tls gott is good

Sol struggles for decent returns
ANAYSIS
Robert Gottliebsen
August 12, 2006
THE best thing that could happen for Australia and Telstra is for the Future Fund to end up with a big parcel of Telstra shares with the fund chief David Murray going on the board.
I know of no better person than David Murray to explain to Communications Minister Helen Coonan how modern business works. After 13 years as chief executive of the Commonwealth Bank, Murray understands that public companies must get a return of at least 15 per cent, and usually above 20 per cent, before they can invest. If they accept a lesser return they are hammered in the market.
Commonwealth Bank officials now concede that Murray's $1.5 billion "Which New Bank" strategy was a high-risk exercise. When Murray set out, he promised his board and shareholders that the bank would receive an average annual benefit over three years of $300 million - a rough return of 20 per cent. Of course the return was ongoing and the bank actually bettered the 20 per cent estimate in the three years.
Telstra chief executive Sol Trujillo this week issued an open invitation to Helen Coonan and ACCC boss Graeme Samuel - "our door is always open to talk, if people want to respect the requirements of our shareholders".
And until someone can convince Coonan (or her replacement should the ALP gain government) and/or Samuel to knock on the Telstra door and talk realistically, Trujillo vows that more and more Telstra investment money will be channelled away from regulated areas and into non-regulated areas such as mobiles, Sensis and Big Pond where returns meet the corporate requirement of 20 per cent-plus.
According to Trujillo, Samuel does not recognise the increasing costs of copper and other inputs, so proper returns are not even on the agenda. Other chief executives I have discussed this with say that Telstra appears to be required to sell to rivals on a marginally costed basis. They are horrified. Whether that's what Samuel intended is immaterial. It means that while the rest of the world is scrambling to provide the returns necessary to have globally competitive communication systems, Australia will fall further and further behind.
The board of Telstra understands the need for a 20 per cent return. All the directors, including government representatives, took the unprecedented step of sacking their former chairman and CEO, partly because they advocated investments that did not provide proper returns and were pandering to the Government on this issue.
Without acceptable returns (and in this case it's a question, first, of recognising the costs) the company will only invest the minimum required to keep the regulated business ticking.
Telstra directors have unanimously given their shareholders an iron-clad undertaking that they will not buckle to Canberra on this issue. If Coonan wants Telstra to invest in modern internet infrastructure without a proper return, starting with cost recovery, then every Telstra director will have to be sacked. No Australian director will replace them if they are ordered to invest at sub-economic returns, so the board would have to be replaced by compliant public servants.
While this is an absurd notion, it reflects the increasing anger in the Australian corporate community about Helen Coonan's lack of understanding and the effect this will have on Australian companies requiring modern communication systems.
Of course there is an alternative - buy back the infrastructure at true value and fund it as infrastructure on the basis of irrevocable "take or pay" contracts by Telstra, Optus and others. With technology changing, there is considerable risk in this, which is why higher returns are required. But, leaving that theoretical proposition aside, the Government chose to have the infrastructure in a public company, which means returns must meet the public company requirements.
But how does the Telstra board rate Sol Trujillo? They are disappointed that he could not get Helen Coonan and Graeme Samuel to understand that without proper margins Australia would have a second-rate telecommunications system. He could have managed the situation better, but attitudes were entrenched, and it was never going to be easy.
Directors will be now demanding that Trujillo keeps to a minimum capital expenditure on infrastructure where the Government decrees Telstra should not cover costs and/or receive marginal returns.
That debate is now settled.
Some of the directors were stunned last year when he explained to them that writedowns and staff restructuring would slice more than $1 billion from profits and make it impossible to maintain the dividend - unless there was a big change in government/ regulator attitudes. The company borrowed to pay the latest dividend and it would be simply irresponsible to continue the past dividend policy - T3 or no T3 - unless returns from the base business were stable.
Last year, Trujillo put to directors a bold capital investment plan, which they accepted. Accordingly, he is now being rated by the board not for the short-term profit setbacks that gain so much media attention or any government-engineered dividend cut, but rather for the progress of the reconstruction he designed.
In essence, he is rationalising the Telstra legacy systems, transforming the supply arrangements and introducing more efficient labour systems. Many CEOs have failed attempting such a plan - especially at a time of enormous capital investment to replace lost revenues.
Trujillo is staking his reputation on a massive investment in 3G, Big Pond internet services and Sensis. Some board members are uncomfortable that he does deals with mates, but that will only become a serious issue if he stumbles on the big projects.
Mobiles, internet services and directories are areas the government does not regulate. Trujillo's promises of 20 per cent-plus returns on the new investment, and an enormous customer base, will be his litmus test.
Trujillo's total plan covers the five years to 2010. It's too early to know whether he is going to pull it off. He has created many enemies in Canberra and if Coonan is still the minister after the next election and Trujillo looks like seriously stumbling, then she will demand his head. But if the Trujillo gamble is starting to pay off towards the end of 2007, then it will be Coonan's head that is vulnerable if, by that time, the disastrous consequences of recent decisions become apparent.