Debt servicing would not leave much cash for capital spending, writes Arthur Beesley

Once more with feeling. No sooner do the Swiss bidders for Eircom disappear than the Aussies come calling. But if Swisscom was as a natural suitor for the former State telco, the investment fund Babcock & Brown Capital entered the field this week with an altogether more complex proposal. Months could pass before this particular affair is settled.

Numerous uncertainties surround the "friendly" approach to Eircom from Babcock & Brown, which has spent the best part of €400 million since October building its stake in the Irish company to more than 18 per cent.

Chief among these is the manner in which the Australians propose to fund a bid that could value Eircom at €2.4 billion. Then there is matter of a dialogue with the staff-controlled Employee Share Ownership Trust (Esot), which owns 22 per cent of Eircom.

And while corporate finance advisers for all sides are likely to start their engagement next week, the matter of due diligence and regulatory clearance is some time away.

The funding of any transaction will have a big bearing on the company's financial performance after any takeover. More important than that, it might also determine the quality of Ireland's telecoms infrastructure for many years to come.

Eircom's debt pile already amounts to some €2 billion and it is safe to assume that its debts would easily exceed €3 billion if a leveraged buy-out by Babcock & Brown went ahead.

Equally safe is the assumption that the cost of servicing such debts would not leave a lot of surplus cash for capital expenditure. This is crucial, both for Eircom itself and from the perspective of Ireland Inc.

Like any serious player in an industry defined by the relentless evolution of technology, Eircom has big capital commitments. Its capital expenditure last year was in the region of €220 million. This could top €400 million in 2006 and 2007 as its integrates Meteor, its new mobile unit, and strives to make up for the loss of fixed-line revenue with new broadband custom.

Remember too that Eircom was a bidder last year for the final third-generation (3G) mobile licence. It did not prevail, but it might one day need a lot of money for a 3G venture.

These are internal matters. But for the business community generally, the importance of the broadband issue cannot be under-estimated. For all the hype about Ireland's tech-centric economy, the roll-out of high-speed internet networks here lags far behind the rest of Europe. This does nothing for competitiveness or Ireland's attractiveness to the investment world in an economy in which high costs are already a big problem.

Whether ComReg, the telecoms regulator, might wish to intervene in a takeover deal to ensure that the roll-out of broadband or any other basic telecoms infrastructure is not held back by the transaction is moot.

Once basic conditions on the transparency of pricing and access to the network are met, the regulator has no power to veto such deal.

A ComReg spokesman would not comment on any aspect of the Babcock & Brown courtship. Yet even in the absence of a veto, the regulator's previous pronouncements suggest that it might actually approve of the proposal that the Australians are developing.

The consensus in reports about its preliminary approach is that Babcock & Brown will formally split the wholesale part of Eircom's business - its network - from the retail part, which sells landline, mobile, internet and other services to its business and domestic customers.

In the absence of firm information from the fund, this information must still be treated as speculative. Nevertheless, a formal split of the company might to chime with a suggestion the regulator itself made only last April in its Forward-Looking Strategic Review of the Irish Telecoms Sector.

Still, ComReg entered a strong caveat about the practicality of such of division. "While, theoretically, the separation of Eircom into wholesale and retail companies (as opposed to the current notional separation into different business units within the same company) would remove any incentive for it to discriminate in favour of its own downstream arm, it must be recognised that it would not provide either a quick or easy solution."

It is safe to assume that the Australians and their adviser, JP Morgan, examined such issues in detail before making their preliminary approach last Tuesday. Equally, the fact the Babcock & Brown does not already own Irish telecoms assets and Eircom's three previous changes of ownership make it a racing certainty that the regulator is unlikely to come up with a negative answer when asking whether a transaction serves to enhance competition in the sector.

So what's in it for Babcock & Brown? Its executive director Robert Topfer declined yesterday to talk to The Irish Times, but he emphasised the infrastructure angle in an interview with the Australian media.

"Possibly uniquely in our minds, we see network assets as akin to infrastructure assets, somewhat like a toll road, or a railway or an airport, especially in a country where the population is so small that it is very unlikely there will ever be network-based competition."

The suggestion of a formal division of Eircom leads analysts to believe that the Australians will pursue the same strategy as Eircom's previous private equity owners of leveraging yet more debt into the network while growing its revenues by opening it up to other telcos.

In this scenario, Eircom's retail division would continue as before. This might be very appealing to the ESOT, whose members have borne the brunt of the drive for "efficiencies" in its three changes of ownership since 1999.

It should be noted here that Topfer stressed Babcock & Brown's desire to specifically tailor its approach to the interests of the ESOT.

It's very early days yet, but a possible transaction is taking shape. Eircom was willing to do business with Swisscom at €2.42 per share. Traders say the market believes it will do business with the Australians at around €2.30.

The argument that such a deal would improve Ireland's telecoms infrastructure has not yet been made.

Be it in theory or in practice, that is an argument that will be difficult to prove.