KEY POINTS:
Theresa Gattung's thirty-first and final quarterly results presentation as Telecom's chief executive was a sombre occasion. She leaves on June 30 with the company facing an uncertain future because of the proposed introduction of a draconian regulatory regime.
Gattung's first quarterly results commentary on November 16, 1999 contained
this statement:
"Ms Gattung said startup costs associated with the Southern Cross Cable across the Pacific and funding costs for Telecom's purchase of the initial 19.8 per cent shareholding in Australian telecommunications company AAPT had reduced earnings by $7 million.
"Both of these projects are expected to add significant long-term value."
Gattung failed to deliver on AAPT and Telecom's share price closed at $4.88 yesterday compared with $7.84 after her first quarterly result announcement.
It was ironic that her final profit presentation was on the 23rd floor of the Ernst & Young building in Sydney, AAPT's head office.
But Telecom's current problems are not due to AAPT or Gattung's mismanagement.
The problem goes back to 1990 when the company was sold to two US companies and four influential New Zealand businessmen. These owners extracted as much cash as they could from the business and hopelessly underinvested in the network.
The situation was exacerbated by Roderick Deane, chairman until June last year, who believed that the company had property rights over the network and the Government had no jurisdiction to regulate these assets.
This high-risk strategy failed and the Government announced on May 4 last year that it would introduce a tougher regulatory regime, including the accounting separation of Telecom's business operations and the introduction of more competition between exchanges and users.
The main objective of this was to boost broadband use by encouraging investment in the telecommunications infrastructure.
Telecom has been in a state of disarray, as far as its long-term structure is concerned, since the May 4, 2006 pronouncement.
Chairman Wayne Boyd opened this week's presentation with the announcement that Telecom was proposing a capital return of $1.1 billion from the $2.16 billion Yellow Pages Group sale proceeds.
The AAPT office was packed with media, Australian telecommunications analysts and a small number of New Zealand investment managers. Attendees were far more interested in hearing about the capital return and regulatory developments than the third quarter result.
Confidence in the company has dropped so far that one analyst wrote that a capital return of $1.8 billion would be the best case scenario and a $1 billion payment the worst outcome. In other words, investors don't trust the company to make good use of the Yellow Pages proceeds.
Boyd was extremely critical of the Government's proposed regulatory regime. He said any proposal had to encourage investment and the latest one did not achieve this objective.
Gattung and chief financial officer Marko Bogoievski sped through their result presentations. Gattung looked nervous and disjointed, and skipped most of her slides, but she said afterwards she and Bogoievski had decided to rush through the profit figures as most of those present would have been more interested in the capital repayment and proposed regulatory regime.
In her concluding remarks she said the company would have to break with tradition by not giving any earnings or capital expenditure guidance for the next financial year. Gattung said the group's future structure was uncertain and it had too many moving parts for the board to adopt a 2007/08 budget.
THIS extraordinary situation was the focus for much of the question and answer session that followed, with Bogoievski telling one analyst that it was not viable for an asset to be regulated and commercially robust.
Gattung said the telecommunications sector would be a "train wreck" in New Zealand if it kept going down the current path and stressed that we had to have a live and active national debate about broadband as is the case in Australia. She said the country had to resolve its broadband underinvestment problem and not let it drag on for years.
Telecom's structure is a key factor to resolving this issue and there are a number of options, including:
* Leave Telecom unchanged as a fully integrated telecommunications group. It is too late for this option as the Government has decided that the company's structure has to change.
* The Ministry of Economic Development is proposing that Telecom splits into three separate divisions; network, wholesale and retail. The network division would operate as a standalone activity and the wholesale and retail divisions would buy services from it on the same price and conditions as any outside user. This is unacceptable to Telecom because the group board would have to make investment decisions regarding the network unit that would benefit outside parties. Telecom has said it will not make sufficient investment under this scenario to upscale the country's broadband.
* The company has countered with a proposal to turn the network division into a separate company and undertake a simpler form of operational separation between wholesale and retail.
* Simon Botherway of Brook Asset Management is promoting the complete split up of Telecom. He told this week's presentation that Telecom's capital expenditure was too high given its poor earnings outlook. In his opinion the best option under this scenario would be to split the group up entirely.
This issue is extremely important as far Telecom and New Zealand economic development is concerned.
New Zealand is slowly but surely dropping behind the world in terms of economic prosperity. The Government has correctly decided that improved broadband access would help reverse this trend. Its aim is to have 90 per cent of the country receiving broadband at 5 megabits per second by 2010 - a big improvement on the current situation in terms of access, speed and quality.
Telecom says it will have to invest $1.5 billion to achieve this goal, but under the operational model in the second option it would only invest $500 million. This cap would mean 50 per cent of the population received broadband at 5Mbps.
One analyst suggested that Telecom could be penalised for under-investing under the new legislation, but the company is adamant that it will not invest if it does not achieve adequate shareholder returns.
There is no doubt that Deane and the Telecom board overplayed their hand on private property rights but the Government is now going too far under its proposed operational separation model. Its proposal will not deliver the investment required to achieve 90 per cent broadband penetration at 5Mbps.
The Government has called for submissions on the Telecom proposal by May 15. Hopefully the issue will then go to the Prime Minister and the Minister of Finance because the modernisation of the country's telecommunications network is vital to achieve the 90 per cent/5Mbps broadband goal.
Telecom has been naive and made mistakes, but so has the Government, by selling the company to a US/NZ consortium in 1990 without setting any regulatory or investment guidelines.
The Government now needs to listen to Telecom if it is to achieve its broadband goals.
A quick and realistic resolution is essential as none of us wants to sit through another embarrassing presentation in Sydney when our largest listed company tells the Australian media and investment community that it can't give any guidance for the year ahead because of its uncertain structure.
Disclosure: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.
