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To: ms.smartest.person who wrote (507)	3/7/2001 9:48:10 PM
From: ms.smartest.person	Read Replies (1) \| Respond to of 2248

After bruising times, Telstra goes back to the future By STEPHEN BARTHOLOMEUSZ Thursday 8 March 2001 Last year was bruising for Telstra, filled with controversies, distractions and an odd sense that the organisation was losing focus and purpose. The dot-com crash last March, which ended some fantasies and left-field thinking for Telstra and others, and the steep slide in telco share prices that followed and threatened to overwhelm the payment of the T2 second instalment, was a wake-up call. Yesterday's result would appear to indicate that Ziggy Switkowski and his team heard it. The Telstra game plan, before the frenzied environment of the dot-com bubble seized its imagination, has been relatively simple and stable since competition was introduced to its industry in the middle of the last decade. The plan was for Telstra to defend its turf ferociously and slow competitors' incursions, to cut costs in its old franchises deeply and to remain competitive and maintain profitability in those businesses for as long as possible. Telstra was to invest aggressively to build new businesses to offset the impact of competition and technology on the old. Ultimately, it was about using Telstra's strength as one of the world's most fully integrated telcos to enable it to make a transition from the old telecommunications industry to the new. The latest result suggests that, thanks to the ratcheting up of its already aggressive cost-cutting last year, Telstra is back on track. The December-half result was extremely impressive. Earnings before interest, tax, depreciation and amortisation (EBITDA) rose somewhere between 10.4 per cent and 15 per cent (depending on which version of its "normalised" profit is preferred) on a 5 per cent increase in sales. The EBITDA margin on sales rose from an already staggering 49.8 per cent to 58.8 per cent. Return on equity rose from 38.8 per cent to 42.3 per cent. It would be tempting but simplistic to see Telstra's result simply as a cost-reduction story. It would be equally simplistic and wrong to see it as the flip side of a failure of competition. Costs were clearly a major factor in Telstra's ability to drive gross profits at a multiple of sales. Operating costs were held to an increase of only 2.1 per cent. In areas unrelated to its cost of sales, depreciation and amortisation - mainly labor costs and normal operating costs - there were significant falls in costs. This will continue ad infinitum because the "old" Telstra will, in relative terms, continue to shrink. Simply to maintain profit, or slow the rate of decline, dictates that costs must fall at least in line with falls in revenue. If costs were a significant element of the result, the more interesting one is how Telstra is adapting to its new and still-involving environment. Competition is biting hard and deep and at an accelerating rate. Last financial year, for the first time, Telstra had a significant fall in revenues from its old telephony businesses. This process not only continued into the first half of this year but appears to have accelerated, with aggregated revenues from basic access, local calls, long distance and international falling just under 3 per cent. Telstra says that since competition was introduced, revenues from those services have fallen an average of 2 per cent a year. Telstra has lost 700,000 to 800,000 customers. It has also lost substantial volume and absorbed big price cuts. This trend will continue. The only question is the rate of acceleration in the run-offs of those businesses and Telstra's ability to keep in step with them. Given that those old businesses have been the heart of Telstra's profitability and cashflows, their decline poses a threat and a challenge to stability and returns. Telstra has offset this decline with a drive into the new sectors of telecommunications - wireless, data, text and Internet services and wholesaling (where sales soared 33per cent in the half). These businesses, all in competitive markets where Telstra does not have the dominance that it has in the wireline networks, have been growing their revenue base 18 per cent a year since the introduction of competition. The growth rate is steepening. As the businesses grow, they will start to produce volume and scale effects that will have a leveraged impact on their contributions to profit, particularly because they are based on very different architecture from the old, people and capital-intensive Telstra networks. It is not as simple as replacing the old with the new. The mobile-phone business, for instance, has seen prices and gross margins tumbling. But the volume effects of a business whose customer base grew 25 per cent over the past year and where billable minutes grew 27 per cent, are powerful. Telstra should also gain increasing returns from its $20 billion investment in the past five years in new networks and business - its ADSL, CDMA, broadband and e-commerce platforms - and from its new Asian growth platform created through joint ventures with Pacific Century CyberWorks. Telstra's cashflow strength gives it the ability to spend $4 billion or $5 billion a year. The PCCW joint ventures and their balance sheets give Telstra the ability to leverage its growth in Asia at a time when rationalisation and the fall in prices for telco assets have created a window of opportunity. With Switkowski and new chief financial officer David Moffatt promising greater discipline on deployment of capital there is a sense of a "back to basics" approach emerging as the group starts to understand and use the strengths inherent in its full service, fully integrated portfolio. Telstra has already cut its net churn rates in its retail businesses to almost zero by adopting a bundling approach to some retail services. Only a year ago, the Telstra management was canvassing options for dis-aggregating the group with its board. Telstra's renewed confidence has been buttressed by the imminent change of ownership of main rival Cable & Wireless Optus. Whether or not CWO is sold intact to SingTel, or dismembered if Vodafone succeeds, it will not be in as strong a position to compete in the medium term. Any acquirer will pay bucketloads of goodwill for CWO's assets - so the acquirer will have to generate acceptable returns from a significantly higher cost base. This will discipline CWO's competitive behavior and create a competitive opportunity for Telstra - or a bottom-line opportunity. As it heads into the second half of this financial year and beyond, Telstra no longer appears confused about what it is or where it is heading. Its progress is not simply measured by the numbers, impressive as they might be. bartho@theage.fairfax.com.au This story was found at: theage.com.au