Telstra faces split if bumped from broadband

WELLINGTON (Reuters) - Australia's largest phone company, Telstra Corp (TLS.AX), could face hefty regulation if the government goes through with a threat to bypass the company in building a $6.9 billion national broadband network.

Telstra has been shut out of the planning and, if the project is granted to a rival, it could see its network arm forcibly separated to provide a platform for the network.

Analysts say uncertainty over the ability of Telstra's rivals to build a network to span Australia's vast distances and inhospitable terrain to reach the government's target of 98 percent of the population, means Telstra must be involved.

"This requires parts of Telstra's network, and if they're not prepared to provide it willingly then it will have to be legislated," said Luke Sinclair, investment manager at Karara Capital.

Australia has slower and more expensive Internet than many developed countries, and the government has pledged A$4.7 billion to help build a national broadband network, with the successful bidder expected to roughly equal that amount.

But the project has been beset by political wrangling, descending into a face-off between the government and Telstra, which dominates the market and infrastructure.

The government panel reviewing proposals for the network on December 18 dumped Telstra's plan as it did not include smaller businesses, while accepting another five bids.

"This decision reveals fundamentally a growing level of frustration from the government with Telstra's very public demands and ultimatum for regulatory concessions," said JP Morgan analyst Laurent Horrut in a note to clients.

Telstra has sought assurances from the government it would not be forcibly broken up before submitting its bid. The government has responded by saying the network could be built without Telstra.

Telstra could still be selected, however, if Minister for Broadband Stephen Conroy, who will make the final decision, decides to ignore the panel's recommendation.

Of the five other bidders who registered interest, Telstra's main rival Optus, owned by Singapore Telecommunications Ltd (STEL.SI) and backed by a consortium of smaller players known as Terria, is seen as the most likely candidate.

While doubts persist whether anybody other than Telstra can muster the estimated A$5 billion needed on top of the government's contribution, a joint venture could be the solution.

"Even if you have one leading tenderer, let's say Terria, it would be possible for them to work with other players to get it built," said Paul Budde, an independent telecoms analyst.

Or the government may address how much it is willing to contribute to the project to support a less capable bidder, Karara Capital's Sinclair said.

Besides the Optus-Terria consortium, the other bidders are Canada's Axia Netmedia (AXX.TO) and a local consortium, Acacia. TransACT and the Tasmanian government have only submitted plans for their state or territory, not a national plan.

Credit rating agencies Standard & Poor's, Moody's and Fitch all maintained their Telstra ratings despite the government decision, with all three saying it was too soon to say what the impact would be on the company if it was left out. That is partly because the process could become mired in legal challenges, resulting in lengthy delays. Telstra has called the decision to exclude it from the bidding "legally questionable," and has reserved the right to challenge it.

Telstra shares, which fell almost a fifth to an 11-year low in the wake of the decision, have recovered some ground after the company said its earnings outlook would not be affected.

The shares are expected to survive relatively intact even if the government awards the contract to a rival firm, as it would take the winning bidder years to build the network, time in which Telstra could mount a competitive response.

Damage to Telstra's value would depend on whether it was forced to split -- a scenario that JP Morgan's Horrut said would remove A$1.32 from the stock's standalone valuation of A$4.73 a share. If Telstra is chosen to build the network, however, that valuation would increase by $0.41 a share, Horrut said.

Telstra is opposed to splitting off its network business from its retail arm, saying that would destroy shareholder value, citing similar regulation imposed on Britain's BT Group (BT.L) and Telecom Corp of New Zealand (TEL.NZ) as a precedent.

"One of the conclusions from the last week is that some of the good outcomes the market had been looking for are now a lot less likely," Karara Capital's Sinclair said.