As senior director and head of institutional equities at Craigs Investment Partners Geoff Zame keeps a daily watch on tech stocks – most notably Telecom and Chorus (which represents 10.6 percent and 3.3 percent of the NZX50 respectively). Prior to joining the broker, Zame was investor relations manager and then finance manager for Telecom's business retail division from 2002 to 2007. He speaks to Sarah Putt ahead of Telecom’s first half-year financial report since structural separation.
Why are Telecom and Chorus shares worth more separately then they were together? Because Telecom before structural separation hovered around $2 a share, it was lower than $1.80 at one stage, now Chorus is around $3.25 and Telecom $2.15 - how come they are worth more apart then they were together?
You could argue that, but who is to say they wouldn’t be worth that aggregate value if they weren’t the same company? You can’t prove the counterfactual now. But you’re right, in aggregate the stock is trading at 12 month highs. In theory it appears that the split has been beneficial.
Often businesses create value just when they split simply because they have more efficient capital structures that better serve each business. They have focused management teams, they have appropriate governance, and a board which reflects a better fit for the strategy of those separate companies. And they have a more razor-like focus on executing on the costs and the drivers of the business, as opposed to being all in one where you end up with the lowest common denominator.
I guess one of the reasons Telecom did get to a lows of around $1.80 was because people were waiting to see if it got the government contract for the Ultra Fast Broadband rollout.
The stock was arguably oversold at that point, you’ve got to remember that the market was arguably pricing at a worst case scenario; that is that Telecom would not be successful with the UFB, the majority of it might be awarded to competing lines companies, at which point Telecom would face government-funded competing infrastructure and be overrun to some extent. That was the worst case scenario and as it became evident that was unlikely to materialise, and Telecom was successful, the share price started to recover.
Subsequent to the split there’s been a lot of activity in both stocks but it was situation where often one plus one equals more than two. That is, the sum of the parts is worth more than the whole. And that’s played out a number of times but, as I say, the counterfactual is always difficult to really quantify that because who is to say that the value of the overall business wouldn’t be something similar to what it is today?
You said that when a company splits there’s a razor-like focus, there’s good governance, and the company is looking at its cost structures more closely. None of that seems to me to describe Telecom in its current form. It’s got a CEO that’s about to go and we don’t know who is going to replace him, it must be massively overstaffed – it's probably about the same size as a Vodafone in terms of its operation but at least double the headcount. This is not an efficient company – do you think?
I think that there is always room for efficiencies. Incumbent telcos have traditionally traded on EBITDA margins in the 40-50 percent range, which have been perceived as high, but arguably they should have been higher for an infrastructure company. Why shouldn’t they have been more like 60 percent? It’s just a reflection of the cost structures, the legacy cost structures that are there.
Your question is – is Telecom efficient and is it rudderless and leaderless? We’re looking forward to the result but there is still continuity in management. In terms of the CFO who is leading a lot of the discipline and some of the other teams that are leading a lot of the disciplines around cost and capital management and they’re the levers that Telecom is working hard to pull at the moment. The top line is soft and the macro environment is pretty ordinary, so you have to pull what levers you can in that situation.
There is a transition for the CEO, arguably that does create a bit of uncertainty, but it’s a big annuity business and there is still some continuity in management, and of course there have been changes at the board level. I think the make up of the board composition is arguably fairly strong. And of course the chairman has had previous experience. He’s reasonably comfortable with the business, so he doesn’t have to come up to speed as much, so it sort of mitigates some of the issues.
So you’re happy with Nick Olson (CFO) and you’re happy with Mark Verbiest (chairman) – who do you want to see as CEO?
I don’t have a strong view. There are a couple of capable internal candidates.
Alan Gourdie and Chris Quin?
I don’t want to name them. There are a lot of internal candidates and there are any number of external candidates. Also, there are a number of capable kiwis currently offshore who might be willing to come back and run these sorts of businesses. And a good example of that recently are people like Christopher Luxon who’s running the international business at Air New Zealand and Tim Bennett who’s come in to run the NZX. So they’re just examples of people not known to the market but who are capable kiwis offshore.
How much does it matter to the market who the CEO is?
It’s very important because ultimately they set the strategy which gets stamped by the board and that dictates operating performance and returns to shareholders. So what they choose to focus on has a huge bearing on the company. And of course some of the softer stuff like morale, company culture, and all those sorts of things. It will be a challenging role, Telecom needs to be more innovative, and they need to be faster with products and services to market, at the same time they need to continue to take costs out. To prepare themselves for UFB and maintain disciplines in capital management when you’re trying to build the brand, while at the same time potentially reducing headcount - it’s a tricky balance to manage.
Do you think they should rebrand?
I’m not a brand expert. I think there’s possibly some merit at the product level thinking about new brands.
Yeah potentially around the mobile space. But I don’t have a view; I think there’s still a lot of capital in the Telecom brand in terms of its reliability and as a provider of fixed services. But, having said that, Chorus is a good example of a new brand which has quickly established itself.
I’m not too worried about the connection numbers; I don’t get preoccupied with them any more. It’s a lot of noise in connection numbers these days. Once upon a time we were obsessed with who had the most customers, but penetration has gone past 120 percent, with all the myriad of issues around the customer count, the level of activity and so forth. I’m more focused on the area where you can’t have any ambiguity which is in the actual revenues - and if we are seeing any reasonable revenue growth now that a lot of the XT issues are behind them.
So that is the core focus. I think the customer connection count issue will probably come to the fore around July when the CDMA network gets shut down because there are still a huge number of customers of very low value customers on the CDMA network and arguably it may cause a one-off adjustment to Telecom’s subscriber count base. It’s of less relevance, what matters is the traction in the market place – and that’s the revenues.
So what do you want to see on Friday?
I’ll be looking for modest growth in revenues, and if the trends are the same, there’s still pricing pressure. Voice ARPUs (Average Revenue Per User) are arguably flat to down and some modest increase in the data ARPU.
I think the other thing to watch is, not so much this result given they only started officially reselling the iPhone late last year, but there is certainly the sense that handset subsidies have gone up in the market. There is more competition in that space, so I’ll also be looking at the mobile acquisition costs (how much they are paying to retain and acquire customers).
Paul Reynolds is leaving Telecom, so how will he be remembered, what kind of CEO has he been?
The first thing we’ll remember is that he definitely has a genuine affability with people in the market, in the sector. Most people speak very highly of him as a personable Scottish character.
He’ll be remembered as executing well on what was in front of him in terms of the split. Admittedly it was the government’s framework for deploying UFB which drove the split, but their decision to come on board and deal with the compete versus co-operate scenario and choose the latter was an unprecedented situation globally for telcos.
I would argue it’s really put Reynolds and Telecom on the map in a global context. So I’m sure that his experience and services would be sought after should anybody else be looking to go down that track.
Tomorrow Geoff Zame talks about Chorus, the role of Sky TV and tech companies listed on the NZX.