New Zealand has the landmass of Great Britain inhabited by a population smaller than Scotland, yet it’s a nation that likes to punch above its weight. As anyone who has seen the haka performed before the All Blacks play rugby will know, the Kiwis like to make a bit of a noise too.
This week, Telecom New Zealand, the incumbent carrier, completed the demerger of its domestic access and regulated wholesale business from the rest of its operations. Whilst other operators, including BT, have created dedicated access divisions to concentrate regulatory scrutiny, Telecom New Zealand (TNZ) is the world’s first incumbent operator to separate fully. Both new businesses are now listed independently on the New Zealand stock exchange. The financial upside of the split to date has been such that shareholders and the boards of incumbents around the world should be reaching for their calculators.
One of the two new businesses is Chorus, responsible for the country’s broadband access network and the regulated element of its domestic wholesale business. The other, which retains the Telecom New Zealand brand, does the rest, including mobile. Chorus was created as an access-only unit within the TNZ Group in 2008. It has had ample time to complete the organisational gymnastics required to align its resources and processes. Furthermore, the demerger should do away with any residual accusations that the national incumbent isn’t playing fair with competitors over access.
Shareholders voted 99.8% in favour of the split, which gave them one new share in Chorus for every five shares held in Telecom. This shareholder support has been rewarded with an aggregate increase of around 35% in the value of the shares since the beginning of 2011 when the demerger plan was first muted. This increase in value materially outstrips the capital appreciation of any mainstream telco index over the same period. A basket of telecoms shares in the UK shows an increase of less than 3.5% over the same period time. Early indications are that the aggregate dividend from Telecom and Chorus will remain agreeable to shareholders too.
In addition, both Standard and Poors and Moodys, the credit ratings agencies, have allocated healthy and stable investment grade credit ratings to both businesses, important considerations for the interest rates they will incur on borrowings. Chorus, with EBITDA of almost NZ$0.6bn per year, has taken on NZ$1.7bn, or two thirds, of Telecom’s original debts, leaving the ‘New Telecom’ with debts of less than NZ$1.0bn. It also offers shareholders the prospect of rising capital returns from improving trends in cash generation.
The demerger was in part driven by an agreement with the New Zealand Government which in return will provide Chorus with NZ$929 million of cash and attractively priced, long term financing to help bring subsidised, fibre-based broadband to 75% of New Zealand’s residents and businesses by the end of the decade. A condition of the cash injection is that the Chorus network and services must be ‘competition-ready’ and open to all on an equal, wholesale basis.
The architect behind the demerger within the business is Paul Reynolds, the Group CEO and former boss of BT’s Wholesale arm in the UK. When he took the helm in 2007, Telecom New Zealand had a well-publicised, troubled relationship with the national Government in Wellington. Customers and shareholders weren’t great fans either. Since Reynolds’ arrival, the business has improved its network, products and productivity, radically improved customer service, built what it claims is one of the best 3G mobile networks in the world, begun to rollout broadband over fibre and reduced costs. The NZ Government’s investment in Chorus is testament to the business’ improving relationship.
While a similar upside can never be guaranteed, boards of directors have an obligation to continually review what’s in the best interests of their shareholders. As BT’s creation of Openreach has also shown, separating an access business from the core retail business can improve service and reduce costs for customers by encouraging market-based competition.
If the New Zealand demerger experience is any indication, there’s genuine reason for some urgent modelling to be done, particularly among incumbents that remain stubbornly wedded to a fully integrated business model. If the shares in both Telecom and Chorus continue to perform strongly, it can’t be too long before questions are asked elsewhere. The investment banking fraternity, untroubled much by a largely inactive market for transactions in the current economic climate, might take an interest too.