Brian Gaynor: Telecom's travails offer no cheer

Telecom's June year result was well received by the market but it has negative implications for the New Zealand corporate sector. The country's largest listed group wrote off $850 million in Australia and demonstrated once again that our big companies are finding it extremely difficult to make successful overseas investments.

Telecom first entered Australia in 1992 when it set up a joint venture company, called Pacific Star Communications, with Bell Atlantic. The new company successfully tendered for the contract to manage the Queensland State Government's telecommunications network.

But Pacific Star was a disaster. It recorded a net loss of $29.6 million for the March 1996 year and $50.2 million for the following year. Pacific Star was subsequently closed down after incurring further write-downs of $7.4 million.

Telecom re-entered Australia in mid-1999 when it bought 19.9 per cent of AAPT. In September the New Zealand telco made a full takeover offer for AAPT and ended up with 80 per cent at a total cost of $1.57 billion. The purchase was totally funded by debt.

The acquisition was made shortly after Alan Gibbs, David Richwhite and the Bell Atlantic and Ameritech representatives had left the Telecom board. They argue that when they resigned the company was in a strong position to focus on the New Zealand market and to continue to pay a high dividend to shareholders.

In the middle of the AAPT offer Dr Roderick Deane was appointed chairman and Teresa Gattung replaced him as chief executive. The other Telecom directors were Peter Shirtcliffe, the former chairman, John King, Patsy Reddy, Michael Tyler and Paul Baines. None of the directors had any extensive working knowledge of the Australian telecommunications sector.

At the end of 2000 Telecom bought out AAPT's minority shareholders. Telecom's AAPT carrying value was $2.8 billion including post-acquisition investments, representing nearly a third of group assets.

AAPT has been as disappointing as Pacific Star. For the June 2002 year Telecom's Australian operations had an operating profit (earnings before interest and tax) of just $44 million on revenue of $1.8 billion. The group had an operating profit of $1.5 billion in New Zealand on revenue of $3.8 billion.

Telecom reported a net loss of $188 million for the June 2002 year after AAPT was written down by $850 million, from $2.85 billion to $2 billion. Analysts still believe AAPT is overvalued as they assess these operations to be worth between $600 million and $1.3 billion.

Deane and Gattung tried to put a positive spin on the situation but the AAPT investment has had a huge negative impact on shareholder wealth. Just prior to the AAPT investment Telecom's share price was $9.60 and it was paying an annual dividend of 46c a share.

Since then its earnings from traditional operations have risen but its dividend has been cut to 20c and its share price has almost halved. The negative figures are almost totally because of AAPT.

The inability of our big companies to make successful overseas investments has been a big drag on the NZSE. Telecom should have been far more successful across the Tasman, particularly as it has had two bites of this cherry.

Notwithstanding further potential write-downs in Australia analysts have a positive view of the telco. They point to its strong cash flow and relatively cheap price/earnings ratio compared with other international telecommunications groups.

At yesterday's closing price of $4.97 Telecom has a prospective price/earnings multiple of 12 for the current year and 10 for 2003-04 based on consensus forecasts. But the profitability of its Australian activities will continue to have an important influence on investor sentiment and the group's share price performance.

Waste Management

Waste Management had much better news from Australia when it announced its earnings for the six months to June 30. The company reported an operating profit (earnings before interest, tax, depreciation and amortisation) across the Tasman of $2.3 million compared with a loss of $200,000 for the same period last year.

The strong performance of its newly acquired Australian operations has been a timely boost because operating earnings in New Zealand declined from $22.8 million to $22.5 million. This was mainly because of the loss of the Auckland City rubbish collection contract from July 1 last year.

On July 5 Waste Management announced the acquisition of the All Waste liquid waste collection and treatment business in Melbourne from Thiess Services. This is being integrated into Hines and will increase the output of that operation by 30 per cent. The directors said: "Our Australian operations are meeting budget and we continue to look for opportunities to grow these businesses and to improve productivity."

Waste Management's share price has been disappointing but share-holders can look forward to better times if the group achieves more earnings growth across the Tasman.

Mr Chips

The mood was buoyant and champagne flowed at Mr Chips' annual meeting. The meeting coincided with the opening of the company's new $13 million factory expansion in South Auckland, a rare occasion for a listed company.

The new plant will almost double the size of the company, in dollar terms, and raises its potato chip production from two tonnes an hour to five.

After McCain's purchase of Heinz Wattie's potato-processing assets last year there are two big french fry producers in New Zealand. Canadian-owned McCain has 55 to 60 per cent market share and Mr Chips 25 to 30 per cent.

Mr Chips believes the McCain/Heinz Wattie merger has presented it with an opportunity because big users might not want to buy from a producer that also supplies its competitors.

Subsequent to the merger Mr Chips has picked up the Restaurant Brands contract, which now accounts for about 25 per cent of its total output.

The new expansion was funded by $5.5 million of new equity and a $7.5 million loan from the Bank of New Zealand.

The rights issue prospectus predicted that sales for the March 2003 year would increase by at least 25 per cent and operating earnings (earnings before interest and tax) by more than 100 per cent. Mr Chips is on track to report a net profit of $1.3 million for the current year and $1.9 million for the March 2004 year.

* Disclosure of interest: Brian Gaynor is a Telecom shareholder.

* bgaynor@xtra.co.nz