2000: Telecom faces biggest test

By RICHARD BRADDELL

At the end of the year, Telecom shares were hardly free, although they were a far cry from the $12 analysts once told us they were worth and the $10 they reached at their peak.

But even as the shares slid relentlessly, it seemed inconceivable they could go below $5.

They did, underscoring the huge challenge faced by chief executive Theresa Gattung in turning Telecom from a company focused on domestic earnings into an integrated high-growth transtasman telco.

The fall from grace of the telco stocks globally, growing competition and the telecommunications inquiry have done nothing to help Telecom's share price. But in the end, the difficulty lies in the risk associated with the Australian strategy.

On paper it looks good, and Telecom probably has little choice but to proceed if it is not to atrophy. But the test of Ms Gattung's stewardship will be whether she can pull it off, and that will not be apparent for a couple of years.

She has a couple of things in her favour. While Telecom's Australian equivalent, Telstra, has outgrown Australia and must look for Asian partnerships with culturally different players such as PCCW in Hong Kong, Telecom has a market that is nearby and culturally not too different.

Australia is also a land of opportunity. That Telecom was able to take over AAPT and propel itself to No 3 in the Australian market attests to that.

Now, the break-up of Australia's second-largest player, Optus, as its owner Cable & Wireless reorients globally towards business and data, offers an exceptional opportunity that could cement Telecom's place as the No 2 Australasian carrier.

It will not be easy. Optus' mobile business is possibly worth more than Telecom itself, and it will take some clever restructuring to put a deal together and beat off other contenders, who are said to be lining up with large cash offers.

The rumoured partnership with NTT DoCoMo in a bid for Optus mobile remains unconfirmed. But Telecom has a bargaining chip of its own in the half stake it has in the multibillion-dollar Southern Cross Cable linking Australasia and North America.

Since Southern Cross is also 40 per cent owned by Cable & Wireless Optus, it may be an attractive holding to be swapped, in part payment at least.

But a gentle reminder that there is nothing easy about Telecom's strategy came last week when construction of AAPT's $A700 million ($867 million) mobile network was suspended until March, pending review with the lead contractor, Lucent Technologies.

There are two reasons for the delay. The official one is the significant delays in its construction.

But it also makes a lot of sense because of the pending Optus mobile bid, which would render the AAPT network superfluous.

There is also a suggestion that the delays may not all have been down to Lucent, and rumours have circulated that it wanted to pull out of the contract anyway.

Regardless, the $200 million network Lucent is also building for Telecom in New Zealand will be operational on time in the middle of next year. But it could be yet another case of Telecom making the wrong strategic decision on mobile infrastructure.

In New Zealand, it agonised about whether to go for a GSM network like Vodafone's, or for CDMA, which it finally chose for Australia and New Zealand.

But if Telecom succeeds with Optus, the problem is that the resulting mismatch of technologies in Australia and New Zealand will mean Telecom's New Zealand mobile customers travelling to Australia will have to roam on to Telstra's network, not its own.

The world Telecom faces is in marked contrast to the last decade, when it held all the cards. It still has the best ones, but the game is far less assured.

While the Government's telecommunications policy detailed last week was about as benign as could be expected, the belated emergence of serious competition is placing a definite crimp on Telecom's dominance in New Zealand.

Clear is enjoying something of a rebirth after British Telecom committed more than $200 million to network development.

Vodafone has demonstrated that it can outsell Telecom in the cellular market, and Telstra Saturn, having built residential networks in Wellington and Christchurch, will be obliged to tackle Telecom in Auckland to develop economies of scale.

Telecom's own behaviour in making access to its network expensive for competitors has increased the attractiveness of building competing infrastructure.

Telstra Saturn chief executive Jack Matthews admits that while the bulk of its revenue comes from the Telstra division acquired when the namesake companies merged at the beginning of the year, nearly all the profit margin lies in Saturn, which operates from its own residential network in Wellington.

Even with much more favourable interconnection and wholesaling agreements, the costs of Telstra's heavy reliance on Telecom's network to service its business market customers leaves it with little profit margin, he says.

Based on third-quarter figures disclosed by half-owner Austar United, Telstra Saturn's current annualised revenues would be around $140 million.

About $100 million of that is from the Telstra side, which is active in the business market, and the balance from Saturn's Wellington residential network.

While Telecom's pricing has staved off competition in the short term, it has left enough headroom to make it economic for competing facilities-based companies to build networks such as that being constructed by Telstra Saturn.

The Government's decisions on the Kiwi Share for the most part maintain a reasonably favourable status quo.

But Telecom's residential market share will drop and the time will surely come when it will be better business to spin it off.

Herald Online features:

2000 - Year in Review