Telecom New Zealand (NZT) is the leading telecom operator in New Zealand, providing fixed line calling, broadband, wholesale and mobile services to business and retail consumers. They also have operations in Australia.
- Intrinsic Value: $21 - $24 per share
- Accumulation Range: $17 or better
One thing is certain: financial markets are positively allergic to regulation and Telecom New Zealand's share price has borne the brunt of this. The government's action to force the company to split their operations has really hit the stock hard over the last year or so. But close examination suggests this to be an unwarranted overreaction, especially for long-term US-based investors.
Telecom is one of the largest companies in New Zealand and the largest component of the domestic stock exchange. The company seemingly relied on its legacy as a former state monopoly in the past, which engendered a backlash among government, business and consumers. This led to a series of regulatory and PR setbacks for the company culminating in the forced split of Telecom in hopes for more investment and faster implementation. While this is a fearsome backdrop for any company to work in, the size and importance of Telecom should prevent the politicians and bureaucrats from getting too carried away.
Early media reports and press releases indicate that Telecom and the government came to an agreement for the operational separation that both sides can live with. This suggests that necessary incentives were conceded to compensate the company for future infrastructure investment as this was a key sticking point for Telecom earlier in the year. The entrenched position of Telecom combined with the limited economy of scale of New Zealand leads to a simple reality: if Telecom doesn't make the investment, then it won't happen. The small population combined with the rural aspect make adequate investment returns a challenge. The Auckland Chamber of Commerce made some noise about building their own high-speed network but that would defeat the whole purpose of privatizing Telecom in the first place unless only private money was used. But generating returns to compensate for the investment is a major challenge in a country of 4M.
In the end, the company should be able to use its size and position to maintain a nice level of profitability in the future despite the inconvenience of this new regulation. The organization exacerbated some of its problems with some rather foolish comments regarding the politicians involved (forcing their back up) combined with a callous disregard for customer service and satisfaction.
I like the move to bring in an outsider for the top job. Incoming CEO Paul Reynolds has experience in the fiercely competitive European telecom market and hopefully can bring some competitive fire with him. The company forecasts that bottom-line growth will be fueled more by streamlining cost rather than market growth. While no announcement has been made to this effect, I expect Telecom will pursue this avenue to improve results. Reynolds, being non-native, may have an easier time pushing through cuts.
Reynolds has made the customer experience a top priority. If Telecom can address this and learn to compete while keeping its mouth shut, shareholders will be rewarded with steady, if unspectacular, returns. American investors should be keen to take advantage of this opportunity to diversify out of the weak US dollar.
The operational separation and shifting regulatory landscape makes future calculations a bit shaky.
The company's returns on invested capital for FY 2007 and 2006 were 33% and 46%, respectively. While ROIC and margins should come down over the next few years, Telecom should still be comfortably profitable.
DCF analysis estimates cover a broad range due to all the moving targets. The company has guided to 5-8% lower EBITDA YOY and NZ$950-975M CapEx. Depending on assumptions used, intrinsic value can range anywhere from $15 - $25 per ADR. This assumes Australian operations to add nothing to the bottom line. If the company can ever bring that segment to profitability, that's an added bonus.
I am reminded of an anecdote from Warren Buffett and Charlie Munger. They bring up the example of an overweight person who walks into your office and you don't know if the person is 80 lbs overweight or 120 lbs overweight but you know the person is heavy. It's much the same case here. The company looks cheap but if we're wrong, we getting in low enough that it won't hurt much.
Certainty Rating: B+
Telecom will not offer much in the way of growth over the next five years but it will offer one thing American investors desperately need: shelter from the US dollar. An 8% dividend and an entrenched position should lead to solid gains or at worst, a flat stock price while we collect high yield which will probably appreciate in value relative to the currencies involved.
Disclosure: Author has a long position in NTZ