Telecom's big loss slashes valuation

Theresa Gattung

Analysts yesterday downgraded their valuation of Telecom as the market absorbed the company's dismal full-year $435 million loss.

Telecom shares crashed to a 13-year low of $3.95, recovering later in the day to close down 2c at $4.08.

Merrill Lynch said the Telecom result was below its estimates. It slashed its valuation by 9 per cent to $3.93 a share and its dividend forecast by 14 per cent to 32c a share for the 2007 financial year.

Australian analyst ABN Amro cut its valuation from $4.15 to $4.05, but maintained a recommendation to hold shares.

Telecom chief executive Theresa Gattung said on Friday the company's culture had changed and it was "getting on with it".

She outlined a four-year strategy called "new generation Telecom" aimed at overcoming predicted declines in its fixed-line revenue and the effect of the Government's regulatory review.

The company planned to simplify its product offerings and start its own voice-over-internet service, and expected these moves to help lift earnings before interest, tax, depreciation and amortisation slightly, from $2.22 billion to $2.23 billion over the next four years.

But analysts remain unconvinced about Telecom's ability to maintain earnings.

The Government still has to set the price for the wholesale services Telecom sells to customers.

ABN Amro analyst Ian Martin said Telecom's earnings forecast was "optimistic" as this pricing was still unknown.

The company's result showed good revenue gains, but an increase in customer costs and implementation of new strategies had reduced margins.

"We expect a similar pattern through the next two or three quarters before pressure steps up a notch late in 2007," said Martin.

Goldman Sachs JB Were analyst Andrew White said Telecom continued to face "significant uncertainties".

The Commerce Commission was likely to recommend changes to mobile regulation that would open the way for a third, and maybe fourth, mobile competitor.

"Telecom will be exposed to increased mobile market share loss as its customers substituted fixed-line phones with mobiles," said White.

These wholesale prices had a significant bearing on Telecom's estimates of the likely effect of regulation on its value.

Also, Telecom's proposals for its wholesale network do not isolate the wholesale services within a subsidiary structure - as was done with British Telecom. The Government has indicated it prefers the BT model and has yet to reach an agreement with Telecom on its separation plan.

"The problem for Telecom is that its NZ fixed-line profit margins are high by global standards, and full structural separation would increase transparency and could lead to a destructive rate of return," said White.

Merrill Lynch analyst Patrick Russel said Telecom would probably have to upgrade to a wireless version of its mobile standard CDMA and the Government would force it to invest in more fibre.

This would require a big lift in capital spending in the 2008 results.

Telecom reported on Friday that about $394 million was lopped off the value of its Australian operations, including AAPT, on top of the $897 million writedown on the business reported in the half-year results.

Forsyth Barr analyst Jeremy Simpson said uncertainties and a declining earnings trend would make it difficult for the share price to rally.