The deconstruction of Telecom is nearly complete. If the vote at Telecom’s annual general meeting on October 26 goes ahead as planned, Telecom will split into two new businesses, under a new operating model, leading to a new telecommunications industry structure.
The separation scheme booklet makes it clear that the demerger has been structured to give both companies equal odds out of the starting blocks – and we suspect, a similar initial share value in order to make each one attractive to shareholders.
New Chorus carries considerably more debt, and it is this allocation of assets, costs and debt that has closed the EBITDA gap between itself and New Telecom. New Telecom carries the labour cost but retains customer scale and the PSTN profit pool. Yet each business faces quite unique challenges:
New Chorus has the benefits of scale, cash flow and the opportunity to redefine the traditional telco investment business model to one aligning with very long term infrastructure investment.
Importantly, it has as its partner the one investor with the clout to remove barriers with a stroke of its policy pen.
Nonetheless, it carries significant debt of NZ$1.7 billion and is contractually bound to invest in fibre above and beyond normal commercial imperatives, risking significant financial penalties if it fails to meet fibre adoption targets.
The challenge for New Chorus is that it has limited influence over driving fibre adoption beyond wholesale pricing – a blunt instrument ring-fenced by the need to deliver investment returns and shareholder value. This means it is exposed to what we believe will be a messy period of industry restructuring, and the strategies and fortunes of New Telecom, which is expected to comprise over 80 percent of its revenue base.
Of particular concern is the risk that uptake of entry-level fibre packages at a low price point far exceeds service provider incentives to upsell the higher value, higher margin offerings needed to support the long term fibre business case.
New Telecom, as expected, has defined a strategy focused on customer retention, cost-out and mining whatever pockets of growth it can identify within its core capabilities. The real challenge for New Telecom is understanding what the size and shape of the business will be at the point of stabilisation – the inflection point where revenues cease to erode and there is a return to some measure of top line revenue growth.
IDC believes that, for all the cost-out measures to date, much more is required. A staff of 8,000 remains significant, given shrinking revenues and challenged margins.
Detached from network cash flow, tough decisions will need to be taken. The question is one of management will – whether it will be a long term, iterative downsizing, or hard line shock treatment delivered via takeover, perhaps by a dispassionate private equity company, or an international telco looking to improve its local positioning?
IDC nonetheless believes that New Telecom is under no illusion about the challenges ahead – it has had 18 months to consider all aspects in detail. The new structure with a chief product officer centralising and managing all product, pricing and planning strategies is a positive step in an environment of cost management: it prevents the more ad hoc and marketing-driven decision making by business units of the past.
The structural separation of Telecom will disrupt the New Zealand telecommunications market. With disruption comes risk – but also opportunity.
For all the challenges, the demerger has the potential to revitalise the strategies of Telecom’s demerged business units. It is also likely to drive new, more aggressive plays from significant market leaders such as TelstraClear and Vodafone.
Success will be characterised by those who reinvent themselves, intelligently. Telecom has had 18 months to plan its restructure but the change required is more than operational; it requires a transformation of its cultural DNA. Will it live up to expectations and is the rest of the industry ready to respond?
Breaking up may be hard to do, but adapting to a new and unprecedented industry structure is likely to be harder.
Spragg is telecommunications senior market analyst, IDC