Giant US investment company discloses 5% Telecom stake

US investment company Blackrock has disclosed a 5% stake in Telecom – a move that may raise eyebrows given the Kiwishare prohibition on foreign ownership is due to be lifted by the end of this month.

The company passed the disclosure threshold after buying 938,267 on Tuesday. The 5% stake has been built up through 16 subsidiaries.

Blackrock says it has assets under management that total $US3.66 trillion across equity, fixed income, cash management, alternative investment, real estate and advisory strategies, making it one of the world’s largest investment firms.

It has a market cap [NYSE:BLK] of around $US28.5 billion. Among many other invesments, Blackrock is the fifth largest investor in Apple. It holds a 2.5% stake in the world's most valuable company (Apple has a market cap of $US375 billion, making the Blackrock-controlled shares worth around $US9.4 billion.

Unbound Telecom an attractive takeover target
Analysts say Telecom, soon to be freed from the Kiwishare restriction on foreign ownership, is ripe for the picking.

Deutsche Bank’s Geoff Zame thinks the de-merged Telecom is arguable an attractive takeover target. However, he did not think Blackrock lifting its stake was a precusor to larger play. "It's a red herring," he told NBR this afternoon. Mr Zame saw it as a passive, index-fund investment.

Deutsche Bank has a buy rating on Telecom and a 12-month target price of $2.88 (the company's shares [NZX:TEL] were up 1.34% to $2.65 in midday trading today).

As a general rule of thumb, demergers are more likely to create value than mergers, Mr Zame said told NBR earlier.

But the really big gains could come if "New Telecom" becomes a takeover target. “A private equity play would invariably be hostile and hence need to offer a substantial premium,” the Deutsche Bank analyst said. 

Bye bye Kiwishare
In June, the government pushed through legislation to facilitate the spin-off of Telecom network division Chorus (a condition of the company's Crown fibre contract). In a last minute amendment, the “Kiwishare” provision – including prohibitions on one investor owning more than 9.9% of Telecom, or an offshore party more than 49.9% – was removed from the Telecommunications Amendment Act (running against Mr Joyce's 2009 comments to NBR on foreign ownership).

Communications Minister Steven Joyce said “New Telecom” would be subject to no more regulation than retail rivals like Vodafone and TelstraClear ("New Chorus" will be bound by Kiwishare-style foreign ownership restrictions, but they are in contract form rather than legislation).

Deutsche Bank's Mr Zame – often cynical about the company’s prospect’s pre-split (he moved from “hold” to “buy” on July 11 and maintained his buy rating after shareholders voted for separation on October 26 – ticked off a list of reasons why “New Telecom” is arguably an attractive takeover target.

The company’s newly open share register, what he sees as its saleable assets (including Australian division AAPT, Mobile, the Gen-i services division, national backhaul, and its 50% stake in the Southern Cross Cable) and high free cashflow – at least in next two to three years – could all appeal to the right buyer, Mr Zame said.

Private equity buyer more likely than telco
The analyst said it was hard to see a trade player getting involved.

Telstra – in the midst of grappling with the Australian government’s National Broadband Network (NBN) “has bigger issues.”

And Mr Zame saw Singtel (which bought number two Australian carrier Optus in 2001) preferring opportunities in higher-growth Asian markets.

Picking the bones
The most likely suspect was a private equity player in a cost and cash stripping exercise. “I do think M&A could be a feature of the new Telecom,” Mr Zame said. “If not a bid, then the purchase or sale of assets.”

IDC analyst Rosalie Nelson said while there was now nothing to stop Telecom being bought by a third party, “prospective buyers wouldn’t be seeing a growth story, so they’d be looking at how do we get value by sort-of doing cost-out.” While New Telecom was relatively light on debt (most has been shovelled on to infrastructure-heavy Chorus), it was heavy on staff. New Telecom needed to reduce its head count, whether to make itself more attractive to a potential buyer or to become more competitive.

“If you’re not getting top line growth then you have to look at how quickly you can shrink your business and manage costs to sort of stabilise earnings,” Ms Nelson said.

Mr Zame thought any buyout (or business division sale) would be unlikely for at least six to 12 months “while the market gets comfortable with the shape and operations of the demerged business.”

If a friendly or hostile bid comes in soon after demerger (scheduled for November 30), the company would be in a difficult position, given it would have a largely new board and a transitional chief executive. Paul Reynolds is leaving and Telecom says it will appoint a replacement by June next year.

“Any board would arguably like to present an alternative to shareholders, such as a value-maximising strategy under the new chief executive,” Mr Zame said.

More assets than you might think
At Telecom’s annual meeting on October 26, chief executive Paul Reynolds (who will stand down before the end of the financial year), stressed two themes. One was that New Chorus’ interests would become aligned with that of the government. This could be taken as code for: the spun-off wholesale division will be left to do battle in the regulatory quagmire, while New Telecom becomes relatively free. 

Dr Reynolds also emphasised that although New Telecom is the “retail” half of the split, it will retain a lot of infrastructure. Assets will include the XT mobile network, national fibre backhaul (the main truck of the network) and data centres. He could have added that while New Chorus will take control of around 750 phone exchanges – as one might expect – New Telecom will own the 20 largest urban exchanges.

Southern Cross the key
Telecommunications Users Association chief executive Paul Brislen also picked up on the infrastructure theme. Mr Brislen noted that while most domestic infrastructure would come under the heavily-regulated Chorus, the Southern Cross Cable falls under New Telecom which holds a 50% stake. Singtel owns 40%, Verizon 10%.

So on a domestic level, New Telecom will be a retail company, competing against other “retail” phone companies like Vodafone, TelstraClear and 2degrees.

But, by dint of the Southern Cross Cable’s monopoly on the internet connection to the outside world, retail rivals will have no choice but to buy international bandwidth from a New Telecom-controlled entity.