adopters of mobile phone commerce (m-commerce). Millions of consumers in Hong Kong, Singapore, South Korea and Japan now own at least one mobile phone. As well, analysts believe merchants across Asia are not faced with the problems encountered in North America where retailers wanting to trade electronically are shut out by financial institutions reluctant to pay huge costs to convert all their operating systems and software. In Asia especially, transactions over mobile phones in the future is expected to easily outnumber those initiated on personal computers.

Improving share price

The recent gradual improvement in the share price of Telstra indicates that the market is warming to expansion plans that the company has set in place in all facets of its business. Analysts expect this trend to continue until the PCCW deal is finalised on August 10 where a favourable outcome on that date could see Telstra shares rocket higher.

Telstra ordinary shares finished up last Friday on the ASX at A$7.38, some 24% below its high of A$9.16 achieved in the tech bubble earlier this year. On the NZSE, Telstra closed at $9.30, about 24% below its year's high of $11.50. By way of comparison, Cable & Wireless Optus in Australia is down by about 35% while Telecom New Zealand is about 31% off its 1999 high (at time of writing).

Like all investments, there will continue to be both bull and bear points for Telstra. It is a leader in the growth sector of telecommunications with ambitious expansion plans. As such, it will never be far from the public eye. On sheer quality of assets, Telstra's position in the Australian and offshore markets, and its potential for growth, makes it a prime anchor for any investment portfolio. As a longer-term investment, it offers to return strong capital gains to investors in the months to come.

On August 10, when the ink dries on the documents for PCCW to take over Cable & Wireless HKT, champagne corks will undoubtedly be popping at PCCW's and Telstra's headquarters. For Telstra investors, the share price of TLS in the ensuing period will reflect whether Ziggy Switkowski's new direction has star quality. If the market accepts it has, a premium price for TLS can be expected.

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