Telecom NZ feels the heat

The Kiwi telco's share price has fallen -23.6% since our review in issue 61 (Buy - $5.30) and shows no signs of stabilising yet. This is a grim performance indeed. The stock is down 45.2% since the beginning of the year and it has shown little sign of shaking off the blues - and you thought Telstra had problems.

Global unease

Part of this can be explained by the global unease about telecommunications companies in general. NTT, the Japanese giant telco, BT in Britain, Deutsche Telekom in Germany and AT&T in the States have all been taking a beating and are down anywhere between 40% and 60% over a similar period. In this sort of general telco sell-off a company such as Telecom NZ, with a small, mature domestic market, is always going to be dealt with most harshly.

The irony and unfairness of this situation is that Telecom NZ has consistently shown greater vision and better strategic thinking than many bigger telcos when it comes to working towards where it wants to be several years down the track. Its economical purchase of AAPT is a key to this strategy. The problem is, of course, that the AAPT investment - while much more coherent and rational than anything Ziggy and the Telstra boys have come up with - is not going to pay off for a couple of years yet. The market, though, is in no mood to view telcos on growth potential alone.

Domestically, the New Zealand government is not doing the company any favours either. That situation is a microcosm of political brawling which has mired Telstra in the battle for the bush. A government report into Telecom NZ has recommended enshrining the 'Kiwi Share' arrangement - their version of Telstra's Universal Service Obligation - in law.

This is a problem for telcos every bit as great as the problem of provision of health care for governments. The Kiwi Share aims at providing politically necessary assurances that rural services will be kept up to scratch, just in the way that governments are under pressure to ensure that all new advances in medical care are provided to their taxpayers.

Fast access

The problem is that these advances come at a price - and one which is very difficult to meet. Telecom says any requirement to provide fast internet access to rural areas could cost up to $500m in infrastructure investment. That's bad enough, but if the Kiwi Share is enshrined in law, the company is going to be left with an open-ended capital expenditure exposure to support ever-increasing standards of telecommunications throughout the country. With the speed of advancements in technology - as in the medical sphere - those costs just rise and rise.

Now, while we have little faith in politicians anywhere to do anything based on rational judgment, surely even a politician will be able to do the sums to see that the political damage of destroying one the country's biggest companies will outweigh the short-term benefits of keeping the farmers happy. Well that's what one would hope.

There is a more fundamental problem - and it is not specific to New Zealand. The rapid technological advances in the communications sector and the reforms throughout western economies which have seen a move to more market-driven practices, have changed the nature of telcos. No longer are they boring old stable cash cows and as such are seen as being exposed to more risk, but still without real growth options.

Paradoxically, that is why we have always liked Telecom NZ and still do - operationally at least. It has put in place real growth options - specifically through its bargain purchase of AAPT.

It has also shown a keen grasp of trends. Its esolutions division is performing to budget (it was an important component in Telecom winning the $6.4bn Commonwealth Bank telecommunications contract in Australia).

Its rollout of CDMA mobile telephony networks in conjunction with AAPT is likely to push down trans-Tasman call charges and pose a big competitive threat to the likes of Telstra and Optus in the business market.

The company has signalled that digital telephony will be the main focus of the coming year, as well as expanding its relationship with the Murdoch-controlled Independent Newspapers and Sky Network Television to package internet services and pay television in New Zealand.

So what should the investor do? Of the main factors depressing Telecom's share price, only the Kiwi Government's moves really concern us. There's no comforting answer to the question 'how stupid can a politician be?' and much depends on the answer. Telecom's strategies are sound and will pay off over time.

The company has much more scope to grow than Telstra and the investment to do so is, to a large extent, already in place - as long as Wellington doesn't spoil the party. If it doesn't - and surely the public outcry will prevent it from doing so - we believe that the stock will turn around, but it may take some time yet. We're disappointed by what has happened to the price so far, but with the stock at these levels we see little point in bailing out now. And, as we've said often enough with respect to our own Telstra, don't forget the revenue (and dividend) streams these telcos provide. A dividend yield of nearly 9% is not to be sneezed at. For these reasons, if you have a stake in Telecom, HOLD on to it, enjoy the dividends and wait for it to turn the corner. Unless you have a really dim view of the brainpower of politicians - and we understand if you do - there really is no other sensible course of action.