Can Andy Penn save Telstra, and his job?

In early 2015, when Telstra’s respected former chairman Catherine Livingstone coronated Andy Penn as the successor to well-liked chief executive David Thodey, few people questioned the choice.

One exception was John Sevior. The influential stock picker has held Telstra shares for clients throughout his career (but currently does not) and he told those who would listen the appointment was curious and unusual. There is even informed speculation he canvassed his concerns with Livingstone but was rebuffed.

Sevior felt that Telstra, which was about to face an era of unprecedented competition, maybe didn’t need a leader from a financial services background but someone who would tackle its myriad challenges with urgency.

Sevior, who oversees billions of dollars for Magellan-owned Airlie Funds Management, has a pretty strong track record when it comes to matters like these, but his concerns fell on deaf ears. This week they took on added significance, as Telstra shares sank to their lowest levels in seven years following an unscheduled trading update that spooked the market.

No one is publicly calling for Penn to go, but with more than $40 billion of Telstra's market value incinerated under his stewardship, and with analysts openly questioning his strategy, the clock is ticking. For his part, Penn accepts there will be consideration of his fitness for the job, but says he’s determined to right the ship.

“Firstly it’s an entirely reasonable and fair [question]. I work for the shareholders. I have never been more committed to the business. I’ve never felt more determined to make changes we need to make, and to execute and pursue our strategy”.

Citi analyst David Kaynes this week called for “drastic action” at Telstra - including cost cuts, asset sales and even infrastructure sharing to preserve the company’s dividend, which the company cut last year for the first time since 1998. Telstra’s “current strategy isn’t working,” Kaynes told clients.

Penn, unsurprisingly, disagrees. “I think we have the right strategy,” he tells Fairfax. “But there is no doubt we need to be bolder” .

Over the past three years, Penn has outlined a vision for Telstra to become a “world class technology company that empowers people to connect”.

He has added significant technology capability to the company’s executive team - most famously the former chief executive of fallen smartphone company Nokia.

But to many investors and Telstra observers, the messaging struck an odd tone, especially with the company's core business of selling phone and internet connections under siege like never before.

Telstra CEO Andy Penn at the 2018 Consumer Electronics Show in Las Vegas.
Photo: Supplied

“I acknowledge that maybe I could do more to be clearer about precisely what we were talking about,” Penn says.

“This is not about moving away from being a telco at all. It’s actually quite the opposite. It’s about recognising that being a telco in the future, you need skills you didn’t have in the past".

Penn has no plans to attempt to transform Telstra into Netflix or Facebook (or even an IBM or SAP). He does believe rapid advances in areas like 5G and machine learning pose an opportunity for Telstra, as well as a threat if it doesn't invest to keep up with them.

“We are now on the cusp of a pretty significant next step in technology transformation in the telecommunications industry,” he says. “The worst thing would be to not continue to invest. That would be a bad decision. It would be short term. It would undo a significant journey.”

Former Telstra chief executive David Thodey and current boss Andrew Penn.
Photo: Cole Bennetts

Right man for the job?

Andy Penn joined Telstra in 2012 as chief financial officer. It was a left-field appointment driven primarily by Livingstone, sources say, a move designed to strengthen the field of potential successors to then chief executive David Thodey.

Aged 48 at the time, he had no telecommunications experience, but he had already reached the summit of corporate Australia.

Penn is a self made man who dropped out of high school at the age of 15, later studying at night to gain secondary qualifications and ultimately, an MBA. After emigrating to Australia in his 20s, he joined insurance firm National Mutual, later to become AXA-Asia-Pacific, where his star shone.

Reed Hastings, chief executive of Netflix.
Photo: Bloomberg

In his two decades at AXA, Penn’s signature achievement was building up the company’s Asian presence (which it ultimately sold to its French parent company for $10 billion). Rising to the rank of chief executive, he steered AXA through drawn out takeover talks with AMP. That ultimately resulted in the company being acquired by its storied (and now fallen) peer for $13 billion, and Penn pocketing a $17 million severance package.

Penn’s comfortable financial situation - he was also paid $5 million last year - has led some fund managers to privately question his hunger in a role that requires it.

It is a job that also carries significant prestige in Australia and beyond. He regularly rubs shoulders with the global tech elite. He considers himself close to Microsoft chief executive Satya Nadella and Netflix chief executive Reed Hastings. Penn has delivered keynote presentations at the Mobile World Congress event in Barcelona.

“He looks like a guy who has worked his way to the top of one of biggest companies in Australia and now he’s cruising along CBA style,” one institutional shareholder says. “They see more risk in rocking the boat than setting the business up for the future – because the rewards are probably in 5 to 10 years time and he won’t be there”.

Even though Thodey didn’t drive Penn’s hiring, the two made a formidable combination - Thodey the affable front man, capable of disarming Telstra’s many critics in the political sphere and investment community; Penn the benevolent number cruncher - showering dividends and buybacks on an investor base that had been burned by the big T for so long.

Telstra enjoyed a stellar run in the Thodey era as the company dominated the mobile phone market - capitalising on a shambolic situation at Vodafone and the advent of one of history’s most successful consumer products, the iPhone.

As people flocked to buy Apple’s popular devices, they also flocked to the network best capable of handling their bandwidth hungry demands which, at the time, was Telstra’s. This, together with excitement over the promise of billions of dollars in NBN payments and record lows in global interest rates propelled Telstra shares to their highest levels since the dot com boom.

When Thodey left, having doubled Telstra’s share price, there were a host of ambitious executives jostling to replace him. Yet Penn was always considered the presumptive heir, despite the protestations of some investors including Sevior.

Gordon Ballantyne departed Telstra for Healthscope.
Photo: Louise Kennerley

His mooted rivals left soon after his appointment. Gordon Ballantyne who ran customer service and the Telstra Health experiment now runs listed hospital operator HealthScope; Kate McKenzie departed for NZ based telco Chorus; Robert Nason, the man in charge of cost-cutting is now running Indonesian mobile operator Maxis.

More surprisingly, executives Penn handpicked to fill senior positions didn’t stick around for very long. Cynthia Whelan, a former investment banker at Barclays who joined to run “new businesses” at Telstra left for Westfield spinoff Scentre group; former Optus CEO Kevin Russell who joined to run Telstra’s retail business, left after 18 months, his highly touted predecessor in that role, Karsten Wildenberg, lasted only two months.

One of Telstra’s big hires who has stuck around is Stephen Elop, who is in charge of realising Penn’s tech ambitions. Elop was CEO of Nokia, overseeing the onetime king of market’s final “burning platform” days, when it was completely outmanouvered by Apple and Google.

Penn's challenge

It has been a torrid 18 months for telco sector in Australia, with the NBN’s steep wholesale prices hurting margins for established players in fixed line broadband, and the mobile market undergoing a period of intense (and some would say irrational) competition.

While Telstra shares have been hit hard, TPG Telecom and industry problem child Vocus have suffered steep falls as well. Within this context, Penn still has his supporters. “I think he is doing a reasonable job,” says Anton Tagliaferro, the investment director of Investors Mutual, a longtime Telstra shareholder.

“I don’t think he has had much choice for what has happened. Maybe Telstra was a bit little slow to move, but I think it was assumed when he took over there would be some margin to be made out of reselling NBN, and that doesn’t seem to be the case.”

“And when Andy took over, there was no talk of a fourth entrant to the mobile market either.”

That fourth entrant being TPG Telecom, led by the redoubtable (and reclusive) David Teoh, which is notoriously agressive on costs and prices.

Even the way this week’s market update was handled has raised eyebrows. Telstra said its earnings (before interest, tax, deprecition and amortisation) would fall within the lower end of a previously specified range of between $10.1 billion and $10.6 billion. It insisted it was not a profit downgrade - the company did reaffirm its 22¢ dividend and actually raised expectations for free cashflow generation. But the market saw through it, sending shares about 10 per cent lower for the week .

To put it bluntly, Australia’s most famous communications company is struggling to communicate. And shareholders are wearing the cost.

A "nice guy"

Penn lacks the natural charisma of his predecessor Thodey, who, like the best CEOs, timed his exit from Telstra to absolute perfection. But colleagues and supporters describe him a “nice guy” who is likeable and pragmatic, if occasionally buttoned up. He has steely determination, they say, and worked hard to improve his technical knowledge of the telecommunications business.

He isn’t afraid to make tough decisions either, these sources say, citing his decision to bite the bullet and cut Telstra’s dividend last year. Shareholder payouts had been sacrosanct at Telstra in the Thodey and Livingstone days, the company even took on debt for a while when earnings couldn’t cover them.

Penn’s management style is said to be considered and collegial. Rather than blasting or humiliating people (as some former Telstra leaders were inclined to do) he delivers firm instructions, but wraps his them polite, pleasant (and English) demeanour.

When he returned from summer holidays one year sporting a beard, several senior male leaders at Telstra decided to copy the look. It was probably intended to be a sign of support for the boss, but to outsiders suggested a sycophantic culture.

Penn had a reputation as a seasoned and shrewd dealmaker when he joined Telstra. He was expected to help the company realise its ambitions in Asia, having built up AXAs operations in the region through a series of bolt on acquisitions.

And shortly after he took the top job, it looked like that might happen. Telstra commenced talks with San Miguel, a Philippines conglomerate best known in Australia for its beer, about a mobile joint venture in the country. The talks ultimately fell apart though, with Telstra, always fearful of a backlash from its conservative investor base, deeming the venture too risky.

Telstra’s next significant deal was an asset sale - it sold most of its shares in Autohome, a Chinese car sales website for $2.1 billion. So, rather than expanding in Asia, Telstra was in retreat.

Next, there was a bungled attempt at financial engineering - Telstra devised a plan to pool together NBN payments into a separate vehicle which could be sold to private investors for up to $5.5 billion. The company went public with the plan, which it said needed NBN’s blessing, which embarrassingly for Telstra, ultimately wasn’t forthcoming.

Penn had more success in finally untangling Telstra’s complex and tortured relationship with News Corp in pay TV giant Foxtel.

He struck a deal that would see Fox Sports (entirely owned by News) absorbed by Foxtel, and Telstra’s stake in the combined entity would fall to 35 per cent.

It creates a much smoother ownership structure for the enlarged Foxtel - no longer would the two owners be squabbling over infrastructure costs, or how to fund bids for sports rights. It also sets the stage for a possible Foxtel IPO in coming years, allowing Telstra to exit the pay TV company altogether.

Penn is described by corporate advisers, who have been sidelined from many Telstra deals (it has used its own in house strategy team on some transactions), as a tough negotiator -”one who strives to get the nth advantage”

They [Telstra and News] squeezed every last cent out of each other, while Rome was burning in the background.
Corporate adviser

He certainly seems to have driven a hard bargain with News over Foxtel. Telstra exchanged 15 per cent of Foxtel (which is struggling) for 35 per cent of Fox Sports (which is much better positioned for the future). It also booked an accounting gain of $263 million once the merger was complete

Even still, critics say the wrangling between Telstra and News over Foxtel (described by others as an asset in search of a strategy) was ultimately counter-productive.

“It took them too long to resolve Foxtel,” says one senior corporate advisor. “They [Telstra and News] squeezed every last cent out of each other, while Rome was burning in the background."

NBN revisionism

Foxtel aside, a much bigger and more significant deal is having a much more significant impact on Telstra’s future. That deal being Telstra’s historic pact to lease infrastructure and transfer wholesale customers to the government owned NBN Co, in exchange for billions of dollars.

One of the most striking differences between the Thodey and Penn eras at Telstra is how is that landmark transaction is being portrayed. During the Thodey era, the NBN deal was widely described by analysts and the press as a “windfall” and the “deal of the century”. It would see billions of dollars in payments flow into its Telstra coffers over the next three decades, money it could use to pay dividends, buy back stock or buy other companies.

Now, it is being seen very differently. “I think the market didn’t understand that when we sold the business to NBN we lost the profit as well” says one person involved in the negotiations.

"The bottom line is, the creation of the NBN, and effectively, the transfer of assets and our wholesale business to NBN is a re-nationalisation of that part of the network," says Penn.

Former Telstra chairman Catherine Livingstone.
Photo: Daniel Munoz

At the time of the transaction being struck Livingstone, and others, warned it was really the least worst option facing Telstra, which had been threatened with being broken up by the government and being forced to divest Foxtel.

Many thought this was just political posturing - Telstra didn’t want its critics in Canberra, and its rivals, to think it was getting a sweetheart deal. But it's increasingly clear it wasn't. “Looking backwards, it’s quite clear the deal the value isn’t sufficient to offset the loss of earnings that comes from needing to pay for access from NBN rather than delivering it over ther copper network,” says Kaynes.

Regardless, Telstra has had a long time to figure out how to live in an NBN world - and it has squandered it. “At the time, it was seen as a deal that bought them time, but they haven’t used the time well enough “ Nikko Asset Management portfolio manager Michael Maughan says.

NBN bowed to pressure from big telcos and cut its wholesale prices temporarily in December. There have been calls, including from Penn, for it to cut prices further. However, with more than 180 retailer providers reselling NBN, such a cut may not be a panacea.

“With that many providers there is too much competition and if NBN cuts the price, retailers will as well,” says Citi’s Kaynes. “I think that everyone probably underestimated how competitive retail services providers would be under NBN. We never anticipated that”

Many of these smaller players can survive on the skimpy margins reselling the NBN involves. For Telstra, which used to enjoy 60 per cent margins on copper - it is much harder to live with.

“For the small providers, the margins are good enough,” says Kaynes. “If you didn’t have a broadband business at all [before NBN] that’s worth going after.”

Yet this was precisely how the NBN was intended to work. One of the basic reasons the massive infrastructure project was conceived by the Rudd and Gillard governments was to increase competition in fixed line telecommunications, a market they argued was being strangled by Telstra, in turn giving Australia some of the highest broadband costs in the world.

A secret plan B?

What if Penn actually does have a plan for Telstra, but he is just not allowed to talk about it?

There is a growing belief inside Telstra, and among its supporters, that 5G could be a catalyst for a renaissance at the company. This might sound surprising, since Australia’s mobile market currently looks extremely challenging. Aggressive competition has led to a price war - or more accurately a data war - with telcos offering unlimited mobile internet access to win customers.

TPG Telecom is spending $1.9 billion rolling out a network that should be up and running towards the end of the year. It is controversial to say that the 5G mobile standard (which is still being finalised) could be a viable competitor to the fixed NBN (which is comprised of a multitude of fiber-based broadband technologies). Yet investors believe that is Teoh’s plan. “That is what TPG are going to do,” says IML’s Tagliaferro. “TPG ‘s whole business model is about building a 5G competing with the NBN”.

Anton Tagliaferro says TPG's plan is clear.
Photo: Fiona Morris

The issue for Telstra is, due its agreements with government over the NBN, it’s legally prevented from advertising mobile services as a competitor to the new network. But if everyone else making that argument, then maybe Telstra will still benefit. “The upside for Telstra also comes from when they have built their 5G network, competing with the NBN,” says Tagliaferro. “Which is what TPG business model is all about. We find it a bit strange how people are comfortable with [TPGs] hopscotch network, while Telstra is going to roll out the best 5G network in Australia”.

The other potential source of gains for Telstra could come from aggressive cost cutting. That is always politically fraught and difficult, especially if it were to involve job cuts.

Asked whether he is prepared to cut costs more agressively, Penn says: "Are we prepared to do that? The answer is yes. I do recognise that we need to do more on costs."

Kaynes’ ideas - that Telstra should consider selling its towers to a third party, or lease its mobile infrastructure to rival carriers would be a radical departure from Telstra’s current strategy. The company has for a long time seen the quality of its networks, which depend on its infrastructure, as its key advantage over its rivals.

“I’m suggesting things that are the complete opposite of what Telstra is doing,” says Kaynes. “That would not be an easy decision for them to make”

Asked about such options, Penn wouldn't rule them out.

Another threat

Telstra’s share register is wide open - it has no dominant shareholder, it doesn’t even have a single shareholder owning the requisite 5 per cent to be classed as a substantial shareholder. This, together with the scope for cost cuts and asset sales has left the company vulnerable attack from an activist investor.

Another Australian corporate behemoth, BHP Billton has been subject to such a campaign from US hedge fund Elliott Management over the past year. Corporate advisors (pitching for defence work) have raised the risks of such an attack to Telstra management, and it has also been discussed at board level, market sources say.

Sources close to Telstra believe that Penn's stategy update in June will be crucial to regaining market trust, and allying the risks of a potential activist attack.

It's entirely possible the decisions Penn is making now will indeed set Telstra up for the future. But whether he will be around to reap the benefits is less clear. Penn’s predecessor, David Thodey (who didn’t respond to calls for this story) arguably benefitted from the investments into mobile infrastructure made by his predecssor, Sol Trujillo.

“You can only make the best decisions for the long term,” says Penn. “As an executive, you are always dealt the cards you are dealt at the time. And you do the best you possibly can for the company and your customers in that situation.

“Sometimes you move into a role when you have an opportunity to build and grow, and sometimes you come into a role when you are heading into a really tough period. And in some respects maybe that’s my timing

John McDuling writes about business, technology and the economy. Previously he was a reporter for Quartz in New York, covered telecommunications and markets for the Financial Review, and worked in the finance industry.