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Why Analysts Divide on Outlook For Australian Telecom Telstra
By Lyndal McFarland
The Wall Street Journal
Thursday, November 29, 2006

SYDNEY, Australia -- After 17 months of cajoling investors and Australian lawmakers to take a bet on his turnaround strategy, Telstra Corp. Chief Executive Sol Trujillo has put some of his own money on the table.

A few analysts aren't sure his gamble will pay off in the long run.

Despite a successful sale of 15.5 billion Australian dollars (US$12.1 billion) of shares by the government this month, Telstra faces stiff head winds in the form of tough competition and falling fixed-line revenue.

Previously, the government owned 52% of Telstra. The share sale cut that to 17%, which has been transferred to the Future Fund, an arms-length fund manager owned by the government.

The government nearly doubled the A$8 billion that Canberra expected to raise from wholesale and local retail investors, as its investment-bank advisers devised a clever marketing campaign, which included a 14% dividend yield on the "installment receipts" at the heart of the sales process known as T3.

Among the buyers was Mr. Trujillo, the former U.S. West CEO, who has caused headaches in Australia's Parliament with his antiregulatory campaign. He spent more than A$500,000 on his first direct holding in the telecom company since joining in July 2005.

So far, Mr. Trujillo has done well with the receipts offered to "mom and pop" buyers at A$2 each. They were at A$2.26 yesterday.

With investors focusing on the receipts' generous dividend, Telstra's ordinary shares have been out of favor. The stock, whose 12-month high was A$4.13, fell two Australian cents yesterday to close at A$3.67. Telstra shares have dropped 6.6% this year.

While the receipts have shown some strength, the risks of investing in Telstra and other telecom stocks since the 2000 global tech-stock tumble are obvious. When Canberra offered its second tranche of Telstra stock in 1999, shares were sold at A$7.40. The stock was just above A$5 when Mr. Trujillo came aboard.

"We believe that once the technical issues associated with the T3 sale subside, Telstra will trade back down towards our valuation," said Merrill Lynch & Co. analyst Patrick Russel in a note to clients, pointing to his A$3.31-a-share target.

Mr. Russel, who has a sell rating on Telstra, cites competition from rivals such as Singapore Telecommunications Ltd. and Vodafone Group PLC, along with regulatory risks.

With Canberra's sale complete and Telstra free of government shackles, some analysts expect Telstra to resume its antiregulatory campaign with a focus on the threat to its bottom line. Telstra has warned that its operating profit in the six months ending Dec. 31 will fall as much as 20% because of costs associated with the transformation plan. The results are due out in February.

Although Mr. Trujillo delivered his third-generation mobile network in record time, investors fear delays in other facets of his turnaround strategy may blow out Telstra's timeline for thousands of layoffs and consequent cost savings.

Richard Wallace, managing director at Wallace Funds Management, says he believes there is still "significant execution risk" surrounding Mr. Trujillo's strategy, which would see Telstra spend billions of dollars over coming years upgrading systems and reducing staff levels.

Mr. Trujillo, who outlined his plans a year ago, has already had to trim his annual earnings-growth forecasts, to between 2% and 2.5% through June 2010, from between 3% and 5%. Last month, Telstra acknowledged costs will rise more than initially anticipated, while margins will be lower.

Of seven major brokers surveyed, two -- Credit Suisse Group and Deutsche Bank AG -- recommend buying Telstra. Three have neutral ratings, and two -- Merrill Lynch and Goldman Sachs JBWere -- have the equivalent of a sell rating on the stock.

In the past two weeks, Macquarie Research and Citigroup Inc. upgraded their ratings, both to neutral. Citigroup's Tim Smeallie sees limited downside -- in a "worst case" scenario, A$3.14 a share. But he urged investors to be cautious, warning that industry head winds remain strong.

Write to Lyndal McFarland at