Richard Inder: Telecom's one worry is AAPT

GROWING PAINS

Telecom's shares yesterday got a caning for its decision to ramp up investment. Its shares at one point touched a six-month low as it indicated the spending would hold earnings at the bottom end of investor expectations for a couple of years.

But the plans for high-speed internet and mobile services, which gobble up the bulk of the new investment in New Zealand, are necessary as the mix of the latest results show.

Sales by Telecom's traditional business of delivering plain old telephone calls fell by more than 11 per cent against the same quarter last year as intense competition continued to bite.

Only through investment in capabilities that can increase the volume of traffic across its network can it continue to hold its own. This means hassle-free high-speed remote and wireless access to corporate networks and high-speed internet access at home.

The one worry is its Australian business AAPT.

Telecom has struggled to make a return on the $1.6 billion investment. Over the last six quarters revenue and trading profits have been bouncing around, asserting no obvious trend.

Now it is planning to lift capital investment in this division from $105 million this year to $140 million next year. It hopes it get the business growing by bundling more services such as the internet and mobile phones, improve customer service and engage more resellers of its services.

It remains to be seen whether this will deliver. Still, the downside looks limited. Telecom's shares are now yielding 10 per cent and there is a more than reasonable prospect it will lift its payout to shareholders.

Furthermore, if it manages to sell its stake in Independent Newspapers to Rupert Murdoch's News Corp, a deal which will see it pocket $272 million, its balance sheet by its own admission will not have enough debt.

That suggests a capital return.

Meanwhile, the company is running a tightrope with the regulator in this country over the take up of wholesale high speed internet access. It has so far signed up 170,000 residential customers using the service. It claims it is on track to deliver on a promise to the Government to sign up 250,000 customers by the end of this year.

On the face of it, the remaining 80,000 customers is not a hard ask as it signed up more than 47,000 in the last quarter alone. The problem for Telecom is the second part of its promise that a third of the connections will be provided by third parties.

On that score it is not doing so well, with wholesale customers making up just over 10 per cent of all its high-speed connections.

Rival internet providers say they would like to sign on more, but are hamstrung by poor regulation that allows Telecom to offer more attractive plans to its customers than it offers for wholesale. Many also believe Telecom customers get connected faster than those who sign up through third parties, although there are no figures to back this up.

Telecom insists it is on track, but a further 64,000 wholesale connections between now and the end of the year, effectively a tripling of the size of current installed base, looks a tall order.

FONTERRA SWITCH

Fonterra's consideration of a plan to adopt US dollars as its functional currency could have considerable benefits for its 12,000 farmer shareholders. If the dairy cooperative followed through with the idea to its extreme, farmers could receive their payouts in US dollars.

A possible big gain is the potential for farmers to take out mortgages in US dollars and allow them to benefit from America's lower interest rates. This could spur growth in the industry.

Fonterra's research shows that such a move may also reduce the volatility of payout, giving farmers greater certainty about their budgets.

Furthermore, Fonterra's $12 billion sales, representing 20 per cent of New Zealand export earnings, is mostly denominated in US dollars. Its reduced demand for the Kiwi dollars could weigh on the currency, ironically boosting farmer returns.

There are downsides. Farmers with US dollar denominated mortgages would face a large foreign exchange risk when they decide to exit the industry. Moreover, they would face uncertainty over how to cover their kiwi dollar outgoings - rates, electricity, farm workers and their own expenses.

But they have plenty of time to think through the desirability of such a move as New Zealand companies are expected to make the shift by the start of 2007.

TAIL AND THE DOG

Kiwi Bank should no longer be considered a nice sideline of New Zealand Post.

Debt rating agency Standard & Poor's this week noted that within two or three years the people's bank would grow to represent 90 per cent of NZ Post's assets.

To put it another way, within two to three years the state-owned NZ Post will be a bank with a nice sideline running the nation's postal service.

Kiwi Bank at December 31 had $1.2 billion of deposits and $218 million of borrowings, all guaranteed by NZ Post.

Its contribution to its parent's profit of $2.42 million in the three months to March is still dwarfed by the returns from NZ Post's other operations. In the six months to December, NZ Post made a profit of $40.4 million. But as Kiwi's asset base grows, a rise in profits must be expected.

NZ Post has a separate board for the bank, but in the face of such a rise the pressure for a more formal separation must grow.