(This story was originally published on 12 June 2009. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

By Greg Peel

Microequities is an Australian financial adviser specialising in in-depth research of listed "micro caps" - those companies of low capitalisation too small to register on ASX indices or to attract research coverage from leading stockbrokers. In June Microequities hosted its Rising Stars conference, at which selected companies presented their wares. FNArena was invited to attend, and over a period of time will provide conference highlights. This is the first in the series.


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"I recently climbed Kilimanjaro," a fellow attendee at this year's Microequities Rising Stars conference told me, "and our Tanzanian guides earned about A$20 a day. This was paid by the tour guide company directly into their bank accounts, but the nearest bank was a day and a half's travel away. Each week the guides would have to make the journey, and pay bus fares and overnight accommodation, just to collect what was left of their meagre pay".

Hold that thought for a moment, as I introduce you to a company called eServGlobal ((ESV)). Apologies to every English teacher I ever had.

ESV listed on the ASX in 2000. Its business primarily revolves around providing software to telco carriers for the purpose of issuing and recharging pre-paid mobile phone services anywhere in the world. ESV is a market leader in this field, and its software, though complex, is a one-size-fits-all for every carrier platform. The company currently boasts 90 carrier customers across 54 countries, and given the complexity of the platforms, ESV's software tends to be a once-only purchase. In other words, customers are pretty much signed up for life, and ESV then continues to draw charging and recharging commissions and ongoing support annuities.

It is no great stretch of the imagination to assume now that just about everybody in the developed world who wants a mobile phone, has one. At the same time, the GFC has caused households and businesses to reassess their spending habits, and excessive mobile phone bills are an area that can be looked into. For global telcos, the challenge now is how to grow subscribers and also maintain margins.

One way to control mobile phone bills is to use the pre-paid system rather than open-ended contracts. This is particularly useful for parents trying to control teenagers - arguably the most prolific users of mobile phones. But while this in itself reduces potential revenues for carriers, the carriers are now facing another, even more fundamental problem.

Young people are now turning to social networking sites, such as Facebook, as a means of communicating with friends. One need only post one message to Facebook friends (eg, "I'm going to the movies tonight, who's in") to achieve the same result as phoning or texting all of them. Again this reduces carrier revenues. And now that the new "smart" phones, such as the iPhone and its look-alikes, are taking over, everyone can have a computer with an internet connection in their pocket.

Worst still, the exponential rise of smart phone applications ("apps") means smart phone users need never go near their home computer, so customers are enjoying virtually "free" internet services with the telco carriers simply acting as reluctant conduits.

For ESV nevertheless, the rise in popularity of pre-paid mobile is a boon. But let's just jump back a bit.

Everyone might have a mobile phone in the developed world, but its a different story in the emerging and third worlds. You might be surprised to learn that 80% of the world's population still does not have access to a telephone. Here the mobile phone is stepping in.

Why would emerging countries go to the expense of moving to the first step of telephone communication, and start laying down land lines? No need. Governments in emerging countries are simply adopting a telecommunications entry straight in at the mobile phone level. By encouraging competition, just as is the case in the developed world, mobile phone services become cheap enough to be afforded by even the lowest on the global socio-economic spectrum. It is thus no surprise the fastest rate of growth of mobile phone take-up is in the emerging world. And the billing method of choice of the world's poorer mobile users is pre-paid.

You might also be surprised to know that we have reached the point at which there are very few populated places left on earth, except maybe for that "shadow" in your own living room, that cannot pick up a mobile signal. Reception is clear as a bell on the top of Mt Kilimanjaro, as it is in the populated areas of Africa and all other inhabited continents. Mobile signals now embrace the great majority of the earth.

What this means is that wherever you go in the world, no matter how poor and squalid a township you're in, you may not find a grocery store, you may not find a restaurant or bar, you most likely won't find a bank, but you'll always find a hole in the wall selling pre-pay mobile phone cards. Anthropologists searching for lost tribes in Western Papua have been surprised to stumble upon cannibals texting each other about the next feast.

What this leads to is another surprising statistic. There are now more people in the world who own mobile phones than have bank accounts.

The next step in the logic chain here is that mobile phone "credits" are transferable. If a telco carrier issues pre-paid credits, it matters not a jot where those credits end up. On that basis, they become a substitute currency. Already the third world has realised that if you don't have actual banknotes to pay for your groceries, you can pay with mobile phone credits instead. The shopkeeper still ends up with the money. And shopkeepers and those holes in the wall can also cash-out into banknotes if required.

Leaping back into the first world for a moment, consider also that any "apps" purchased on a smart phone, or indeed any other purchase over the internet that might require a credit/debit card transaction, could realistically be paid using mobile phone credit instead. Thus telco carriers have an opportunity to seize the day and exploit the mobile phone as a charging device, bringing them back in from the cold.

Clearly as a market leader in charging and recharging pre-paid mobile phones, EVS stands to win again.

Now, let's return to the top of Mt Kilimanjaro once more. What if native guides asked the tour company to pay them in mobile phone credits, debited into their phones or as phone cards, instead of a cash amount debited into their bank account? The local village economy can operate on passing around such credits, until finally someone has to make the one and a half day pilgrimage to the bank. But not every single wage earner has to make that trek.

Do you see where this is heading?

Now consider that across the globe there is an enormous population of migrant workers - with legitimate visas or otherwise - who have left their families behind in their poor communities to find work in more prosperous provinces (such as Chinese rural peasants moving to Shanghai) or in more prosperous countries. These workers then send money home each week or month. Philippinos, for example, are among the world's most prolific migrant workers. So much so that repatriated wages now account for a surprisingly large proportion of the Philippines' annual GDP.

The obvious method of achieving the repatriation is to deposit wages in a bank account in, say, Hong Kong and then a family member withdraws from the same account at the Manilla branch of the same bank. Apart from all the usual banking fees, those wages must pass through a foreign exchange transaction as well. The smaller the amount of money, the wider the spread is on forex transfers. These third world migrant workers are bled every time.

Remember there are more mobile phone accounts in the world than bank accounts, implying there are an awful lot of people in the world who simply don't have - perhaps don't even qualify for - a bank account. How does one then transfer wages?

The most common source of non-bank global cash transfers is via Western Union - the US service with a clear monopoly over the business globally. So powerful is Western Union that it is able to apply legal intimidation to scare off any competitors, and to subvert the regulatory process to ensure its monopoly remains intact.

Western Union charges 16% commission on all cross-border transfers.

You are probably way ahead of me by now. If Tanzanian villagers can transfer currency amongst themselves in the form of mobile credits, thus avoiding a bank, why couldn't Philippino migrant workers repatriate their minimal wages by the same method, thus avoiding not only a bank, but also Western Union and its 16% commission?

The problem is now you are moving into the realm of different telco carriers in different geographical locations, and the inevitable cross-currency requirement. How does one set up a phone credit platform that can handle such transfers without needing the likes of a bank or a Western Union to be fundamental in the process?

But wait, one bright spark at ESV said one day, such a platform already exists! And it has existed for years.

When you go overseas and want to remain in touch on your mobile phone, you switch to Global Roaming. The Global Roaming Exchange, or GRX networks, handle your international phone bills and sort out any cross-carrier, cross-currency requirements. You simply end up with an amount on your bill in your own currency. The way GRX works is not to treat every cross-currency phone call as needing a subsequent forex transaction through a bank, but rather all charges are pooled into a "virtual" global currency - not unlike the IMF's special drawing rights basket of global currencies, but obviously with a much bigger basket than just four. The GRX network operator then makes one periodic net currency transaction with a bank in sorting out its own revenues. In other words, it's the GRX's problem, not yours.

I assume you know what's coming. ESV has entered into a relationship with Belgacom - the Telstra equivalent in Belgium - to provide a global money transfer network using pre-paid mobile phones. Belgacom, with 500 GRX operators, boasts the largest Global Roaming network in the world. Under the agreement, Belgacom uses ESV software to provide the service. The carriers on either side of a call (actually its SMS technology that implements the transfer) charge a 2% fee. The network provider charges a 1.5% commission on each transfer, split 50/50 between Belgacom and ESV. Thus the total commission on any transfer is 5.5%.

You might be wondering just what Western Union's reaction has been to this development, and yes, the lawyers have been on the phone. But this time Western Union has met its match. Not only has Belgacom/ESV patented the money transfer platform, it has the endorsement of none other than the World Bank. And that endorsement includes the concession of recognising that not all migrant workers repatriating wages are actually legal aliens.

Now for some numbers.

Such international remittances now exceed both foreign aid and foreign direct investment in dollar terms. Flows have now reached US$320bn and are estimated to grow to US$700bn by 2012. Earlier this year a study by respected British telco research house Juniper Research estimated that a mobile phone money transfer market would, in a worst case scenario, reach US$73bn by 2011.

To date there are half a million banks in the world, and one million ATMs, but there are three billion mobile phone subscribers (and that number is accelerating).

The greatest proportion of international remittances are sent from the US, UK and the Middle East. The top ten receivers of those funds account for 45% of the total market, and they are (in descending order) India, China, Mexico, France, the Philippines, Indonesia, Brazil, Pakistan, Morocco and Bangladesh.

Naturally such a service is not limited simply to people sending wages around the globe. Coming back to our iPhone discussion, what about other transactions?

EServGlobal was established in 1991 and listed on the stock exchange in 2000. The company has steadily grown its gross profit over the past four years, booking close to $100m in FY08 on total sales of just over $175m. Given the GFC has hit the selling of pre-paid software just like anything else, FY09 sales are expected to be only back to FY07 levels of $150m. ESV's share price, on the other hand, has fallen from a high of $1.40 in early 2008 to its FY04 level of 37c today.

But the global money transfer service, named HomeSend, will not be launched until next month. You do the math.

By Chris Shaw

Economic recessions change assets from weak hands to strong hands, providing opportunities galore to the latter. M2 Telecommunications Group ((MTU)) appears to have grabbed one such opportunity by buying the small and medium-sized business assets of Commander Communications, once upon a time a stock market darling but nowadays in receivership.

The deal is expected to add more than $100 million annually M2's group revenues, lifting them to more than $360 million. The acquisition is costing the company just $19 million with M2 management indicating the deal should boost earnings per share by in excess of 50% in FY10. That is not a typo: fifty percent it is.

The transaction should help the company consolidate its position as the largest network independent telecommunications provider in Australia, the company offering fixed line, mobile and data services in this country and fixed line and 3G services in New Zealand.

Along with the earnings growth already expected from the acquisition, there is scope for additional growth from the deal via an expansion of the products and services offered under the Commander name and via improvements to its sales and service network.

No brokers in the FNArena database currently cover M2 given its market capitalisation prior to the deal was only around the $60 million mark, but one would assume the announced deal will lead to increased attention from investors, as it not only increases the size of M2, but also considering the projected earnings growth by management.

M2 was already on the radar of various smaller stockbrokerages and equity researchers in Australia.

In the 2008 financial year the company generated earnings per share (EPS) of 6.7c and paid 5c in dividends. M2's 1H09 EPS of 4c compared to 3c in the previous corresponding period. Based on FY08 numbers, in combination with management's guidance, the Commander deal suggests EPS of at least 10c in FY10, implying the stock is at present trading on a P/E (price to earnings) ratio of less than 9x  - ex the positive impact from the deal.

The market clearly likes the deal as shares in M2 today are stronger, with the stock up 15c or 26% at $0.72 as at 2.00pm. This compares to a trading range over the past year of $0.42 to $0.72.

By Greg Peel

Meep-meep!

The deserts and canyons of Arizona, Texas and New Mexico are the setting for speedy coyotes to try and outsmart even speedier roadrunners, as popular culture suggests. Popular culture does not, nevertheless, excuse residents of those states who assume their vehicles have carte blanche to act similarly. But the Arizona authorities' attempts to curb speeding in the state came to a head last Sunday when the operator of a newly commissioned mobile speed camera van was shot dead by an irate biker.

Thomas Patrick Destories, 68, pumped five bullets into the van operated by Douglas Georgianni as he passed by the mobile speed camera. Three struck Georgianni, wounding him fatally. It didn't take too long for police to locate Destories, given the whole episode was captured on said camera. A contrite Destories apologised, but is now on trial for Murder One.

Georgianni was an employee of Redflex ((RDF)) - the Australian company specialising in red light and mobile speed camera technology. While Australians have long learned to live with speed cameras, Americans have only just begun to accept their presence. The US has proven a vast growth area for Redflex, as slowly over time various states and counties within those states have trialled and adopted Redflex's world-leading technology. This has always placed Redflex, GFC notwithstanding, in the category of stocks with huge growth potential. Although it hasn't always been smooth sailing.

As recently as March 27, a Texas court dismissed a class action brought against the company by disgruntled speedsters on the accusation that Redflex did not hold a private investigator's licence as required by the Texas Occupations Code. The plaintiffs were attempting to recoup fines they had paid for running red lights. It seemed a long shot, and that's exactly how the judge saw it (just as well it wasn't Marcus Einfield). The case was dismissed on the basis companies administering red light programs are not classed as private investigators.

This was a significant win for Redflex, given the precedent the decision set. However the fact the case was brought at all is indicative of just how Americans feel about this supposed challenge to their civil liberties - particularly in the South. Many argue that speed cameras are not about saving lives but about revenue raising. Sound familiar?

Further north Redflex has been more successful. Only on Monday the company announced new contracts for red light enforcement trial programs in a New Jersey town and in a suburb of Chicago. Redflex Traffic Systems now has contracts with more than 235 US cities and is the largest provider of such systems in the country. With photo speed programs in 9 states and red light programs across 22 states, a company press release informs us, Redflex has consistently led the market in contract wins, system installation rates and market share.

Arizona and Louisiana are the only two states in which mobile speed camera vans are operated by Redflex employees. The operation of those vans has now been put on hold in the wake of the murder. Redflex has stated they will stay on hold "whilst the consequences of this tragic act are considered".

Local television station KPHO reports the Arizona Department of Public Safety has indicated it plans on using mobile photo radar in the future, but it is "unclear when the redeployment would occur". The reporter also made the point that "several motorists [vox popped] said they like the roads better without the mobile units".

Blow me down.

Macquarie, nevertheless, suggests in a report this morning that given considerable public backlash to date, Arizona state lawmakers are possibly considering legislation to end the program when the initial contract expires in 2010. Redflex won the contract from the Arizona DPS in July last year with the intention of ultimately deploying 100 cameras in the state, of which 60 were to be fixed and 40 mobile. By December those numbers were 36 and 42 respectively but media reports suggest further rollout has also been put on hold.

Redflex had guided for a 40% increase in profit in FY09 ($21.4m) but Macquarie believes this number relies on a successful ramp-up in Arizona to meet the mark. Hence the broker now sees short term downside risk to earnings and has reduced its forecasts by 22% in FY09, 30% in FY10 and 24% in FY11.

Credit Suisse has also revised down its earnings expectations to below company guidance. CS expects, however, that the affect will only be short term and will not have a significant impact on either FY10 earnings or Redflex's share price. (The stock has moved no more than with general market movements this week). There is also a small matter of earlier "multiple" bids put to management to acquire 100% of Redflex at or above $3.50. In February the stock was trading closer to this mark, but news has since gone cold.

In the wider picture, neither Macquarie nor Credit Suisse believe the Arizona setback will ultimately undermine Redflex's longer term potential. "The key catalyst," says CS, "is establishment of the long term performance that can be achieved from RDF's new fixed speed cameras, which is expected to be well above that being derived from its red light cameras". CS is maintaining an Outperform rating with a target of $3.76 (last trade $2.30).

"It should be remembered," says Macquarie, "that the Arizona DPS is a speed camera program - a fledgling initiative that has longer term upside but does not contribute the bulk of Redflex earnings in a normal year". The established red light camera market is still growing at 20% plus per year. But the analysts believe the stock may trade lower in the short term given the risks associated with the DPS program. Until they have a better feel for the FY09 earnings impact, they have downgraded to Neutral from Outperform and dropped their target from $3.55 to $2.68.

Macquarie and Credit Suisse are the only two brokers in the FNArena database to update their Redflex forecasts in 2009.



By Greg Peel

Let's start all this with "nodes", for nodes seem to confuse most average Australians.

Think about how you end up with water coming out of the taps in your house. From a central source (such as Warragamba Dam in Sydney) big pipes head off in different directions. After a distance they split and smaller pipes fan out towards different municipalities. Those smaller pipes then split into even smaller pipes which head towards different suburbs, which split into smaller pipes heading towards different streets, which ultimately split into the size of pipe heading into each of your neighbours' and your own homes. Each splitting point is a "node".

It may not seem obvious, but water pipes are the best analogy for telecommunication lines, such as your old-fashioned telephone landline. From a central exchange, telephone cables fan out and pass through several nodes before a line reaches into your house, just as water pipes do. And they start out as big, thick bundles at the source before whittling down to the single line which provides your phone connection. Decades ago, the Australian taxpayer built the country's existing copper telecommunication network.

Since then, a separate network of pay-TV cables has also been laid (two networks in fact). Then along came the internet. Initially slow (dial-up) internet was delivered by telephone cable. Then faster internet (ADSL) was delivered over pay-TV cables. Then improvements in computer software meant even faster broadband could be delivered over the cable (ADSL2+) and even newer software meant the same speeds could be achieved on the old copper telephone wire.

While not expanding the diameter of the cable or copper wire being sent into your home physically, new technology expanded the diameter - or bandwidth - analogously, just as if you were now using a fatter water pipe with a greater flow rate.

The next technological step is to replace the copper telephone wire and copper coaxial cable with optic fibre. This is an expensive proposition, because now we are actually building our water pipes out of a completely new material, and thus need to replace the old ones, rather than just coming up with clever ways to improve flow rates down the same old pipe. But expense aside, fibre optics allow for a "fast" broadband network to become a "superfast" broadband network.

Currently Australia boasts the slowest broadband network in the civilised world. The reason why Australia's network has them doubling over with laughter in South Korea, for example, is because the two previous governments made monumentally ignorant decisions which, ironically, were converse.

Paul Keating's government introduced pay-TV, but insisted on competition. Hence Telstra ((TLS)) built one network at great expense, and Optus ((SGT)) built another. The average Australian could never afford pay-TV because both providers had to charge a fortune to recover the cost of their parallel networks. In New Zealand, they laughed themselves witless. NZ had pay-TV long before Australia did because the government sensibly recognised the population was too small to support more than one system and there was no argument.

Then along came the next government, which decided to sell Telstra and with it the taxpayers' hard-earned telecommunications network. Public property one day, private plaything the next. The government also allowed Telstra to remain involved in pay-TV, meaning it had a monopoly on copper wire services and controlling interest in cable as well.

This has sides splitting in Canada, where the government made a sensible move and ensured the company with the copper wires was different to the company with the cable, such that competition meant ever better service at ever cheaper prices.

Telstra has been able to hold the government, and the Australian people, arrogantly to ransom ever since, and in so doing ensure that Australia remained in the telecommunication Dark Ages while paying twenty-first century prices.

Technology now allows broadband to be sent efficiently over mobile phone networks. This could also be a source of competition. But who leads this market in Australia? Oh yeah - Telstra.

But back to nodes and things.

The nature of fibre optics means that it can live within an existing copper network despite being a completely different medium. This is fabulous, because it means that the ultimately horrific expense of replacing all those millions of copper wires and coax cables can be spread out over time. One can start by just replacing that first step from the main exchange to the first node with fibre. That will provide the first incremental increase in broadband speed. That done, the next step is to replace the copper from the first node to the next set of nodes. Again speed is marginally increased. Keep going, and eventually you reach the last node before the really big split - the one that fans out wires to all the houses in your street.

By that stage, you would have created a network commonly known as Fibre To The Node, or FTTN. In this case, the "node" means the last one. As one can imagine, each nodal split-off of copper implies an exponential increase in individual wires and telegraph poles and so forth. So the really, really expensive part of replacing an entire copper telecommunications network with a fibre one is what is known as "the last mile" - that last step before the connection reaches an individual house. Yet by the last mile, the fibre connection has already sped up broadband access significantly.

Many countries across the globe long ago moved to FTTN. They now consider FTTN to be about as modern and up to date as bakelite telephones.

There was absolutely no reason why Australia, too, could not have had an FTTN system many years ago, except one - Telstra. One can imagine an exchange some years ago going something like this:

Government advisor: Australia needs FTTN to remain competitive.

John Howard: Ooh, well we better get Telstra to build us one then.

Telstra: We'll build it, but it will be very expensive, and given we're partly a private entity we will have to charge subscribers a lot of money to provide our shareholders with a positive return.

Howard: You're still partly public and you will charge what I damn well tell you.

Telstra: We might be able to charge competitive rates in the cities, but the real expense will be getting it to the bush. They'll have to pay a lot more.

Howard: No way. If the cockies don't have high fibre to the noodle as well we'll lose the National Party voters.

Telstra: Get stuffed then.

A Cooperative of all Telstra's Competitors (for want of a better word): We can build an FTTN network. But it will have to be from scratch.

Howard: Who cares? I just lost the election.

When Rudd came in he did so on a platform of ensuring Australia would get FTTN ASAP. To that end, he created a vision called the National Broadband Network (NBN) and began a request for proposal (RFP) process from interested parties, including Telstra, to build it in FTTN form. The obvious candidate to build it always WAS Telstra, because for Telstra it was a just case of replacing the copper network by steps, rather than starting from scratch. In fact, Telstra has already done that to some extent, creating what is now known as a Hybrid Fibre Coax (HFC) network. Let's just say the old copper network the Australian taxpayer once built and then had sold from under him is now the HFC.

But Telstra knew it was the only entity that could deliver FTTN at a reasonable price, so it told Rudd either give us the contract or get stuffed.

So Rudd got stuffed, thought about it for a while, watched an arrogant Mexican pick up a zillion dollar bonus and rack off, and listened to the complaints of every Australian for whom Telstra is the most despised corporate entity in the country. He also sifted through the proposals coming in from other parties, realised what limitations were involved and what expenses were implied, and then came up with a new plan.

Rudd told Telstra to get stuffed.

The biggest stumbling block to any FTTN network in Australia is Telstra still owns the last mile of copper, having been handed it by the Howard government. Even if Optus, for example, built a completely stand-alone FTTN network, it would still have to pay rent to Telstra for that last bit of copper. And like Telstra was never going to squeeze that for all it was worth. The NBN plan was always, always, doomed to failure. Telstra couldn't care less - it was building a new generation mobile broadband network instead. Not as good, but not bad. Pretty expensive though.

Rudd's bombshell, delivered yesterday, is that the government now intends to set up a public-private partnership to build from scratch an entirely new Australia telecommunications network alongside the one that taxpayers used to own once but now belongs to Telstra. It will not be FTTN, it will be fibre all the way into the back of your computer. This is usually called Fibre To The House (FTTH) but also (and preferred by Rudd), Fibre To The Premises (FTTP) given we're talking businesses as well.

To put this into perspective, an FTTN system, freshly built at least up to the point it met Telstra's last copper mile, was expected to cost about $5bn. The FTTP system is expected to cost $43bn. A bit more than half will be funded by a combination of existing infrastructure funds in the federal budget, and the issuance of Aussie Infrastructure Bonds to the public. The balance - around $20bn - will have to come from the private sector.

The Opposition yesterday called the whole thing a farce. Unfortunately it doesn't matter what policy the government comes up with - popular, controversial or otherwise - the Opposition will call it a farce, but the Opposition has long ago lost any credibility so no one is likely to pay any attention.

Of consequence, however, is what industry and stock market analysts think about the whole idea. In short, industry analysts love it, but then industry analysts are not focused on shareholder returns. It is a stock analysts' job to focus on shareholder returns, and the short answer there from some is "too ambitious - it will never happen".

But the smart ones get it.

Not only did Rudd announce plans for a FTTP network, he announced a review of the very laws which command Telstra's existence as a quasi-private, quasi-public monopoly. It is a couched threat to do exactly what John Howard should always have done right from the beginning - split Telstra in two.

Howard should always have done this first and sold only the sales arm of Telstra to private investors while keeping the Australian people's infrastructure for the Australian people. Unfortunately it's too late to get it back now, but Rudd can make Telstra split into two entities, thus disabling the Telstra monopoly. All service providers would then have equal access and competition could flow. Or Rudd could force Telstra simple to sell its HFC to a third party, thus smashing the Telstra monopoly once and for all. A similar result could be achieved by making Telstra sell off its cable (Foxtel) network and keep only its copper.

This time it's the government calling the shots.

Telstra thus faces ignominious defeat on two fronts. If the FTTP is built, it will offer direct competition to Telstra's previously monopolistic network. It will also be superior, condemning Telstra's network into eventual obsolescence. A price war would ensue in the meantime. And if Telstra is hobbled by legislation, the game is all over anyway.

But wait - Telstra does have another option. And this is where Rudd's proposal comes from the "I have a cunning plan" school.

Telstra is not excluded from participating in the new NBN in any way, shape or form. Having told the government to get stuffed, it was excluded from the original NBN plan. If it chooses not to participate, it will surely suffer, assuming the Rudd plan is indeed ever do-able. But if it chooses to sign up as a participant, Telstra's still in the game, albeit at a reduced level of power.

The Opposition, and several brokers, say Rudd's $43bn plan is a pipedream. The private sector was struggling to come up with $5bn let alone $20bn. The ultimate cost to the household will be way too much. Telstra can choose to agree and just get on with life as it is.

But $20bn for a system that really does take Australia into the next century is a lot better proposition than $5bn for one that might drag the country up to around the end of the last century, some note. The economies of scale might be there. But more importantly, an FTTP system could be built for a lot less than $43bn if the project started with Australia's existing system - now Telstra's HFC - and just upgraded it.

In other words, if we threaten to smash Telstra the likelihood is they'll come on board instead. And then - believe it, or choose not to believe given some many bad experiences - the whole deal might just be in the interest of all Australians. At least there is now some vision on the table, rather than a short-term solution to win over swinging voters in a handful of marginal seats.

If the brokers agree on one thing, it is that Rudd's new policy is monumental in scope, a complete shock, and something that leaves many questions to be answered. The good news for Telstra is that it is potentially back in the game, the bad news is it may be all over bar the shouting. The initial response from analysts is to be split.

Citi has upgraded its Sell rating on Telstra to Hold and GSJB Were has upgraded its Hold rating to Buy. UBS and Deutsche Bank have retained their Buy ratings while Macquarie and JP Morgan have reiterated their Sell ratings. RBS, Credit Suisse and Aspect Huntley have not yet chosen to comment, so the B/H/S rating in the FNArena database is currently 5/3/2. The average target is unchanged at $3.56. Telstra shares are currently trading at $3.36.

In other words, collectively analysts see Telstra benefiting by finally being a kid in the sandpit who shares his toys.

By Andrew Nelson

Telstra's high handed approach to its relationship with Canberra looks to have blown up in its face, with the national carrier yesterday being ruled out of further bidding in the National Broadband Network (NBN) scheme. The news saw shares drop to their lowest point since listing in November 1997 with at least three of Australia's big brokerage houses dropping their rating on the company.

Shares were as low as $3.36, down more than 7% earlier this morning after dropping more than 12% yesterday when the Australian Federal Government told the company it would be ruled out of further participation in plans to build a nationwide high-speed Internet network because its submission lacked a plan for small businesses to provide goods and services to the network. The inclusion of such plan was not optional, but a requirement.

This is where the finger pointing starts, because Telstra said it provided its small businesses plan to the regulator in early December after submitting its bid by the November 26 deadline. Telstra chairman Donald McGauchie said the government couldn't have dreamed up a more trivial reason to exclude the company.

In Response, Federal communications minister Stephen Conroy said supporting small businesses is not a a "trivial matter" and confirmed he couldn't accept Telstra's small-business plan, as it was submitted after the November 26 deadline. As such, the government could have set itself up for legal action by other bidders.

Either way, there is no doubt the decision is bad news for Telstra. It is not only a blow to the group's plans to strengthen its dominance in Australia's high-speed Internet market, but it also casts a shadow of doubt over the company's entire long term strategy.

Broker reaction post the government's rejection has generally reflected this and resulted in at least three downgrades on the stock. But, even the brokers who have downgraded are struggling to define the real implications for Telstra. 

GSJB Were, Macquarie and ABN Amro all moved the stock from their version of a Buy to their version of a Hold this morning. All three maintained earnings forecasts and only GSJB Were changed its valuation and target price, but this was due more to a change in its financial modelling than to the decision.

The broker thinks that we're a long way from the end of the story, as there's a good chance that none of the remaining bids are worthy of further consideration. If this is the case, the minister will have to restart the tender process, potentially opening the door back up for Telstra. This makes sense to the broker, as it sees Telstra as the only logical builder of the NBN.

This fits in with the general view of most of the brokers, with everyone thinking that Telstra has some chance of getting back into the process.

JP Morgan is a clear exception to this, with the broker saying there is no possibility the government will re-engage Telstra in the negotiation. The broker fully expects the government to proceed without Telstra and the Panel to recommend one or several bids to the government by the end of January.

"Today's was the rather spectacular regulatory backlash we had warned investors against for the past six months",said JP Morgan analysts Laurent Horrut and Colin Morawski.

So why the downgrades?

GSJB Were admits there is a real chance the government could find one or more bids are worthy of further consideration. If this is the case, Telstra will likely be out of the running.  On the broker's numbers, the valuation under this worst case scenario drops down to around the current share price, so it is not so much a case of any more downside in the decision, it just removes some of the upside risk.

The broker thinks the company is in superb shape operationally, but now that the spectre of higher risk has raised its ugly head, the investors that have been using the stock as a safe haven over the last year or so may now decide the haven isn't as safe as they thought it was. Look at the selling over the last few days and you'll see this sentiment has been borne out.

To quote UBS, "Our forecasts remain unchanged, however we believe there are no catalysts to drive a near term re-rating."

Macquarie pretty much agrees, saying it's the elimination of the upside scenarios, even if only on a short-term basis, that makes it very difficult to identify any sort of positive catalyst for Telstra in the next two months. At the same time, the broker thinks there will be plenty in the way of negative catalysts, hence its downgrading of the stock.

The broker thinks the company will deliver a weak 1H result in February and most likely announce a further top up of Telstra Super following an actuarial review of the December quarter performance. On top of that, it is now more likely that hostilities between Telstra and the government will likely increase. That's why Macquarie sees little upside in the share price over the next few months and has downgraded to Hold.

ABN Amro is a little less mixed in its view. The broker thinks, if anything, the company's actions and subsequent exclusion demonstrates it would rather take its chances in the market investing and operating against any rival broadband builder and free of any regulatory inconveniences that would ultimately put a significant cap on profits.

The broker admits even its worst case scenario where Telstra is excluded from all aspects of the project makes little impact to its FY09 or FY10 forecasts. Nevertheless, says the broker, the regulatory uncertainty has been lifted to a new level. This risk and the lack of any tangible near term upside is what pushes the broker to drop from Buy to Hold.

Merrill Lynch mirrors this sentiment, saying even if the NBN contract goes to another bidder, according to its  estimates the earnings impact will be minimal until FY11.

So it all comes down to how you look at it. Merrill Lynch thinks that Telstra's exclusion is a relatively minor issue and believes the government is just playing hard ball as part of an extended negotiating process. It, like GSJB Were, sees the likelihood of significant investment in high-speed broadband as unlikely without Telstra.

The one issue that most of the above mentioned broker have skirted well around is the regulatory risk that Telstra may now be facing. It is simply too hard to factor it into their models, so we're told.

This is where JP Morgan's reaction to the news differs to most, as it is upfront in assessing this massive risk to the company.  Remember, the broker is so far alone in assuming the government will definitely not revisit its decision and that it will look to deliver the NBN project without Telstra.

If this is the case, the broker sees no reason at all why the government would not engineer a regulatory framework that enables the roll-out by a third party. This would most likely result in the further operational separation of Telstra and the chances of this happening have now "dramatically increased".

The question that remains to be answered is: Have Sol and Co finally written a check they can't cash?

It seems JP Morgan is unequivocally on the affirmative side, while the other seven remain still undecided. One thing all eight agree on is that there is still a long way to go in this complicated saga, so it is too soon to tell.

By Chris Shaw

So many companies are now cutting their earnings guidance at their annual general meetings to prepare investors for the disappointment sure to come with the quarterly results. That's why Telstra's ((TLS)) announcement yesterday at its annual strategy day that it remains on track to meet previous earnings guidance for FY09 and earnings and free cash flow targets for FY10 was viewed by most in the market as a big positive.

While risks remain from the condition of the broader economy and uncertainty abounds about any FTTN (fibre to the node) project the telco may have to undertake, Macquarie notes the group's transformation remains on track and this will drive future cost savings. It expects there will be additional benefits flowing through beyond FY10, as many projects currently being worked on will be completed in the next couple of years. The result of this will be further reductions in the company's cost base.

As well, the broker notes the competitive environment remains relatively favourable, as revenue trends are still solid and competitors are either lifting prices or removing products from the market, all of which works in Telstra's favour given its dominant market position.

In Citi's view, the update means investors can't argue with the company's operational strategy, as it remains aligned to the broker's checklist it presented to the new management team when it was appointed in 2005 and is now starting to deliver as expected. Although, the broker notes the major upswing in earnings terms won't be achieved until the second half of 2009.

Where there remains an issue, in the broker's view, is in respect to the FTTN network, as attached to this project is the chance for the company to be forced into a structural separation. However, the broker notes the government has not proposed such a move. As a result, the broker expects the company to bid for the right to build the network.

But JP Morgan sees risks surrounding the national broadband network project, arguing the separation risk for the company if it gets the nod to build and run the project should be priced into the stock. Countering this is the view of Merrill Lynch, who thinks that alternatives to the project being handled by Telstra are dwindling, which it regards as a positive for the company.

Another question posed by JP Morgan is whether the transformation program, with respect to operating leverage indicated by the company in coming years, will really deliver benefits to shareholders. While there is no doubt the company is now in a better position, it has cost almost $6 billion to get to this point.

The broker also suggests FY09 earnings guidance will be tested by the weaker economic environment in Australia at present, especially with respect to revenue softness from lower corporate and government spending and scope for weaker directory advertising and discretionary spending on items such as handsets and pay-TV.

By Chris Shaw

The slowing economic environment in Australia is impacting on all sectors, with even industries connected to government spending feeling the pinch, as evidenced by a downgrade in earnings guidance from IT player Oakton ((OKN)) at the group's annual general meeting yesterday.

Outlook commentary at the meeting was very cautious, as while 1H09 earnings are now expected to be marginally above the first half last year and full year earnings in FY09 should beat those for the year recently completed, Credit Suisse notes this guidance is materially below what the market had previous expected.

Evidence the company is finding it tougher comes from staff numbers, as essentially revenue growth and therefore earnings can be tied to how many more staff the company employs to deliver on work on hand. There has been a drastic slowing in this measure, with GSJB Were noting numbers in the first quarter rose by only five employees.

This is well below previous indications FY09 would deliver around 200 new staff and the broker notes management yesterday made no mention of the outlook for the year now IT spending has become far more volatile thanks to the credit crisis.

AS UBS notes, while management is proposing a cost reduction program to offset lower growth in headcount additions, little success is likely here as cutting staff would mean lower revenues and fixed costs account for only around 6% of the group's total costs. This implies downward pressure on margins in the broker's view.

To reflect this, UBS has been quite severe in its earnings adjustments, taking 20% from its FY09 earnings per share (EPS) forecast and 35% off its previous estimate for FY10, meaning its adjusted forecasts are now 27.1c and 23.7c respectively. This suggests the broker doesn't believe management's guidance of slightly higher earnings in FY09 given EPS in FY08 was around 31c.

Others have been less severe in their earnings adjustments. GSJB Were has only cut its numbers by 7% in FY09 and 8.5% in FY10 to put its new EPS estimates at 31.5c and 34.8c respectively, while Merrill Lynch is at 30.6c and 31.4c and Credit Suisse expects EPS of 31.3c and 34.3c. The FNArena database shows consensus forecasts of 29.6c and 30.1c respectively.

Macquarie has pre-empted the AGM comments by earlier this week cutting its forecasts by more than 20% on the back of a report to the Federal Government suggesting reduced use of IT contractors. But in the view of Merrill Lynch, this threat has seen the stock oversold, as while the Acumen division is most impacted and accounts for around 20% of group revenues, it will be possible for the company to re-assign staff to other more profitable areas until conditions improve.

As a result the broker continues to rate the stock as a Buy, while overall the FNArena database shows a total of two Buys, one Accumulate, three Holds and one Sell recommendation.

The adjustments to forecasts have seen price targets cut and again UBS has been the most aggressive, lowering its target to $2.45 from $4.10, while Merrill Lynch has lowered its target 10% to $3.60 and GSJB Were has cut its by a similar percentage to $4.12. The database shows an average target now of around $3.10 against $3.85 previously.

Today, shares in Oakton are slightly weaker and as at 11.10am the stock was down 4c at $2.17. Its trading range over the past 12 months is $2.12 to $6.48.

By Greg Peel

Microequities is an Australian financial adviser specialising in in-depth research of listed "micro caps" - those companies of low capitalisation too small to register on ASX indices or to attract research coverage from leading stockbrokers. In June Microequities hosted its Rising Stars conference, at which selected companies presented their wares. FNArena was invited to attend, and over a period of time will provide conference highlights. This is the third instalment

I walked past the new Apple building in Sydney the other day and was impressed by its all-glass facade, its spartan but hi-tech showroom, and the milling throng of young things marvelling at the products. Unfortunately however, the Beatles weren't playing on the roof.

Australia is now in a countdown to the debut of the iPhone - the latest offering to the world from Steve Jobs of iPod fame. The iPhone has been available in the US for about a year, but only in 2G form. Those Yanks are a bit backward, you see. So we've had to wait a while for a 3G version to be produced which is compatible with the latest Australian telco networks. For those wondering just what an iPhone actually is, consider it as a mobile phone that "does everything" - from the internet to television, videos, photos, games and so forth. Oh and you can apparently make calls on it too. Perhaps the most endearing feature of the iPhone is it has no buttons, just a touch-screen. No more trying to hit a single button with a fingernail, and no more squinting at a postage stamp display.

Why am I going on about iPhones? Because just like the iPod, Apple's latest gizmo is set to revolutionise the world. A couple of years ago we were all talking about the internet - as accessed on the home computer or notebook - as taking over from the traditional media of newspapers, television and radio. However the introduction of the iPhone, and the mounting copy-cats, has surprised even industry observers. For suddenly the world is very rapidly moving away from actual computers and onto mobile phones. And why not? We now carry them around as ubiquitously as a wallet. If you are in "new media" and you're not involved in mobile phone delivery, you've missed the boat.

There are now more mobile phones in Australia than there are people. The rapid evolution of this device has been startling. When I worked for a well-known investment bank back in the early nineties, my trading desk had one mobile phone between us to be allocated to the person who might be most likely to need contacting over lunch. It was a house-brick. These days restaurants are moving towards banning mobile phones in the dining room.

In arguably the most gizmo-loving nation on earth - Japan - 60% of internet access is now achieved via a mobile phone. Since the introduction of the iPhone in the US, internet content consumption has increased tenfold. Unfortunately for those who use public transport, and for people like me who'd just like something that would only make phone calls and texts, the new offerings are complete communication and entertainment packages in one little box.

Warning: Trite industry jargon ahead.

MobileActive ((MBA)) is Australia's leading independent mobile entertainment, content and services company. The company was founded in 2003 to provide those highly irritating ring tones you hear constantly advertised, and while ring tone mania is still alive and well the evolution of MobileActive has a lot to do with mobile content consistently moving "off deck".

Well I did warn you.

What this means is that previously the carriers of the world, such as Telstra, provided their own offerings in mobile content as part of their own contract packages. This would be stuff available on the "deck" of the phone. However, telcos have got enough going on without having to worry about creating entire content packages on their decks and keeping them up to speed with today's tech-hungry youth. Hence carrier decks are now in decline, or at least flat in growth.

This has led to the rise of the outsourced deck which, to use another form of jargon, has led to companies like MobileActive breaking down the "walled garden" of carrier content services. Another competitive player in the market is Jamster, which is 50% owned by News Ltd. MobileActive provides business-to-consumer services in the form of marketing and distribution (games, video, music) and inbound licensing and aggregation, and business-to-business services in the form of infrastructure partnering and outbound licensing in in-house development.

The internet itself has revolutionised advertising. Consider that free-to-air television networks, for example, still rely on accumulating ratings numbers (which have always been argued to be extremely unreliable) and then pouring over the data, breaking them down into demographics of sex, age and economic capacity. This data is then used to entice advertisers, who hope that a particular show remains popular enough to justify an enormous ad-spend. Television viewers are notoriously fickle, and program managers are forever madly chopping and changing shows to keep up their ratings numbers.

On the internet, it's a different game. Specific sites and services are readily demographically apparent, allowing advertisers to confidently reach target markets, and the growing industry is one where sites and content are specifically created as thinly-veiled advertising vehicles. As MobileActive's CEO Chris Thorpe describes it, "niche web destinations with relevant content", allowing "low cost acquisition of specific consumers". And to actually use English, it's very much a case of "give them what they want now".

The internet has also now long taken over from the old concept of local community activities. Instead of gathering at the local hall once a week to play the same crowd at chess, you can go on-line and be whipped by some kid from Belarus. Instead of trying to follow around your favourite band to venues that don't exist anymore, join the on-line fan club, hear the latest tunes, chat with like-minded aficionados, and buy the T-shirt. Your into surfing? Get the latest weather details, event dates, hot photos and merchandise here. Your a fan of Desperate Housewives? Watch on the train, complete with embedded product-placement.

It has truly become a small world after all, with the advent of booming social network sites like MySpace and Facebook. MobileActive is able to exploit "social shopping", which Thorpe describes as the "new shelf space", by creating mobile-accessible incentives, benefits and clubs as well as managed events, subscription premiums and recommendations. From the advertisers point of view, MobileActive can manage the "digital asset" by monitoring hits, sub-genres and emerging trends, specific "content clustering", and through "sophisticated acquisition, partnering and creation".

As MobileActive has been a pioneering player in this new virtual game, it can point to several barriers of entry to discourage pretenders. These include the complexity and scale of the company's infrastructure, relationships (more than 50 global partners), product quality and depth, marketing expertise and reach, and five years of "brand equity" development.

MobileActive is currently a 4c stock suggesting a market cap near $7m. Guidance for the end of FY08 includes Australian EBITDA of $1.5m (up 35%) on year-on-year revenue up 23%. Group net revenue should be $11.9m. The company holds $1.7m in cash and is debt free.

The mobile medium has already grown rapidly, but with the advent of iPhones and similar products Thorpe believes it is now set to explode.

Equally excited is David Sweet, CEO of ComTel ((CMO)). ComTel is a mobile video network operator.

See previous warning.

In short, ComTel sells advertising. But it is not simply an advertising agent, as the company has created its own specific mobile service. At last count the company boasted a database of over 500,000 advertising recipients. This is a concept I personally have begun to (slowly) become familiar with, as FNArena looks to fund its growth through offering advertising to our own database, and through accessing other databases to advertise FNArena. This is the new, on-line world.

We are all now familiar with the concept of "Fly-Buys" - the ability to accumulate reward points in the form of air tickets by being a frequent flyer, or being a frequent shopper at a particular store or using a particular credit card. This concept has since expanded, allowing, for example, shoppers at a supermarket to enjoy a discount at that supermarket's petrol station, or shoppers anywhere receiving accumulated "points" towards discounts or other incentives. By offering such rewards, retailers are investing in the ability to keep shoppers coming back.

ComTel takes these concepts onto the mobile phone. As Sweet explains it, "consumers want value and rewards that reduce the cash costs of meals, groceries, holidays, entertainment, fuel, clothing, mobile phone rates, whatever". And on the flipside, "advertisers want to target niche audiences who quickly respond to messages via the most receptive media - mobile and email". Both, notes Sweet, have become worldwide phenomena.

What ComTel thus exploits are "permission-based marketing databases". ComTel's technology captures and segments consumers willing to receive advertising offers of personal value, and be rewarded for it. Once again this shifts the world away from the typical forms of intrusive advertising we've all come to hate, such as billboards that impair vision of an oncoming bus at the bus stop, or ear-splittingly loud, endless and repetitive ad-breaks during Underbelly. ComTel's model works only by advertising to those who want to be advertised to. Perhaps you have stuck your hand up as liking Big Macs. Well look - your mobile phone has just received an email offering you a dollar off a Big Mac at the outlet just around the corner from you! (Your mobile can be traced). And no doubt you'll probably purchase fries and a Coke as well.

Thus through ComTel's mobile services Just Prepaid (budget pre-paid mobile), Amichi (18-29 years pre-paid) and RewardMobile (over 35s post-paid), customers can register and opt into a permission-based marketing database such as ComTel's smspup, CommuniTel, WhatDoYouThink.com.au, SinglesWhoClick.com.au, BigGiveAway.com.au, and iDonate. Advertisers then pay ComTel database hosting and campaign management fees.

And, supposedly, everybody's happy.

To grow the business, ComTel foresees an expansion of the above service providers and the above "portal brands". It will also expand through "white-labelling" its technology. In November 2007, ComTel acquired Empowered Communications, an expert in tailoring on-line community networks.

ComTel shares trade at around 8c for a market cap of $10m. The company has grown its revenue from $2.6m in FY06 to an expected $35m in FY08. EBITDA has grown from negative $1.1m to positive $8m. The company has $3.5m of current debt and $15m of non-current debt. As the company has been investing and growing it has yet to make a profit.

It's rather hard now to foresee what the next step in communications innovation might be, although it would probably involve some sort of surgical implant.