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Telecom tipped to take breakup option

Telecom tipped to take breakup option

Announcement expected in the next three months, sources say.

A breakup of Telecom could be announced in the next three months, sources say, with shareholders likely to be offered stock in spun-out infrastructure unit Chorus. The scheme would represent a big climbdown for Telecom and its chief executive, Paul Reynolds, after fighting to find a way to take part in the Government's $1.5 billion fibre optic infrastructure plan without splitting.

"I think Telecom genuinely thought [it] could strike a deal with the Government before any of this went out to tender," said a source with knowledge of the process. "I think Telecom's board is now thinking 'there's a real risk we could lose this'."

Under the Government's plan, tenders have been invited from industry players to invest alongside state- owned Crown Fibre Holdings to install fibre reaching 75 per cent of the population during the next 10 years.

The rules around Crown Fibre, which bar telcos with retail businesses from board control of the Crown's joint venture fibre companies, have effectively excluded the country's biggest telco because it won't invest the huge sums required without control.

As a result, power lines companies led by Auckland-based Vector have climbed into the driving seat and have looked increasingly likely to become the Government's favoured partners in building the subsidised fibre network, an outcome seriously damaging to Telecom's earning power. With Crown Fibre aiming to choose its joint venture partners soon, perhaps as early as next month, Telecom's position has become more urgent, sources say.

"The split's coming," one market source said. "And before that, what's coming is the sale of [Australian unit] AAPT. [The AAPT deal is] getting down to the business end and shortly after that you will see Telecom ask for government approval to split the business."

Chorus chief executive Mark Ratcliffe stepped down this month to lead a team focused on ensuring Telecom's participation in the Government's ultrafast broadband investment initiative.

Spokesman Mark Watts says Ratcliffe's secondment was expected to last for "the better part of the year" and would remove any perceived conflicts. A likely structure for the spin- off would be to distribute shares in Chorus to Telecom's shareholders. The infrastructure company, which owns the fibre and copper networks linking Telecom's exchanges to its customers, would then be listed on the stock exchange.

One source said plans for a separation of Telecom would be announced "in the next three to four months," and it would take at least the next six months to implement.

Much of Telecom's existing debt could be migrated to Chorus, whose less volatile earnings profile could tolerate potential debt levels of more than $1 billion.

In the half year to December, Chorus had earnings before interest, tax, depreciation and amortisation of $374m on revenue of $511m. On those numbers Chorus is the most profitable of Telecom's businesses, earning more than double the retail unit on half the revenue.

Sources say the Government's investment could be accessed by issuing new shares to the Government and rivals such as Vector could also participate.

"Whatever happens with fibre, it's going to have to involve Vector in some shape or form," one source said.

One institutional investor said a listed Chorus would be welcome. "The New Zealand market needs a solid infrastructure stock with a regular income stream," he said, and Chorus would fit the bill provided it had "a sensible regulatory environment."

Investment banking adviser Cameron Partners is advising Telecom on its options, but the firm declined to comment on progress.

Although Telecom appears to have resisted a structural split for as long as possible, The Independent understands the option was discussed at length last year by Communications Minister Stephen Joyce and advisers to the Crown Fibre scheme.

"I do think Telecom had an opportunity to short-circuit this whole thing," said a source. "Probably in June, July, August [last year] but their offers were 'this works for Telecom' rather than what works for both parties."

According to some sources, self- interest influenced views on both sides. For example, Telecom's board hired Reynolds at great expense to run an integrated company, a salary bill that would look excessive for a retail business.

"There's a bunch of guys at Telecom in the 'turkeys don't vote for Christmas' position," one source said.

And even Crown Fibre Holdings faces entrenched views, he said.

"CFH has now got strong incentives not to go with Telecom. The board are on short-term contracts and there's a real possibility that CFH would be dissolved if the Government went with Telecom."

Crown Fibre chairman Simon Allen did not return calls seeking comment.

However, even if a Chorus spin-off breaks the deadlock, thorny problems remain.

For one, Chorus owns the copper local loop - a legacy asset that provides much of its earning power. Investing in fibre while maintaining the copper could generate some difficult internal conflict for its managers.

For another, Telecom is likely to have depreciated Chorus to well below its market value, so a transaction realising Chorus's full value could land Telecom with a unwelcome tax bill.

A third issue involves what level of service the Crown's infrastructure company offers. The original plan involved "layer one" or "dark fibre" service, a raw physical fibre link still requiring electronics to be lit up and connected.

It now looks likely the preferred option will be "layer two" service, which includes the electronics to light the fibre. The Independent

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Tags mark ratcliffeVectorChorustelecomTelcoPaul Reynolds

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