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.