Wednesday, September 13, 2006

Coles Myer and Telstra: Peas in a poisoned pod.

What do Coles Myer and Telstra have in common? Each is a monster created by a merger. Neither would have been permitted under the competition rules applying today. And, as unlikely as it seems, each would have been better off if a regulator had said, ‘No,’ and forced it to remain a smaller, unmerged company.

What follows is a real-life Australian parable about how big often isn’t better.

The competition regulator never even got to run a ruler over the merger of Telecom and the Overseas Telecommunications Corporation (OTC) that created Telstra. Both were government-owned, and the Minister at the time, Kim Beazley, argued that scale would allow the conglomerate to promote Australian industry.

When Telstra became partly privately owned, its suddenly highly paid executives began to feel all the cash it was generating burning holes in their pockets. It expanded overseas (after all, its shareholders expected growth and it already had most of the Australian market) and lost billions on speculative high-tech start-ups in Asia.

When I was the ABC’s correspondent in Japan in 2001, I was invited to a function in the office of Telstra in Tokyo. When I asked why an Australian telecommunications company had an office in Tokyo, the executive launched into a pre-prepared spiel about fish. He said Telstra wanted to be a ‘big fish’ and that meant it had to swim in the ‘big ponds.’ Billions of burnt dollars later, I am not sure that Telstra’s shareholders would agree with him.

How different might things have been if the OTC and Telecom had been allowed to compete against each other... Each would have had a reasonable size and each would have been forced to concentrate on serving Australian customers rather than burning excess cash.

Telstra is now worth roughly half of what it was. Quite an achievement. I have a feeling it may have held its value better as two competing institutions.

It’s not just Telstra of course. The National Australia Bank (NAB) under Chief Executive Don Argus was forever promoting the ‘national champions’ argument. He said banks needed to become big, really big, so they would be able to take on the world on behalf of Australia. The NAB expanded into the US, bought the mortgage processor Homeside, made a basic mistake about fixed versus variable mortgage interest rates and lost four billion dollars of its shareholders’ money.

We hear less about ‘national champions’ these days.

Coles was allowed to merge with Myer at a time when big was generally held to be better. Two subsequent Chairmen of the Trade Practices Commission and its successor the ACCC have told me they never would have permitted it.

The Coles Myer monster began life with 70 per cent of Australia's department store sales, and 77 per cent of its discount store sales. It was Australia’s biggest private sector employer.

And it was also almost impossible to manage. Target’s raison d’ĂȘtre had been to steal customers from Kmart. Kmart’s reason for being had been to steal customers from Target. Combined they didn’t really know what to do. Eventually Target differentiated itself by specialising in more clothing and Kmart gravitated towards hardware, unwisely (and perhaps arrogantly) lifting its prices.

Coles Myer built a gleaming black monster of a national HQ in the Melbourne suburb of Tooronga — nicknamed the ‘Darth Vader Building.’ One of its Chief Executives, Brian Quinn, renovated a gleaming home in one of Melbourne’s leafier suburbs using Coles Myer contractors and served time in Pentridge Prison for fraud.

Meanwhile, Woolworths concentrated on retailing. It now turns over more than Coles Myer with far fewer stores.

Coles Myer became so weak it had to sell the Myer Department stores and now there’s talk of it breaking itself up even further in order to fend off an unwelcome takeover. Kmart, Target or Officeworks may be next on the block.

The market is doing what our regulator wouldn’t — busting Coles down to a manageable size.
And it might happen with Telstra soon.

Further privatised, a rational Telstra management might find that it has more value as two distinct companies: one that runs the boring wires and pipes, renting them out to all comers; and another that rents those wires and competes for retail customers, unencumbered by government-imposed ‘universal service obligations.’ Institutions such as the Macquarie Bank have discovered legions of investors who are prepared to pay very well to own stakes in boring pieces of infrastructure — be they toll roads, radio transmitters or electricity wires — just as long as the company is unable to take risks.

It would be deliciously ironic if in its attempt to unlock value, the market broke up Telstra and Coles Myer in a way that our regulators could not or would not.


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