Peter Nowak: More blood will be spilled when regulation bites

In the settling dust of the Government's monumental telecommunications regulatory action two weeks ago, Telecom has so far seen about $2 billion of its market capitalisation vanish into thin air.

But make no mistake - the worst of the bloodbath is yet to come.

Observers who think the company's shares are a bargain are labouring under several misapprehensions: they're missing the Government's point, not using their imaginations, and assuming the stock will continue to pay dividends.

The most overused phrase of the past two weeks has to be "the devil is in the detail" - used by just about every commentator in reference to exactly what the regulation will mean for Telecom. The Government has announced a far-reaching set of actions: the unbundling of Telecom's local loop, unconstrained internet speeds, the separation of phone and internet services from one another, plus accounting separation.

The "devil" will be in the exact pricing details on the unbundled, unconstrained and naked services, and it's hard to predict the real financial impact on the company until these are known.

Unbundling will work on a cost-plus basis, meaning that Telecom will have to demonstrate the per-user cost of provisioning broadband. That's the price that will be charged to competitors, who will then tack on their own costs and profit margins. Regulators will ultimately decide what this cost will be.

Unconstrained and naked service prices, on the other hand, will be retail-minus. That means the regulator will set the charge for competitors by taking Telecom's retail price of the services and subtracting a suitable profit margin for them.

Some analysts and investors don't think these mandated prices will be too bad for Telecom, but they couldn't be more wrong.

The Government has been crystal clear that it is serious about boosting broadband uptake, and it's not afraid to do billions of dollars of damage to Telecom to do it. Telecom's argument all along has been that it won't invest if there's regulation, while the counter has been that competition will force the company to invest. The Government has obviously chosen to believe that second argument, and it would be very reckless indeed to announce such a sweeping regulatory package and then enact prices that weren't low.

Take Japan as an example. In 2000, the Japanese Government decided it wanted to make high-speed broadband available to 30 million of its 46 million households within five years. To that extent, the Government enacted the incredibly low unbundling charge of US$2 per user. The result? Several new companies, including ones not traditionally involved in building internet infrastructure, such as Yahoo, entered the market with cheap, fast broadband offerings.

Japan easily surpassed its goal and now offers DSL speeds over 40 megabits per second.

Communications Minister David Cunliffe is far from reckless. He's a fan of Bill Clinton, and worked in the US Congress during that President's Administration. His penchant for speaking in soundbites is a disguise for his well-honed diplomatic skills.

Cunliffe also knows the importance of setting all-round low prices, as they are the only way to encourage infrastructure investment and spur the competition needed to boost broadband uptake quickly. As Japan has shown, the point of regulation was not to punish the incumbent but to properly set the table for new investment.

Some analysts have suggested that Telecom's main competitors TelstraClear and ihug are in no position to invest much because of problems with their Australian parents. While that could be true, these analysts have limited their thinking.

Search engine titan Google has reportedly been buying up unused fibre cable around the world, with an eye to perhaps getting into the broadband-provisioning game. With low-enough service prices and New Zealand's history as a test market, could the idea of Google trying such an experiment here be that crazy? If Yahoo did it in Japan, why couldn't Google do it here?

Then there's the issue of Telecom's dividend. As one market analyst put it, the shareholder's time is over and it's now the consumer's turn. The Government's message to Telecom was clear: start investing and stop paying out dividends, or structural separation will follow.

Once that dividend is cut, the real bloodletting on the share price will begin.

How can Telecom avoid a further share price freefall? The answer is simple: its board needs to set in motion voluntary structural separation and enact a top-level house-cleaning. Telecom is a fat and lazy monopoly, and it can't survive in a newly competitive market under the people who have it made it that way - especially when they have lost the trust of customers and shareholders.