ntg rights issue, page-12

re: ntg rights issue (grant62) Hi Stocko,

As NTG is to SME, then SME is to CDR.

TRADITIONAL AREAS OF KTS AND PABX:

In the traditional areas of KTS and PABX, the Australian market has plateaued. This is why Telstra exited KTS (in favour of maintaining a 20% interest in CDR, and a proportional interest in Plestel), and why more recently, Telstra sold its PABX business to Damovo, an offshoot of Ericsson (in which Ericsson still holds a 20% interest).


NEW BUSINESS CHOICES:

Both CDR and Damovo are rapidly moving into new areas of CPE (including web switches, video conferencing, IP-based services, VOIP, etc.

For its part, NTG has either been too slow to do the same, or lacks the vendor depth to match either CDR or Damovo, in the SME market.

In CDR's case, the company works with and sources solutions from some of the world's leading technology companies, including Nortel Networks, Siemens, Lake Communications and 3Com.

In Damovo's case, the company works with and sources solutions from Ericsson, Mitel, Cisco, Rockwell, and Genysys, amongst others.

NTG, conversely, works primarily with NEC and Alcatel.


2001 PABX MARKET SHARE:

New installation work in 2001 has shown that the market in major PABX installations is hotly contested, with NEC having a 32% market share, but under increased challenge from Ericsson (25%+), Nortel (25%+), Siemens (5%), and others, including Lucent, Alcatel and Fujitsu (<10%).

However, with Damovo acquiring the PABX business from Telstra (35% market share) in late 2001, it has since become apparent that this installed base is progressively being changed over to Ericsson, Mitel, and other Damovo supported replacement solutions.

The same also applies to CDR which in late 2001, acquired the Siemens PABX business.

The danger for NTG, therefore, is that its PABX installed base (and replacement business) is now under competitive threat from both Damovo and CDR.


AUSTRALIAN SME MARKET:

The overall SME market in Australia has been in decline for some time, with PBX and KTS, both showing signs of decline since their peaks of the late '90s.

From an equipment supply perspective, the PBX market is currently worth $120m (in vendor terms, or VT), and ~$150m (in reseller terms, or RST). The PBX market peaked in 1997 (@$145m, in vendor terms), fell to $125m (VT) in 2001, and was estimated by Paul Budde @$120m (VT) in 2002, and again @$120m (VT) in 2003.

Conversely, KTS solutions peaked @$80m (VT) in 1997, and have flat-lined @$60m (VT) since 1999.

Showing market growth has been those CPE solutions covering (all figures, in VT, without adjustment for RST):
1)
datacoms (up from $1.25B in 1997, to $2.1B in 2001, and estimated @$2.0B in 2002, and $2.1B in 2003); and
2)
visual imaging (covering fax, video conferencing, etc), which has grown from $370m in 1997, to $650m in 2001, and was estimated to grow to $700m in 2002, before increasing to $800m in 2003.


NTG's MARKET SHARE:

Currently, 70% of NTG's revenue comes from concentrating on the SME market, involving the supply, installation, integration and ongoing management of IT&T systems and applications.

With equipment sales generally accounting for 60% of the "whole-of-life" SME market, and "ongoing management and maintenance" for the rest (ie: generally spread over 4 -5 years, but assume 4 years), it is not unusual for market vendors (such as NTG) to bundle these together into a single integrated solution.

In FY02, ~$82m of NTG's revenue was accounted for through the SME market.

It, therefore, depends on the extent to which NTG may have been forward booking "maintenace" revenue properly attributable to the outlying years, as to whether NTG is currently facing an emerging business risk in respect of its control of the SME market.

Clearly, NTG's SME revenue grew strongly in FY02, up 76% YoY (from $47m in FY01, or $40.3m in the 10m post listing period). However, the proportional separation of equipment sales, from O&M revenue, is not further dissected in the accounts for FY02. That said, if we apply the "60 /40 rule" (outlined, above) and assume revenue recognition referable only to each year under review, then:
1)
FY02 equipment sales, approximated $60m; and
2)
FY02 O&M activities, approximated $20m.

In FY03, O&M activites should approximate $30m+.

Given that NTG was originally estimating FY03 revenue of $170m (since, trimmed back to $140m), it should be reasonable to argue that NTG was originally expecting SME sales of ~$120m, with $30m+ of this accounted for by O&M, and the remainder, by increased equipment sales. Now, however, with the rimmed down forecasts, it would appear that NTG is expecting SME sales of ~90 -100m, of which equipment sales would account for ~$60 -70m of this amount.

This result seems to be borne by NTG's own ominous warning to the market about a "(s)oftening in the outlook for the SME market" (ASX 12/12/02).

CDR (NTG's main listed competitor in the SME market) said much the same at its AGM (ASX 14/11/02):
"Revenue has increased with acquisitions contributing strongly, with some softening in our smaller voice systems".


RISKS:

With:
1)
CDR being strongly aligned to Telstra (both as a supplier, and as a 20% shareholder); and
2)
Damovo being strongly aligned to both Ericsson (as a supplier, and as a 20% shareholder) and to Telstra (in November 2001, Damovo acquired Telstra's PABX customer base and maintenance business),

it is quite likely that NTG has suffered:
3)
a loss of market share to its main competitors;
4)
a loss of market traction (ie: being further behind in the launch of web-based switches, etc, than either CDR or Damovo); and
5)
a softening SME market outlook (ie: due to increased customer resistance during late cy02+ to increased CAPEX commitments into cy03).


CONCLUSION:

NTG may well argue that there has been a softening of the SME market in recent times. But, from 2000 to 2002, Ericsson was distracted from directly competing in the Enterprise market. Now that Damovo has been independently established, it is clear that Damovo is directly acquiring market share through a combination of:
1)
strategic acquisition;
2)
targeted selling;
3)
adopting a multi-vendor, multi-disciplinary approach to servicing the market; and
4)
organic growth (coupled with strong customer financing solutions).

CDR has done much the same thing with its own business approach.

Conversely, NTG has spent too much of its time in acquiring businesses (and not enough time, bedding those businesses down, or establishing a consistent business approach to the market).

Businesses acquired have included LCR Telecom (04/01), Pahth (partially, 04/01), Recom Corporate Communications (10/01), ASP Communications (04/02), PSINet Australia (06/02), New Technology Group (11/01), Senteq (04/02), and Totalcoms Australia (05/02).

The danger for NTG, therefore, is that:
1)
it faces strong, robust and well backed competitors;
2)
it has grown market share through acquisition; and
3)
it faces further erosion of its market in 2003 through being slow to market with replacement offerings, and /or through the loss of the Telstra PABX business /customer base to Damovo.


WILL NTG SURVIVE?:

In my view, the answer to this is, yes. But not without some further profit /revenue downgrades in the coming months.

NTG needs to survive 2003 in order to thrive. However, unlike CDR and Damovo (et al) which went through their horror stretches in 2001 and again in 2002, NTG now faces its horror stretch in 2003.

To survive 2003 will, therefore, mean that NTG will prosper in the future. To fail, however, may well mean that NTG will be acquired through consolidation activity (with both CDR and potentially Damovo, likely cabdidates by year's end.