Telstra: A Tough Sale
CEO Sol Trujillo tries to connect with investors as the Australian phone giant heads toward a $19 billion stock offering.
On his sheep farm in Wandering, Australia (population: 460), Max Watts rips into Telstra Corp., the nation’s largest phone company. Cellular service stinks, e-mail crawls and phone outages can take a week to fix, he says.
Keeping Aussies like Watts from hanging up on Melbourne- based Telstra has become an Outback-sized headache for Sol Trujillo, the company’s American-born chief executive officer. Since becoming CEO in July 2005, Trujillo, 54, has struggled to hold on to his customers, combat new competitors and shore up Telstra’s sagging stock. He’s clashed with Prime Minister John Howard over how to regulate Australia’s 33.3 billion Australian dollar (US$24 billion) telecommunications industry and complained that the government has hob- bled Telstra, the world’s ninth-largest fixed-line phone company. Shares of Telstra, a former monopoly, have tumbled on Trujillo’s watch, sliding 27 percent to trade at A$3.68 on April 7.
Trujillo doesn’t have much time to connect with investors. Formerly CEO of Denver-based U S West Inc. and Paris- based Orange SA, Trujillo is steering Telstra toward one of the biggest stock sales the world has ever seen. Howard’s government plans to sell its remaining 51.8 percent stake as early as October. The government says it wants to raise A$26.4 billion with the sale. Investors say it will be lucky to get A$23 billion, the market value of its shares in early April. Either way, the stock sale is likely to be the third larg- est of all time, and the biggest since Tokyo-based Nippon Telegraph & Telephone Corp. sold a total of $62.6 billion of shares in 1987 and ’88. Telstra’s sale will dwarf the largest initial public offering of 2005, the $9.2 billion sale by China Construction Bank.
Trujillo—who dressed up U S West for its sale to Qwest Communications International Inc. in 2000 and turned Orange around before France Télécom SA bought the rest of that company—says running Telstra has turned out to be his hardest job yet. “I think it’s the most complex I have had,” he says.
Trujillo says he’s prescribed ‘tough medicine’ to turn Telstra around by 2010. ‘I can’t re-create the past, but I can create the future,’ he says.
Trujillo must contend with a century-old legacy of government control. It wasn’t until 1997 that the Australian government fully opened the telecommunications industry to competition. Though the government sold slightly less than half of Telstra in the late ’90s, the company must still provide phone service everywhere in Australia. The country is as big as the continental U.S., with only 20 million people, less than 1⁄14 the U.S. population. As Australia’s first phone company, Telstra is also required by law to lease its national network of land lines to competing carriers at what it says are below-market prices.
“Sol’s U S West and Orange experiences have prepared him well for the competitive pressures of the Telstra job,” says Dan Rein- gold, 53, director of the telecommunications finance project at Columbia Business School and author of Confessions of a Wall Street Analyst (Collins, 2006). “But government regulations can have a critical impact on the value and fortunes of a company. How well he and his management team do on the regulatory front may make the difference between Telstra’s success and failure.”
Trujillo and his lieutenants have urged the government to loosen the reins. They’ve warned that the restrictions imposed on Telstra might jeopardize the company’s stock sale. The government’s competition regulator wants Telstra to charge competitors tiered fees, under which carriers would pay Telstra A$13 monthly per line to reach the 70 percent of Australians who live in cities. Telstra wants to charge a flat rate of A$30. The company argues it has to make enough money to subsidize rural services, like the one on Watts’s sheep farm. Telstra also has proposed charging competing broadband Internet providers A$90 each time they connect or disconnect a custom- er to its lines. The government has called that request “not reasonable.” Telstra wants the prospectus for this year’s stock sale to carry warnings about the financial impact of regulation. As of early April, the government hadn’t responded.
Trujillo and his executives have sounded the alarm already. In August, Trujillo’s group managing director, public policy and communications, and former U S West colleague, Phil Burgess, 67, said he wouldn’t recommend Telstra stock to his 88-year-old mother, given current regulations. In March, Chief Financial Officer John Stan- hope, 55, said that if the government imposed the A$13 fee limit, the result would be “horrendous.” Such a move might wipe A$6.1 billion off Telstra’s market value over the next de- cade, he said.
Trujillo, meantime, has told investors that Telstra is in worse shape than he’d thought. Competition is intensifying. Since 1997, Telstra’s market share has withered to 62 percent from 80 percent. In 1997, Telstra had just two competitors. Today, it has 153. The company’s fixed-line business is melting down as customers switch to mobile phones, e-mail or rival carriers, Trujillo says. This past February, he told investors in Sydney: “The financial trends at Telstra are not good. We’ve got a cost structure we can’t afford.”
Such comments have helped trigger the plunge in Telstra stock that, through April 7, had erased A$17.3 billion of shareholder value. In early April, Telstra was trading at less than half the A$7.80 that institutional investors paid for shares when the government last sold stock in 1999. The col- lapse has prompted the government to slash by one-fifth the amount of money it expects to raise from this year’s sale, to A$26.4 billion from an original A$33.8 billion.
Government officials have blasted Trujillo and his team, saying their comments have depressed Telstra stock. Howard has called Telstra executives’ behavior “disgraceful.” He told Parliament in September, “I think it is the obligation of se- nior executives of Telstra to talk up the company’s interests, not talk them down.”
Trujillo says he’s just speaking the truth. “There were a lot of misunderstandings and bad assumptions relative to the shape of Telstra,” Trujillo says in an interview in Telstra’s red- upholstered boardroom in Sydney. “My job as CEO, and the job of any CEO around the world, is to disclose fairly what the conditions are.”
Trujillo says he’s prescribed “tough medicine” to turn Telstra around by 2010. He’s proposed slashing 12,000 jobs, or 23 percent of the workforce. To save more money, he plans to invest A$10 billion to unite the company’s voice and data net- works into a single Internet-based network. Once he gets Tel- stra on track in Australia, he says, he’ll push further into fast-growing Asian markets. Telstra already owns a majority stake in CSL New World Mobility Ltd., Hong Kong’s biggest mobile phone company. “I can’t re-create the past, but I can create the future,” he says.
Trujillo has his work cut out for him, says Peter Wilmshurst, a Melbourne-based money manager who helps invest US$130 billion for San Mateo, California–based Franklin Resources Inc. “I think it’s bold,” Wilmshurst, 34, says. “They’re taking some positive steps, but managing a telco is a tough business.”
Don Hamson, who helps manage A$20 billion for Boston-based State Street Global Advisors, which owns Telstra stock, says investors must take Trujillo on faith. “He’s not been here long enough to judge his Australian record,” Hamson, 45, says.
Trujillo has spent his entire career in the telecommunications industry. He grew up in Wyoming, the son of a laborer on the Union Pacific railroad. His ancestors emigrated from Mexico in the 1700s. After graduating from the University of Wyoming in 1974 with a bachelor’s degree in business and an MBA, Trujillo joined Mountain Bell Telephone Co., which was later renamed U S West. By 1998, he’d risen to CEO.
U S West, one of the Baby Bells created after the 1984 breakup of AT&T Corp., was in dire straits when Trujillo took over. The company’s poor service had earned it the nickname “U S Worst,” says Thomas Friedberg, 46, a Denver-based in- dependent telecommunications consultant and former U S West director of strategic finance.
Trujillo boosted spending on new technology and, with the Nasdaq stock boom in full swing, began hunting for a buyer. Under Trujillo, U S West stock almost dou- bled to $85.75 in June 2000 from $47 in July 1998. Profit rose 4 percent to $1.56 billion in 1999. When Qwest offered $43.5 billion for U S West, Trujillo and his board accepted. Before the acquisition closed in 2000, Trujillo quit, citing differences with Qwest CEO Joseph Nacchio.
“Sol was the best of the five CEOs U S West and, later, Qwest had in 20 years,” Friedberg says. “But he had been dealt a bad hand by his predecessors, and he was wise enough to look for a bid and run with it.”
By the time Trujillo quit, the tech bubble had already begun to burst. Soon, accounting scandals tore through the U.S. telecommunications industry. Qwest stock plummeted 98 percent, to a low of $1.07 in August 2002 from a high of $66 in March 2000. In 2002, the company restated its earnings for the previous two years by $2.2 billion. Nacchio was indicted in December 2005 by a federal grand jury in Denver on 42 counts of insider trading. He pleaded not guilty. Now free on $2 million bail, his case is due to go to trial this year.
Trujillo wasn’t implicated in the Qwest scandals. Today, he says he did right by U S West shareholders and that he didn’t see Qwest’s troubles coming. “The shareholders did very well in terms of the value creation that we de- livered,” he says.
U S West employees didn’t fare well from Trujillo’s deal, says Mimi Hull, Denver-based president of the 40,000- member Association of U S West Retirees. Nacchio eventually fired 17,000 employees and paid their severance out of the company’s pension plan, Hull, 62, says. “We don’t know how much Sol’s departure was a personality clash or whether Sol knew trouble was brewing,” Hull says. “There are some employees who worked with Sol who swear by him and others who hope he gets his dues.”
Reingold, who spent 14 years as an analyst at Credit Suisse First Boston, Merrill Lynch & Co. and Morgan Stanley, says that, in retrospect, Trujillo’s deal with Qwest was a bad move. “But at the time, it looked like a tremendous deal be- cause of the premium Qwest was paying,” Reingold says.
After leaving U S West, Trujillo joined La Jolla, California–based Graviton Inc., a closely held wireless sensor network startup partly funded by In-Q-Tel, a venture capital arm of the U.S. Central Intelligence Agency. Orange, a publicly traded unit of France Télécom, appointed him to its board in 2001. When Trujillo quit Graviton in 2003, shortly before that company dissolved, Orange named him CEO.
‘There are some employees who worked with Sol who swear by him and others who hope he gets his dues,’ the head of U S West’s retirees says.
Thierry Breton, then CEO of France Télécom and now France’s finance minister, said at the time that he’d hired Trujillo to cut spending, introduce new data services and boost sales. Trujillo pulled Orange into the black. The company earned 4.4 billion euros (US$5.4 billion) in 2003 after losing ¤4.5 billion in 2002. In September 2003, France Télécom of- fered ¤6.6 billion for the remaining 13.8 percent of Orange that it didn’t own and completed the purchase the following year. Trujillo moved on again. “Sol always seems to be able to find a way to get out at the right time,” Friedberg says.
Trujillo says he planned to take time off after his Orange turnaround. Then Telstra called. After initially rebuffing the offer, he signed an open-ended contract that pays him as much as A$10 million annually.
Trujillo says he got more than he bargained for in Telstra. The fixed-line service turned out to be losing customers even faster than the company had thought. After posting a record profit of A$4.45 billion for the fiscal year ended on June 30, 2005, profit during the next six months fell 11 percent and costs rose 6.3 percent. Trujillo has forecast a slide in profit of as much as 26 percent for all of fiscal 2006. In the last half of 2005, customers canceled 180,000 phone lines and mobile sales growth slowed by almost half, to 4.6 percent.
The government’s requirement that Telstra provide service everywhere in Australia costs the company big. Telstra says it loses A$800 million annually on rural services and at least A$847 million more by leasing its copper wires to rivals.
Australian Finance Minister Nick Minchin, who’s in charge of the stock sale for the government, says Telstra should share its wires with the competition. “You don’t want two telephone lines down every street,” Minchin, 53, says. “It’s not sensible to have precious investment dollars diverted into the provision of parallel services.”
Minchin says he wants the stock sale to go ahead in October or November to avoid holding it in 2007, an election year. He planned to take a proposal on the sale to a Cabinet meeting on May 8. On April 6, Prime Minister Howard said the government would not sell at fire sale prices.
Right now, foreign investors own 5.8 percent of Telstra stock. Under Australian law, that figure can rise to 35 percent. The government has hired ABN Amro Rothschild LLC; Goldman Sachs JBWere Pty., a Melbourne-based brokerage 45 percent owned by Goldman Sachs Group Inc.; and UBS AG as lead underwriters. The firms will share fees totaling not more than 1.1 percent of the dollar value of the sale, or about $290 mil- lion, Minchin says. Spokespeople for the investment banks declined to comment.
As long as Telstra stock keeps sliding, it will be a buyer’s market for the new stock, State Street’s Hamson says. “If I do buy it, I will want to get it even cheaper than it is now,” he says of the stock.
Some money managers may be forced to buy the stock be- cause the sale will change Telstra’s position in stock indexes that many institutional investors use to measure returns. Telstra currently accounts for 5.7 percent of a 20-member Morgan Stanley Capital International Asian telecommunications index and 1.47 percent of a 39-member Standard & Poor’s global telecommunications index.
One reason it’s taken the government so long to sell its remaining Telstra stake is that politicians, including members of Howard’s conservative Liberal-National coalition, fret that the company might curb rural services once the government lets go.
National Party Senator Barnaby Joyce threatened to block the sale by voting with the opposition until Howard agreed to spend A$3.1 billion on rural communications. As a former monopoly, Telstra has an obligation to the Australian bush, Joyce, 39, says. “If you left it up to the market, you simply wouldn’t have phone services in regional Australia, because you wouldn’t get a return on the investment,” he says.
Back in Wandering, Watts says it took him eight years to get Telstra to put his exposed land line under the ground, where it’s now safe from gnawing sheep and lightning strikes. “If Telstra is this slow to respond to complaints when it’s government controlled, it won’t respond at all when it’s run
purely for profit,” he says.
It doesn’t help that Trujillo is an American in Oz—and is trying to instill U.S.-style management at Telstra. Since Trujillo took over, he’s brought in a dozen former col- leagues, mostly from U S West and consultants from Boston- based Bain & Co. Some newspapers have taken to referring to Trujillo’s three deputies—Bill Stewart, 56, managing director for strategic marketing; Chief Operating Officer Greg Winn, 56; and Burgess—as “the Three Amigos,” a nickname that Donald McGauchie, Telstra’s Australian-born chairman, calls a slight to Trujillo’s Mexican heritage. “Some of these comments have a racist overtone to them,” McGauchie, 56, says.
Trujillo laughs off the Three Amigos gibe. “It’s become a bit of a joke,” Trujillo says. “It’s a fun expression now when I get in a taxi. People ask, ‘Are you one of the Three Amigos?’”
CFO Stanhope, an Australian who’s spent 40 years at Telstra, says the company’s former Australian management team didn’t have the skills to turn Telstra around. “Sol and the team he has brought in is the difference,” he says.
Trujillo says he helped shore up U S West and Orange, and he can fix Telstra, too. “If I didn’t think that, I don’t think I’d be here,” he says. For Telstra’s American CEO to succeed, he’ll have to connect with Aussie customers—and investors the world over.