Government reveals terms for reduced Telstra sale

Existing retail investors get sweet deal with discounted price, bonus shares and high yield. The deal is expected to raise A$8 billion.
It was not without a certain sense of accomplishment and pride that the Australian government yesterday revealed the final details of its long-awaited third sale of Telstra shares (known as T3).

While reduced in size to about A$8 billion ($5.9 billion) from initial expectations of A$10 billion, the sale will see the government divest about one third of its remaining 51.8% stake in AustraliaÆs largest operator of fixed line and mobile telecom services, finally ending its days as a publicly-owned company. The overhang wonÆt be completely reduced, however, as the governmentÆs remaining shares will be transferred to the Future Fund, which was set up earlier this year to deal with some of the governmentÆs pensions obligations. The fund will hold the shares in escrow for two years and can then sell or hold on to them based on its own investment decisions.

The roadshow, which kicked off in Australia and New York on Monday (October 9), comes after the company launched its nation-wide wireless 3G network ôNext Gö ahead of schedule last Friday, creating some positive buzz around the carrier. However, at an investor day also held on Friday, the management revised down its long-term EBITDA growth guidance to 46-48% by 2010 from 50-52% previously and said it expects costs to rise moderately in this period, compared with earlier assertions that costs would remain flat.

While the share offer, which comprises 2.15 billion shares or 17.3% of the company (plus a 15% greenshoe), turned out to be slightly more generous than the previous sell-down in 1999 for current retail investors, institutional investors were left somewhat wanting and it likely wasnÆt a coincidence that the share price recorded its biggest slide in seven weeks after the prospectus was published Monday.

Institutional investors will get their guaranteed entitlement of one new share for every two they hold now, which is more generous than the one-for-five share entitlement offered last time, but they will have to pay for the first installment like everybody else and there will be no preferential treatment for long-term shareholders.

According to the details released yesterday, any institutional investor who holds shares in the telecom operator on the November 17 record day will be able to subscribe for their guaranteed allotment.

ôThis doesnÆt take into account how long you have been loyal to the company and means that you can just buy in November to get a right to subscribe to the ensured entitlement,ö says one analyst.

The sale does offer the potential of some pretty good returns. Just like in the T1 and T2 sales, investors will pay for the shares in two instalments û a A$2.10 per share upfront payment now and a second one in 18 monthsÆ time û but will have the right to collect full dividends for their shares in the meantime. Based on the companyÆs intention to distribute A$0.28 to shareholders in the fiscal year ending in June 2007, this will result in a fully franked yield of 13.3%.

For retail investors, who will receive a 10 cent discount on the first installment, the yield will be an even greater 14%. Retail investors will also receive one bonus share for every 25 shares they buy in T3 if they hold onto them until the final instalment is paid. This is instead of offering a cash discount on the second instalment as was done during the previous two sales.

According to people involved in the sale, the bonus share equals an effective discount of 4%, which together with the 10 cent reduction in the first instalment will equal a 6-7% total discount for retail investors. The price on the final instalment in May 2008 will thus be the same for both institutional and retail investor and will be determined following a three-day institutional bookbuilding exercise on November 15-17.

ABN AMRO Rothschild, Goldman Sachs JBWare and UBS are acting as joint global coordinators for the sale.

The bookbuilding will be completely open with no range versus the existing share price to guide the orders, a banker involved with the sale says. Market players expect the final price to offer a discount of up to 10% to the share price at the time.

The split between retail and institutional investors will be decided based on demand, but like in the previous two sales it is expected to favour retail investors as it has always been the governmentÆs intention to involve the public as much as possible in its privatisation exercises. In the Telstra IPO in November 1997, 60% of the shares went to retail investors and in the T2 sale two years later, they were allocated 66.5%.

The focus on retail investors is further evident by the fact that the government is spending A$20 million on a multi-media advertising campaign to promote the shares û more than twice the A$8 million it spent on the T2 sale in 1999.

The campaign may be needed though as the government will be trying to convince investors to buy more of a stock that has tumbled just over 50% since the T2 sale which was done at A$7.80 and has been a consistent underperformer over the past year. The past three weeks has seen a bit of a rebound, but on Monday it dropped 2.4% to A$3.74.

The sentiment for the stock has soured as a fierce competitive environment has eaten into earnings. The Telstra management led by CEO Sol Trujillo blames this partly on unfair regulations that favour its smaller competitors by giving them cheap access to the TelstraÆs network services while increasing TelstraÆs costs and reducing its opportunities to grow. Over the past year the company has been repeatedly criticising the regulators for destroying shareholder value û which has perhaps not been the best marketing for an upcoming share sale.

In the 2006 the fiscal year profits fell 26%, which may have been the final trigger convincing Prime Minister John Howard that it wouldnÆt be possible to sell the governmentÆs entire remaining stake in one go as originally planned.

Since he came on board as CEO in July last year, Trujillo has embarked on the massive five-year transformation plan to turn the company around, however, and what investors are asked to put their money into is a business that is aiming to grow revenues from new products and services to offset the stagnant fixed line operations and to significantly cut costs. The main benefits from the plan arenÆt expected to be seen until fiscal 2008, however, while the costs and capex related to this program is expected to peak in the current financial year.

As such, investors will be buying into a company which has yet to prove itself in its new form, which could be risky û especially in such a competitive market. At least the government has been honest when choosing the motto for the advertising campaign with the catch line ôShare in the futureö having replaced the ôItÆs for youö line used for T1 and T2.

In a letter attached to the retail offering document issued yesterday, Chairman Donald McGauchie also noted that: ôInvestors need to understand that there are significant costs and risks involved in undertaking such an immense exercise and that in the early years, transformation significantly reduces our earnings and cashflow. For our plan to succeed we must incur these costs, reinvest in the business and take those risks now.ö

In a research note following FridayÆs update on the progress, Morgan Stanley analysts Andrew Hines and Sachin Gupta noted that the downward revisions to the profit targets and the higher cost projections werenÆt too surprising as ôthe companyÆs previous long-term projections were unrealistic, in (their) view.ö ôTelstra is undertaking a significant transformation and it will not become clear in the next 1-2 years whether it can achieve its new targets,ö they said.

Among the positives, the analysts referred to the roll-out of the 3G network ahead of schedule as a ôtremendous achievement,ö but expressed some concern that the company now seem to be focusing primarily on this new wireless network at the expense of its fixed line services. They deemed this a ôrisky strategyö in a segment where it has only a 45% market share.

Other analysts noted the fact that one year into the program, 35% of the overall transformation has been completed, including a reduction in headcount by 5,000 people, and that the revenue growth projections were maintained at 2%-2.5% for the next four fiscal years.

So far, retail shareholders have stuck with Telstra and with more than 1.6 million Australians holding shares in the company, they may be the best bet to get this sale away. The yield will obviously be a key selling point, but long-term shareholders who decide to take up their full entitlements will also be reducing the weighted cost of their combined purchases significantly. It may not be the sexiest argument by which to market a share sale, but it could well work.

The retail offer will run from October 23 to November 9. Trading of the installments on the Australian Stock Exchange will begin on November 20, on the same day that the final installment price will be determined.

¬ Haymarket Media Limited. All rights reserved.
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