Monday, November 20, 2006

Tuesday Column: Telstra sold too cheaply??

The government thinks it has just sold Telstra.

I think it’s done much more.

Let me explain. When the T3 process began, just six weeks ago, it looked anything but revolutionary. Senator Minchin and his colleagues expected to offload another sliver of Telstra (about one sixth of the company), which in addition to the half of the company they had already sold would leave private owners with around two-thirds of Telstra, and the Government through its Future Fund with one-third.

One-third was important because it would have given the Government continuing control. By control I don’t mean the ability to direct the company about the way it made its day-to-day decisions – the Government wouldn’t want to do that – but the ability to veto any major change of direction.

(If you are one of those people who believe that a government committed to getting out of the telecommunications business would never want to step in throw around its weight in Telstra, you haven’t been paying attention. That’s exactly what it did at last week’s Telstra AGM when it used its voting block to install its nominee on the Board against the wishes of the Board itself.)

There is one particular change of direction that the Government has been extraordinarily keen to prevent. It is the splitting of Telstra into two separate companies – a boring “utilities” company and an exciting “digital media” player.

On one estimate a decision to do that could double the value of the resulting shares.

But just before the T3 launch the Government demanded and got an assurance from the Telstra Board that it wasn’t planning to split the company.

That assurance would have been enforceable if after the T3 sale the Government had, as expected, kept control of one-third of the shares. It could have reminded the Telstra Board of the assurance and used the threat of the veto power its one-third shareholding gave it to make sure the Board stayed in line.

It no longer has that threat... The weekend success of the share offer has left the Government through its Future Fund with just one-sixth of Telstra, which given the way I am assured these things work, gives it no hold over the Board whatsoever.

Melbourne University’s Professor Ian Ramsay explains it this way: Corporate control is an all-or-nothing game. If you own enough of a company to get one person elected to the Board (and in a company like Telstra one-third is enough) you own enough to replace the entire Board. You hold the biggest of sticks.

But if you own less than a certain threshold (and one-sixth of the company is certainly less than the threshold) you don’t have the power to get a single person onto the Board unaided. You have no stick whatsoever.

Telstra is now free to decide to split in two if it so chooses. It is generally held legal view that an undertaking given by one board cannot bind a future board (in the same way as an undertaking given by one Prime Minister cannot bind a future Prime Minister).

If shareholders do decide on a split they could double their money.

According the telecommunications guru Paul Budde the maths work like this: Right now each Telstra share is worth a little under $4.00. If each shareholder was given instead, one $2.00 share in a dull infrastructure company that charged for the use of its wires, and one $2.00 share in an exciting digital media corporation that used those wires and offered TV, the internet, mobile and fixed phone calls to consumers, the shares in second company could triple in value. After about a year the shareholder who used to own one $4.00 Telstra share would be holding instead one $2.00 infrastructure company share and one $6.00 digital media corporation share. $2.00 + $6.00 = $8.00.

Why would the shares in the digital media corporation triple in value?

Its Bigpond, Sensis, Foxtel and fixed and mobile call businesses could be combined and unleashed. Right now they are limited in what they can do because of regulations – regulations imposed because of Telstra’s sensitive position as the dominant communications wholesaler.

In Paul Budde words: “Right now Sensis cannot move into video and Foxtel cannot move into telecommunications and Bigpond can’t use television.”.

But he says unleashed, “the $2.00 digital media company would find itself valued in the same mind boggling category as YouTube, a Yahoo or an E-Bay”. Its share price could triple.

And the dull $2.00 infrastructure company would be valuable too, to a certain sort of investor. Australia’s Macquarie Bank has shown that as part of their portfolio investors and funds love the security of owning toll roads. The returns are never exciting, but they are consistent. Cars pay to use the roads every day, just as phone companies pay to use wires and exchanges every day.

The Macquarie Bank is already extending its model for setting up toll road trusts into the field of communications. This year put together a consortium to buy and split up the Hong Kong telephone business which was knocked back the Chinese government.

Right now Australia’s other big packager of infrastructure trusts Babcock & Brown is working on splitting the Irish telecommunications firm Eircom.

It is beyond doubt that both are running their rulers over Telstra right now, and are delighted that our Government can’t stop them.

The Telstra Board could. And given that the present board’s whole strategy is built around keeping the company together, it is a fair bet that it will try. But boards and superstar imported CEOs don’t last forever. If Macquarie and/or Babcock & Brown start do buying shares in Telstra there are likely to be changes at the top.

If all goes to plan Telstra’s one-million plus shareholders would be enriched, Macquarie and/or Babcock would pocket very well earned commissions and our Government which on Sunday was very pleased with the $15.5 billion it had raised from T3 would look as if it had unloaded our communications company for a song.