Feb 9 2002
UP IN SMOKE
SingTel's Lee Hsien Yang paid $14 billion for Optus and its growth story. Eric Ellis and Geoff Elliott write the next chapter
BRITISH royalty aren't the only people who have anni horribili.
Singaporean princelings have them too.
Like the one that Lee Hsien Yang, youngest heir to Singapore's self-styled
philosopher king Lee Kuan Yew, and SingTel Optus shareholders are having as they
grapple with the grim truth that he paid way too much, $14 billion, for Optus.
The reality that's long been evident in the market - where SingTel shares are
down almost 40 per cent in the past year - hit home with Lee yesterday on the
plush 32nd floor of SingTel's head office in the city state.
Flanked by Optus chief executive Chris Anderson, an uncomfortable Lee fidgeted
through an unconvincing briefing that was part results announcement but in
larger part a justification of the struggling Optus deal.
"We paid fair value for Optus," Lee stoically maintained, and if you
are Cable & Wireless, Anderson and Optus's recently departed finance
director Norman Gillespie, you couldn't agree more. C&W got $14 billion for
Optus and the two executives pocketed upwards of $10 million between them as
their options kicked in on the sale to SingTel.
But the harsh truth for Lee Hsien Yang is that Optus is burning a big hole in
his well-tailored pockets.
He clearly thought he was buying a company at the bottom or near the bottom of a
cycle. He was wrong, and yesterday's results offer stark proof.
Optus is not self-funding. SingTel's anticipated Australian growth hub requires
$1.7 billion a year from outside the business to keep going. And that's at a
time when debt funding for telecommunications companies is tight and share
market investors don't want to touch phone companies.
SingTel will pay to keep the operation ticking over, and with its publicly
unquestioning Singapore Inc government controllers it can. In fact, it's going
to pay big-time through higher borrowing costs.
If economic conditions turn around quickly it will surely turn out all right,
since in advanced economies like Singapore and Australia higher GDP invariably
equates to more phone calls, more emails, and thus better sales for phone
companies.
But SingTel's Lee admits capital markets have shut off the valve, in the area
where it hurts most - telecommunications.
The glossy interpretation of that, and one Mr Lee exploited yesterday, is that
it means less competition for Optus in Australia.
But it also means that the funding for all those internet and
telecommunications-hungry companies - the dotcoms and the e-commerce divisions
of big corporates - has stopped. It was an area where Optus achieved huge sales
growth and was a key impetus for SingTel to pay so much for the company in the
first place.
Little wonder, then, that yesterday both Lee and Anderson were stressing that
growth was now in mobile retail, when six months ago the sexy part was data and
wholesale.
From a run rate of more than 20 per cent a year, sales in the last quarter in
the "Optus Business" division have hit a brick wall, down more than 11
per cent in the last quarter compared with the previous corresponding quarter.
"There is no doubt that there has been a very significant fall in wholesale
traffic," Anderson said yesterday.
Now, SingTel is looking to recover the situation. To cut the costs of running
Optus it will need to pare back Optus's business dramatically through lower
capital expenditure, a fact acknowledged yesterday by Lee and Anderson.
Anderson said the company was working through that issue now, but it looks set
to slash capital expenditure to about 20 per cent of sales compared with 32 per
cent before.
When Anderson and Lee sign off on that and wind back the business it will be the
most tangible evidence that SingTel's $14 billion acquisition has blown up in
Lee's face.
But Australian consumers should be thankful: without the deep pockets of SingTel,
Optus would hit the wall and Telstra would have the game to itself.
With that huge funding requirement of $1.7 billion, Optus is still a start-up
company. That's fine when growth is running at 20 per cent or more but it's dire
when growth starts evaporating.
"There will be continuing weakness in the fourth quarter," Lee told
reporters yesterday.
While the headline numbers for the nine months ended December 31, 2001, scream a
headline loss of $213 million for Optus, it's a red herring - and has nothing to
do with the main game when it came to SingTel's acquisition of Optus and why
it's turning out to be such an expensive move.
Lee, his advisers, telecommunication analysts - even some Optus executives -
were always circumspect about former Optus chief financial officer Norman
Gillespie and his attempts to tart up the company's bottom line.
As soon as SingTel arrived it slashed nearly $500 million of Optus's net profit
line, undoing years of Gillespie's work. Gillespie quit suddenly last month. He
was a former executive at Cable & Wireless in the UK, the former owner of
Optus and the company on the other side of the Optus transaction that did so
well to get out when it did, as it also did when it sold Hong Kong Telecom at
the top of the market to a now struggling Richard Li.
The newly enriched Gillespie has gone and it appears only a matter of time
before the polished Anderson does likewise, despite the denials to the contrary
and his mateyness with Lee in Singapore yesterday.
The joke doing the rounds in the market was that Optus's past accounting
practices were "Norman Gap" accounting, a satirical reference to how
Singapore GAAP (generally accepted accounting principles) were far more
conservative than the Australian principles that Gillespie applied.
And while all that might strike one as similar to the collapsed US energy giant
Enron, everyone knew what Gillespie and Optus were doing. Optus was never about
the bottom line and the ability to pay dividends, anyway. It was always about
growth.
Singapore is an island state, small economy, dominated by one of the biggest
cash generators in the world: Singapore Telecommunications. With its docile
government a major shareholder, SingTel cares less about the bottom line of the
companies it buys; it has enough cash to splash around and to absorb the
operations.
Still, it doesn't want a business going backwards.
But two of the three businesses within Optus that SingTel has bought have been
slammed into reverse.
"At the growth rates for Optus when SingTel acquired the company last year
they paid a premium," said one analyst of the $14 billion acquisition
price. "At the growth rates now, SingTel paid at least 50 per cent too
much."
On that analysis, that's $5 billion of shareholders' funds, mostly the Singapore
Government since it is the dominant owner of SingTel. The US consulting giant
Stern Stewart takes an even harsher view, noting that since 1996 - about the
time Lee took over as SingTel CEO - the company has lost a staggering $US30
billion in shareholder value.
Could the news get worse? Yes. Singapore is struggling out of the world's worst
recession outside of Afghanistan, and last week came the $US12 billion collapse
of the trans-Atlantic Global Crossing group, bailed out in a $US700 million deal
by Hong Kong tyro Li Ka-shing, Richard Li's much savvier father, in joint
venture - deliciously - with Singapore Technologies, the company run by Lee's
sister-in-law.
Global Crossing's dramas suddenly make SingTel's own $2.1 billion pan-Asian data
carriage play, C2C, look a little less sexy than it did when Global Crossing was
valued at $12 billion. That's about when Lee started pushing ahead with the C2C
platform in a part of the world less economically active that the Atlantic
region.
Yet things change. Rapid shifts in market conditions often can catch executives
holding the bathwater and no baby.
But the folly of buying growth in a sector when asset prices have gone through
unprecedented price appreciation - the thing that also meant Telstra chief
executive Ziggy Switkowski had to admit to a humiliating $1 billion writedown on
his Asian investments with Richard Li - has become something that now dogs Lee
Hsien Yang and Singapore Inc.
Optus's chief operating officer Paul O'Sullivan, who has been promoted since
SingTel took over, says Lee is taking a long-term view. He says the company is
not run by asset traders.
"They have bought a company in the region that is stable and growing and
there is daylight between Optus and its nearest competitors," O'Sullivan
says.
"In the short term (the acquisition price) may look one way or another, but
I don't think it is the way they view it."
And O'Sullivan offers some blue sky, saying Optus expects to make some big wins
with big corporate telco accounts. It won late last year a big contract with St
George Bank and the company is down to a shortlist of two in a contract for the
IAG, formerly known as the NRMA, the big NSW insurance group.
Optus will no doubt benefit from the consolidation in the industry and probably
be able to charge higher prices. It's already followed Telstra's lead on some
price increases, hiking charges on some of its mobile phone products.
But it's this same consolidation that is savaging companies that were buying
Optus's products in the first place.
It's a big contraction in the industry and O'Sullivan, more than Anderson, has
his hand on the tiller in Australia for Lee, steering the ship in tough times.
O'Sullivan acknowledges the difficulties, and he obviously thinks things will
get tougher before they get easier.
And he's not looking for survivors: all merger and acquisition activity has been
shelved this year at Optus and the focus is on costs and other operating
expenses. No doubt capital expenditure will be slashed, a sure signal that the
growth company that SingTel thought it acquired is hardly that.
O'Sullivan will just be trying to keep things afloat until the storm passes, so
that he and his crew can see brighter days.
In fact, in all the controversy over SingTel's acquisition, it is O'Sullivan who
will play a key role in determining whether SingTel can eventually claim success
for its Australian strategy.
For now, SingTel and its chief executive are nursing some mighty bruises.