Employee ownership and cost reductions will bring new efficiencies to Telecom

Few share issues have generated as much interest as the impending flotation of Telecom Eireann. Not only is it the largest privatisation in the history of the State, but it is in a sector that has returned huge gains for investors around the world in the past few years. Telecoms in the UK, Europe and the US have all had an excellent run, particularly in the past eighteen months. What has been driving this, and what are the implications for the Telecom Eireann flotation?

The adoption of new and cheaper technology and the expectation of revenue and profitability growth are behind the massive rise of telecom stocks. Mobile phone penetration rates in Europe are exceeding expectations and in Scandinavia, levels of penetration previously thought to have been wildly optimistic are being handsomely beaten.

While the penetration rate in Ireland has risen sharply to about 26 per cent, there appears to be many years of growth as new applications, greater affordability and competition all seem to be designed to get more of us to use mobile phones more of the time.

Telecoms are an opportunity to invest in the future and this perhaps explains some of the huge gains made by the sector in the past year. However, Telecom Eireann's short and medium term prospects are not founded on far-reaching new applications, but on more mundane (and, thankfully, tangible) issues. Cost reductions are much talked about, but of greater significance is the employee ownership of 15 per cent of the company, which should enable amended work practices to deliver substantial increases in efficiency. A significant attraction of the Irish telecom market is that we tend to talk more than our European neighbours (line usage in Ireland is about 16 minutes a day versus approximately 12 minutes for Europe).

The existence of a young, educated workforce has been important in attracting more value added jobs to Ireland and will prove very beneficial in the willingness to adopt new technology. This, in turn, will drive penetration rates and volumes on both the mobile and fixed networks and therefore the profitability of Telecom Eireann. Internet penetration is set to rise sharply from approximately 7 per cent of the population currently. The Irish telecom market, though small in international terms, thus has hugely attractive characteristics. Telecom Eireann is very well placed to capture these. What are the risks? Regulation is one, but on the basis of the actions of the Telecommunications Regulator to date, I believe the risks of a significant deterioration in Telecom Eireann's situation due to regulation are not large.

Competition is another, and Telecom Eireann has anticipated this by implementing price reductions in advance. The competitive climate will certainly heat up, and Telecom Eireann's market share is expected to fall, but the challenge for the management is to minimise the impact of these, not prevent them from happening.

The biggest risk is market risk should stock markets around the world take a hit in the near future. In such circumstances,

Telecom Eireann will not be exempt. It may seem churlish to remind investors that prices can go down as well as up, and that it is never a good idea to invest money in the stock-market that is needed for other purposes in the near future.

So what will the share price of Telecom Eireann do after the flotation? Interest from retail customers has been strong, as evidenced by the high number of retail registrations. Telecom Eireann's story has been well received by international institutions, reflecting those positive characteristics of the telecom market and the positive view of the company internationally. Investing in Telecom Eireann allows access to a part of the strong Irish economic story and provides some diversification away from a heavily financial dominated index. At the upper end of the pricing range, it is valued at a premium to the European telecom average. The decision of the Government to sell all of its shareholding should improve the liquidity of the shares but perhaps indicates that as the Government has only one bite of the cherry, it needs to make that bite worthwhile. With £40 billion of new telecom shares due to come to the global markets in the rest of 1999 alone, it is understandable that the prospect of another placing in twelve or eighteen months time was not attractive.

Telecom Eireann should be an attractive investment for the medium term, even if the price is set in the upper half of the pricing range. A premium over the European telecom sector is justified on the basis of the strength of the growth in the Irish telecom market, and the prospect of Telecom Eireann growing profits by over 20% per annum for the foreseeable future.

Paul Sweetnam is head of Irish equities at Standard Life Investments