Telstra rings in the next phase of its Asian strategy

Telstra's acquisition of telco Pacnet will lead it a step closer to realising its Asian ambitions, while also fuelling future growth.

The $US697 million acquisition of Asian telecommunications provider Pacnet that Telstra confirmed today adds meat to the bones of David Thodey’s post-national broadband network growth strategy.

Earlier this year, to mark the fifth anniversary of his tenure as Telstra’s chief executive, Thodey gave a spate of interviews in which he began gently preparing Telstra shareholders for a significant shift in Telstra’s positioning from a largely introspective and defensive posture to a far more positive and expansionary one.

With cash now flowing from its agreements with NBN Co and the Federal Government -- and a new recently-signed deal with the government and NBN Co locking in the $11 billion of net present value of the original arrangements -- Telstra is on the prowl for acquisitions to both create future growth and to replace the core cash flows from its copper past that will gradually disappear over the next decade or so.

While there is tension between shareholder ambitions for cash returns from the massive income streams Telstra will receive from NBN Co over the next several decades and Telstra’s own aspirations to become a global technology company, Thodey has made it clear he believes the group’s cash flows and robust balance sheet will enable him to satisfy both.

It is instructive that in announcing the $860m Pacnet deal today, Telstra said it would be more accretive than a share buy hback of the same size. It is acutely aware of the sensitivities and the need to justify an acquisition rather than a capital return.

While Thodey has talked about an evolution towards becoming a global technology company and Telstra has made a spate of relatively modest acquisitions and investments in various e-service and software businesses, he has also made it very clear that a key focus for the group in this next phase of its development is Asia.

Telstra has always had an extensive network of points of presence in Asia. Three years ago, when it dissolved its controversial Reach cable joint venture with Hong Kong’s Richard Li, it took full control of one of the most extensive networks in the region. Subsequently it has been layering its managed networks and cloud-based service products for enterprises and governments over its network.

With chief financial officer Andy Penn (who has extensive experience in the region from his time as chief executive of AXA Asia Pacific) over-seeing the Asian strategy, Telstra has been expanding aggressively and has stocked up its executive ranks in the region to support its ambitions.

Pacnet fits the strategy perfectly. It has an integrated network across the region, with data centres and sub-marine cables across Asia-Pacific targeting enterprise and carrier customers. It is the only foreign player licensed to operate a domestic IP virtual private network and provide data centre services in most of the major provinces in China.

Putting it next to Telstra’s own operations almost doubles their size and offers potentially significant synergies. It creates a leading platform in the region off which Telstra can leverage its cloud and managed network services.

There had been a lot of speculation about the deal, which forced Telstra to confirm it was in discussions with Pacnet’s owners earlier this month. The financial players that own the group -- Ashmore Investment Management, Spinnaker Capital and Clearwater Capital Partners -- have been looking for an exit for some time.

The price is lower than the $1 billion speculated and includes $US400m of Pacnet debt. In 2013 the business generated $US472m of revenue and $US111m of earnings before interest, tax, depreciation and amortisation. Telstra says it will be earnings per share-accretive in its second year of Telstra ownership and will generate a return above Telstra’s cost of capital by year three.

There would be a certain sense of satisfaction among those inside Telstra with some experience of the group’s troubled history with its own cable network in the region.

While it is often mischaracterised as a disaster because Telstra wrote about $1bn off the book value of the Reach joint venture (off inflated values for the assets it, and Li, vended into Reach), there are still some scars within the group as a result of the far more real $US900m 'hair-cut' suffered by Reach’s bankers.

The reason Reach experienced difficult was the explosion in cable capacity in the region in the lead-up to the implosion of the dotcom and telco bubble in 2000. The bursting of the bubble left the Asia Pacific region awash with excess capacity and destroyed returns.

One of Pacnet’s antecedents was Asia Global Crossing, which was part of (and a leading player in) that disastrous pre-2000 Asian land grab (although it was prosecuted more under water than on land), by cable companies in anticipation of the 'Asian Century' that proved so damaging to Reach and Telstra.

Asia Global Crossing was bankrupted in 2002 before eventually finding its way (after several years of partial and then full ownership by China Netcom) to the current private investor group in a $US402m deal in 2006. It was subsequently merged with the C2C cable business and, in 2007, merged with Singapore’s Pacific Internet and re-badged Pacnet.