Wednesday, 3 April 2013

NBN: Deconstructing the 2005 Trujillo-Howard pitch

Having re-read 11-Aug-2005 TLS-339 Briefing paper more closely, I believe it contains material germane to the current NBN debate, especially the politics surrounding Telecommunications.

Provided separately are the 7-Sep-2005 ASX Covering Letter, the Contents and "Path Forward" presentation, which looks to me written for Sol Trujillo to give personally. This was prepared and delivered 5 weeks into the new CEO's contract. We might presume the response, a rejection, set the tone and agenda for the rest of the CEO's  term.

From the 70% increase in the Telstra share price since agreeing to the fibre NBN, we know the market agreed with Trujillo's assessment:
Telstra's Old-PSTN monopoly business model stank and The Internet Changes Everything applied. Unless Telstra aggressively moved into the new world, it's business would collapse like print media.
  • Sol Trujillo served as CEO of Telstra from 1-Jul-2005 to 30-Jun-2009. This presentation was given to  Prime Minister Howard and others 5 weeks after assuming the CEO role.
This document is about a commercial entity on the doorstep of being "set free" of Government controlling ownership (T3 in Nov-2006). The new CEO was determined to do the best for both his new shareholders and was incented to "perform", to drive the business forward. The business' share price, as an exact reflection of how the market valued the company and its prospects, not the Revenues, Profits and Dividends, defines the context for the discussion.

How well "right" did the new CEO get it? Were his presumptions, models and predicted outcomes close to the mark?
  • Telstra float and share price at significant times. There are currently 12.44B shares issued.
    • $3.50 28-Nov-1997 [$3.30 issue price for 'T1'.]
      • $1.95 1st instalment.  4.29B (33%) shares sold, raised ~$14 billion
      • $1.35 2nd instalment , 17-Nov-1998
    • $8.00 01-Oct-1999 [$7.40 issue price for 'T2'. ]
      • $4.50 1st instalment Nov-1999  2.13 B (16%) shares, raised ~$15.5 billion
      • $3.05 2nd instalment 2-Nov-2000
    • $3.75 17-Nov-2006 [$3.60 issue price for 'T3']
      • $2 1st instalment paid. 4.25 billion shares sold @ $15.5 billion
      • $1.60 2nd Instalment 29-May-2008
      • 2.1 billion shares transferred to Future Fund, Feb-2007. $9.21 B notional value.
      • 0.1 billion shares in Future Fund, 15-Aug-2011.
        • $9.37 billion realised in sales & dividends.
    • $4.75 29-May-2008 [T3 fully paid]
    • $9.15 01-Feb-1999 [peak, all time high]
    • $7.36 07-May-1999 [low for 1999]
    • $8.95 20-Jul-1999 [peak, 1999]
    • $5.02 01-Jul-2005 [Trujillo becomes CEO]
    • $3.82 26-Jun-2009 [Trujillo leaves]
    • $2.60 16-Mar-2011 [low, $2.56 all time low]
    • $2.64 18-Mar-2011 Market Cap = $32.84 billion. NBN Definitive Agreements signed.
    • $4.53 22-Mar-2013 Market Cap = $56.35 billion. 
      • After 2years: 70% increase @ 30% CAGR.

Trujillo started his presentation strongly, supporting the view that while the share price was 45% down on the all-time high and 37% down on the T2 release day, the company still had good prospects and a solid balance sheet. (slide 2)
  • Our Reported Earning Announcement Today: Solid Financial Performance
    • Revenue Growth: 3.7%, EBIT Growth: 3.0%, Profit after Tax Growth: 4.6%
    • Driven by strong results in: Broadband, Mobiles, Sensis
Then follow 13 slides (3-15) detailing the multiple "challenges" facing the business, with projections, based around the collapse of their business model:
  • 2nd Half Significantly worse than 1st half
    • PSTN Voice Revenue declined 5% indicating an accelerating decline in that business
  • Retail sales and profitability decline continued to accelerate
  • Wholesale growth was the major factor allowing revenues to hold flat
  • The proposed changes to ULL pricing would be disastrous for Telstra
  • Free Cash flow forecast below dividends: $4 billion cumulative debt at the end of FY2007
  • Revenue Growth had collapsed from 9.7% in 1999/2000 to 3.8% in FY2006 and Earnings (EBITDA) growth from 6.2% to zero in FY2006.
  • Retail revenue (FY2006) had increased 1.3% while expenses had grown 10.1%.
  • Wholesale fixed-line revenue (PSTN/copper) growth of 11.9% had maintained group revenues.
Slide 8, "The Challenges" lays down exactly where the business was suffering, the detail of the change in business model and fundamentals. These are profound changes in the environment and demanded immediate, strong action to address.
  • The Meltdown in the PSTN Business
  • The Mix Shift to Lower Margin Products
  • The Threat to Wholesale Revenues from ULL Pricing
  • Under-investment in core infrastructure and capabilities
Slide 9 is a graphic of the financial disaster forecast for the PSTN business over the next 5 years. Their once core-business would contract at an accelerating rate, projected at 7-8% in 2010/11. Slide 10 asserts that once the decline sets in, it doesn't stop. In Europe, contractions started in 1998, in the USA in 2001/2 and 2002 in Telstra. The "standout" was Deutsche Telekom with cumulative declines of 31% since its peak in 1997.

Slide 11 is illuminating: the historical and projected (2005) Gross Margins of its various products, plus big shifts in the business.

EBITDA Margin1999 % Revenue2005 % Revenue
Domestic LongDist88.0%13%8%
Intl LongDist62.6%4%2%
Local calls54.3%23%12%
Basic access55.0%17%27%
Data Services39.5%21%18%

Slide 12, "Increasing challenge just to 'tread water'". The EBIT Margins would decline from 44% to 25% from FY2005 to FY2008. $1.74 of new income would be needed for every $1 PSTN revenue lost. Slide 13 backs this up with comparisons of monthly revenue per line from Retail, Wholesale and ULL (Unbundled Local Loop): $90, $66 and $27.50, or less than one third.

Slide 14 opines that Telstra had underinvested by $2-3 billion since being floated, both as Capital and Operational (maintenance). In 1994-1997 Telstra and Optus rolled out HFC Cable networks past 2.5M and 2.2M premises (ACCC report), with 80% overlap. Telstra wrote down its network by $961M in 1997, Optus by $1.4B in 2002. Construction costs (BIS Shrapnel) were $4B and $3B respectively. The Telstra 1998 Annual Report notes ~$1.4B in "abnormals" related to the (broadband) HFC Cable network.
  • Received 14.3M fault calls (over 14% of all lines have faults)
    • Significant investment in the network for proactive maintenance
  • Replacement of obsolete or nonvendor Supported equipment
    • Replacing of the obsolete equipment and technologies
  • Ageing of the work force and lack of training in new workers
    • Investment for tools, equipment and training to bring the Workforce to benchmark levels
  • Legacy IT systems not capable of handling the volumes and new services currently being offered
    • Investment in fixing and replacing current IT systems to handle the volumes and complexity
Slide 15 projects cashflows for FY2005-2007 falling further below dividend payments.

Slides 16 & 17 are "motherhood" statements for value-adding to the business and improving service and income.

The last 3 slides, 18-20, are the "Sell": A Digital Comact and National Broadband Plan.
Trujillo pitches the Benefits to the Government and country, the "regulatory reforms" he'd like and a summary:
  • Everyone would benefit under this proposal
    • Jobs to do the build-out
    • Jobs and productivity increases resulting from the build-out.
    • Greater choices for ICE (Information, Communications, Entertainment)
  • More flexibility and more choices:
    • At home
    • At work
    • On the move
  • This proposal would
    • Spur economic growth
    • Create new opportunities for rural and remote Australia
    • Encourage genuine and sustainable competition.
The fourth part of the TLS-339 package began by referencing a report for the Prime Minister on Australia's Export Infrastructure, delivered in May, 2005. Trujillo attempted to tie his National Broadband Network to this report, no doubt a theme explored during the delivery & discussion:
Without action to remove impediments to efficient investment in infrastructure, Australia’s export potential over the next five to ten years risks being compromised.

Despite the later combative, even recalcitrant relationship between Trujillo and the Government and Regulator, the ACCC, he hit the ground running, did his homework, formed a plan, was prepared to "name the unnameable" and acted quickly and decisively.

That was an impressive and much under-rated performance. Did he conclude he'd been given a "hospital pass", i.e. a no-win position? We can only guess...

We'll never know what was said in that room, nor why.
Trujillo and his team obviously had a "Plan B" and went on to execute almost all programs in their later briefings.

Presumably the Howard government was committed to completing the sale of Telstra, realising the very  best price for it and were in no mood to hear, or admit the asset might be "less than perfect".

Sol and his group did a fair job of implementing change in a very challenging environment. Whilst not getting all their reforms done fully, they made a good fist of it.

That the share price during Sol's term fell 34% isn't a real reflection on his ability.
He kept the share price above the T3 float price, probably as good as could be achieved.

The eventual "dead cat bounce" of the share price, around $2.60, shows that all investors eventually took the view that Trujillo put quite forcefully in his 13 "Bad News" slides:
Telstra's Old-PSTN monopoly business model stank and The Internet Changes Everything applied in spades.
The share price breaking out of its stagnation/ghetto when a real NBN deal was agreed in 2011 shows that Trujillo got the problem and solution exactly right in late 2005. Very impressive.

Unfortunately, "Politics is the Art of the Possible", and an NBN was not possible under the Howard Government. Although they were awash with cash and could've easily postponed some of their "middle-class welfare" handouts, their priorities and concerns were elsewhere.

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