Interview: Paul Reynolds of Telecom New Zealand

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Reynolds explains plan to split of Telecom NZ into separate network and services companies

CEO Paul Reynolds wants to split Telecom New Zealand to allow the independent infrastructure company to bid for state broadband funds. Shareholders and government will consider his plans in October

Paul Reynolds: We’ll be the first telco in the world to voluntarily separate. We’d be on the road by early 2011 with separate management teams

Paul Reynolds, the CEO of Telecom New Zealand, is proposing to break the company into two — an infrastructure company and a services company that would own no infrastructure.
If he succeeds in his project, he will be a pioneer — because he means more than operational separation, which Telecom NZ and a number of others already offer — but a complete division into two independently owned companies.
“We’ll be the first telco in the world to voluntarily separate,” he tells Global Telecoms Business.
And the move, to be formally proposed to the New Zealand government as regulator and holder of a controlling share by the end of October 2010, will benefit shareholders by as much as 30%, he says.
“The Telecom New Zealand share price has been depressed,” he says. “There would probably be a 30% rerating” if the demerger plan went ahead.
A deal would need not only the government’s support, but also that of 75% of shareholders. The result could be two independent companies by July 2011, says Reynolds. “We’d be on the road by early 2011 with separate management teams.”
This would be easier in New Zealand than in many places, as the company already has a quasi-independent infrastructure division, Chorus, which is responsible for the fixed network used by Telecom NZ’s own retail operations as well as by that of its competitors, including subsidiaries of Telstra — Australia’s incumbent operator, which has a significant business in New Zealand — and Vodafone.
In the proposals that Reynolds and his colleagues are putting together, shareholders would receive one share in each of the two new companies for each share in the existing business. “They would then be completely separate legal entities,” says Reynolds.
The spur for this move is a project by the New Zealand government to invest in fibre-to-the-home networks. The government has set up a company, Crown Fibre Holdings, to invest NZ $1.5 billion (not quite US $1.1 billion) in a public-private partnership to fund an open-access ultra-fast broadband network, with the aim of getting service to 75% of the population by the end of 2019.

Taxpayers’ money

CFH defines ultra-fast broadband as 100 megabits a second downstream and 50 megabits upstream. It has invited operators to participate in this project, “but there will be no taxpayers’ money to anyone with a retail operation”, says Reynolds.
That means Telecom NZ, even though it already has a national network, cannot bid for any of the CFH money unless it can separate retail operations from the infrastructure business. The rule also applies to other operators in the New Zealand market, he points out, including Telstra and Vodafone.
The timetable is tight. Crown Fibre Holdings has already received expressions of interest from 33 operators and, according to chairman Simon Allen, it plans to recommend the “preferred investment partners” to the government in October 2010, “with the initiative commencing before the end of the year”, he said in July. Allen is a former ABN Amro banker who later chaired the New Zealand stock exchange.
“We’ve put our proposals to the government in order to get this money,” says Reynolds. But for that, the infrastructure company would have to be an independent legal entity from the retail operation. “We could serve the whole industry if we demerged,” he says.
A deal would be good for Telecom NZ and for the country, he says. “We’re a small country at the edge of the earth. The cost of getting broadband is more than in other countries. We could have a very efficient deployment, with our existing resources and with the new fibre.”
The new companies, if the government and the shareholders agree with his proposals, would both be listed on the New Zealand stock exchange, and both would probably be protected against foreign takeover by a so-called “Kiwi share”, controlled by the government.
Reynolds is clearly excited by the proposal, which — though he didn’t say so — can be seen as a logical progression not only from the creation of Chorus but also from BT’s earlier creation of Openreach as its local loop infrastructure provider in the UK a few years before.
BT negotiated the formation of Openreach — in operation from the start of 2006 — as a quasi-independent business that would work equally for all UK retail providers, including its own BT Retail.

Openreach mark two

It’s no coincidence that Reynolds was CEO of BT Wholesale, out of which Openreach was created, until the middle 2007, when he was recruited by Telecom NZ. Chorus, in some senses, is Openreach mark two. Though there are more rules: 200 pages for Chorus compared with just 60 for Openreach, he grumbles, “and no commitment to take regulation away. In the UK we got retail deregulation.”
[GTB interviewed Reynolds on 21CN in early 2006 and Reynolds wrote for GTB on his new task in New Zealand the following year: . Reynolds won a personal award in the Global Telecoms Business Innovation Awards of 2008 for the work he had done at BT and had started to do at Telecom New Zealand. See  ]
But full separation, as he is planning in New Zealand, is very different from the managed functional separation that led to the creation of Openreach in the UK and Chorus at the other side of the planet. When he arrived in New Zealand in 2007 “the country had switched from one of the least regulated to one of he most regulated markets in the world, pretty much overnight”, he says.
At the same time the government wanted Telecom NZ to invest heavily in broadband, from a position in which, he admits, broadband was poor. “High capex was required.”
And, he adds, the company ran a CDMA mobile network that was “out of date and losing market share.” That’s even though it is a 3G network — that is, EVDO. It is closing down on November 30 2010. In its place the company has switched to the GSM family, to build a new 3G network with HSPA.
That’s not been comfortable: launched in the middle of 2009, the HSPA network suffered a number of crashes six months later. CTO Frank Mount resigned after the last, in February 2010.
But now the peak speed of 21 megabits is available “to where 97% of New Zealanders live and work”, says Reynolds. And the company has built fibre to the node to serve “60% of the country”, he adds. “People are getting 17 megabits where the cabinets are installed. The infrastructure build has been sensational.”
Fibre and a new mobile network pushed capex up for a few years, something Reynolds warned investors about at his first conference for them in 2008. “We told them of our five-year plan, and said that earnings were going to decline.” Regulated prices were going to fall, capex had to double and ebitda was going to decline.

Fixed dividend

“We rewarded investors with a fixed dividend of 24 cents a share,” says Reynolds. At the current share price — which has hovered between NZ $2 and $3 for the past few years — that’s around 10%. “The shareholders have been pretty good about it, to be honest,” he adds, though the price is well below the $5 level of mid-2007. “We’ve had strong investor support,” he insists.
Meanwhile he’s been wrestling with the consequences of the recession, and — like telecoms CEOs the world over — struggling to reduce costs, “and all the issues that telcos have to face, including no new revenue in the market and none forecast for three years”.
Now, “there is a huge focus on costs”, he says: cutting costs, to be accurate. “We’ve taken $300 million out of the cost base this year alone.”
Much of this has been achieved by improving staff relations and reducing truck rolls, “so we get it right first time, and don’t do abortive visits”.
According to Reynolds, staff motivation “is up 20%”, thanks to “a massive focus on communications and approachability”, he says: “We’re communicating like mad.”
Reynolds did a similar job at BT around five years ago, when the company was planning its all-IP network, the so-called 21st century network. Then he spent months hiking round just about every site in the company, promoting the idea of the project and enthusing the staff.
In New Zealand, “the mantra is one of keeping customers at the heart”, he says. Previously the focus “was more on financial engineering”.
But at the same time, extraordinarily, Telecom NZ’s staff conditions have been tough. Wages have been frozen, around 200 senior and middle managers have been fired, and field engineers have been made self-employed.
He does not miss the managers, describing the approach as “hard-nosed”, to rebuild the business as it would have been “if we had built it from scratch”. And the result? “Once you make the change, the business runs more smoothly because there are fewer people in the way.”

Tools and trucks

The field engineers now own their own tools and trucks and “they are paid by the job done”, says Reynolds, so there is an incentive to get the job right first time. If there’s a fault within a month of a visit, “they have to fix it for free”, he says.
“The guys can control what they earn. They previously got paid for turning up for work. Now if they work twice as hard, they are paid twice as much.” Some work for six days a week until 9pm, others “do enough work to allow them to finish by Wednesday”, he adds.
There was some resistance from some staff, “and some guys didn’t want to work for themselves, but their mates did, so one guy can employ 10 of his mates. We found a way through.” As a result “for the business, our costs are less”, says Reynolds.
This, and other measures, mean that Telecom NZ is in a much healthier state. On August 20 2010 the company announced that earnings had stabilised after two years of decline. Free cash flow grew by 28% to NZ $128 million, the first growth since what Reynolds still calls “the regulatory shock of 2006”, when separation was first mooted. “Capex and earnings have stabilised,” he says.
Now, he has his eyes on the further growth possibilities if the company is split into two, with one part — the infrastructure company — eligible for some of that $1.5 billion the government is offering.
But before then there are laws to be passed and shareholders to be consulted. Assuming it happens, which part would Reynolds be interested in staying with? “It’s too soon to say that,” he retorts. “I’m building the management teams for the new companies. I’m totally focused on getting the right deal for shareholders.”
It will be a challenge, he admits: “There is no more complex job anywhere. No incumbent telco has undergone such rapid change. That’s kept me on my toes.” GTB

Further reading:

NZ Telecom weighs options for wholesale07 May 2010 

Telecom NZ eyes $1bn state broadband plans29 Jan 2010