Why telco Digicel is the new front in Australia’s national security strategy to counter China

The Pacific telco has been caught in a complex web of interests that include an Irish billionaire, the Australian government and corporate giant Telstra.

This emerging strategy involves the Irish billionaire, Prime Minister Scott Morrison and his national security committee, spooks in Canberra, government officials from Washington to Tokyo, and powerful local business players including Telstra, private equity, investment bankers and lobbyists.

It hinges on concerns among national security officials in Canberra that if Digicel’s Pacific subsidiary falls into Chinese hands it could be used to spy on neighbouring Pacific countries and visiting Australian government ministers, to control media communications to disseminate political propaganda for China-friendly Pacific political leaders, and as a patronage vehicle to corrupt the region’s political elite.

It had roped in telecom giant Telstra and was considering how best to stitch together a deal with Telstra to buy Digicel’s Pacific operations – estimated to be worth about $2 billion.

After months of top secret discussions with a range of parties, the federal government was getting serious, increasingly concerned about chatter that China could swoop in to buy a debt-laden Digicel’s Pacific telco assets.

Initial talks between the government, Digicel and Sydney-based private equity firm Pacific Equity Partners about a possible taxpayer-backed buyout had fizzled by late last year.

So the government turned to Telstra – which has a close relationship with the intelligence community – with a view to partnering on an acquisition.

Communications Minister Paul Fletcher late last year also tapped former Telstra chairman Bob Mansfield to act as an informal adviser to the government to keep Canberra abreast of the details of a possible transaction.

In February, Connolly – a frequent visitor to Australia – had been dispatched to the harbour city to discuss the potential sale of Digicel’s Pacific assets after the global group’s near-death debt restructuring in May last year, which included a bankruptcy filing in Bermuda and $US1.7 billion ($2.3 billion) of bondholder debt written off.

While the backroom discussions had been going on for some time, it wasn’t until this month – with billionaire O’Brien back in Ireland and after The Australian Financial Review had reported Telstra had been approached by the government to buy Digicel Pacific – that Telstra confirmed to the ASX it was mulling a taxpayer-backed move on Digicel.

The disclosure triggered an outcry from investors concerned the telco could be used as a government foreign policy tool to outbid China in a deal that chairman John Mullen admitted Telstra wouldn’t otherwise have looked at twice.

But whatever posturing is going on, expectations are a deal – in some form – will be done because of the political importance of Digicel’s Pacific assets.

According to a source who has spoken to Hockey, he has said that if China becomes the biggest owner of telcos in the Pacific, it would be disastrous for Australia because Beijing would control and know everything inside Pacific countries and their communications with the Australian government and security agencies.

Fergus Hanson, Australian Strategic Policy Institute head of international cyber policy, says China is contesting Australia’s standing in the region, so Canberra must step up?

But he’s not sure that a deal has the same strategic urgency for Telstra and its investors.

“It puts Telstra in an awkward position as a former government enterprise acting in the national interests and could conflict with its China business,” he says.

DNR Capital’s chief investment officer Jamie Nicol, whose fund holds Telstra shares, said he had confidence Telstra would negotiate the right deal for investors, and said any Digicel deal had to be seen in a broader context.

“The IRR [internal rate of return] on this may be ok, but there’s a broader range of objectives they have, including a potential selldown of infrastructure assets in the future which requires government approval.”.

The question is whether the government will be able to keep Telstra in the ring, and perhaps even bring back a private equity backer.