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The Federal Government and its advisers have gone all out to make T3 as attractive as possible.

Hang onto your hats. The great T3 sell-off is under way and promises to be an all-singing, all-dancing act. A $20-million advertising campaign, a sales team of just about every broker in the country, and the combined efforts of the Government and their love-to-hate-them colleagues in Telstra management will ensure no potential investor is left untapped.

But what should investors do? Is it better to learn from past mistakes and adopt a "once bitten, twice shy" attitude to anyone flogging a government stake in Telstra? Or is this the time to be bold and invest in Telstra as a turnaround proposition? Should you be seduced by the razzle-dazzle and prospect of a tasty yield - 14 per cent a year on the first instalment price of $2? Or should you be more concerned about Telstra's weak medium-term growth prospects?

The bottom line is that the Federal Government and its advisers have gone all out to make T3 as attractive as possible.

The offer has sweeteners for retail investors. The yield, at 14 per cent, is well in excess of the 4.3 per cent yield on the sharemarket overall and will doubtless appeal to income-hungry investors. Retail investors are also being offered a 10 cent discount on the $2.10 first instalment paid by institutional investors.

Instead of a discount on the second payment, retail investors are being offered loyalty shares - one Telstra share for every T3 instalment held through the 18-month instalment period.

The Finance Minister, Nick Minchin, says the combination of the first-instalment discount and the loyalty shares represents a 6 to 7 per cent discount for retail investors, who are also being guaranteed the final payment will not exceed Telstra's share price in mid-November.

And then there is the good news delivered by Telstra's management in last Friday's marathon update session. The briefing was a blatant PR exercise to promote T3 (and the skills of Telstra's highly remunerated management team), but gave the market some hope that the Telstra ship is turning.

The headline message of the briefing was actually bad news: a downgrade in expected profits in 2009-10, the last year of the telco's five-year strategy. Telstra's chief financial officer, John Stanhope, revealed higher than expected costs would cut projected earnings growth through to 2010 to 2 to 2.5 per cent a year, rather than the 3 to 5 per cent forecast last November. But the launch of the company's new mobile voice-and-broadband network ahead of schedule and improvements in market share in the broadband market have raised hopes that Telstra is finally getting a handle on replacing its old-technology revenues - most notably those fast-falling revenues from fixed-phone lines - with revenues from newer, high-growth technologies.

"[The new network] gives the company another platform for growth," says Michael Heffernan, a senior client adviser and strategist with Austock. "In the future, it could make all the old copper wires redundant and Telstra will be less reliant on that."

Paul Budde, an independent telecommunications analyst, says Telstra desperately needs new growth platforms. He says revenues from fixed lines - a high-margin business for Telstra - are falling by about 10 per cent a year. This revenue needs to be replaced for the company to simply stand still.

In its briefing, Telstra management said while revenue growth would be relatively flat at 2 to 2.5 per cent up to 2010, revenue from new products is already growing and is forecast to comprise more than 30 per cent of sales revenue by 2010. In the year to date, while sales are up only 3.3 per cent, revenue from retail broadband is up 41 per cent, revenue from Sensis is up 10.6 per cent and revenue from mobiles is up by 9 per cent.

Management didn't commit to maintaining Telstra's 28 cent dividend beyond 2007, but in the absence of any real earnings slide, more analysts now believe the company can sustain its dividend.

Peter Hilton, the head of Australian equities with Bridges Financial Services, says while borrowing to pay dividends (as Telstra has been doing) is far from ideal, Telstra has the capacity to do so because of the high amount of cash it generates. Management is forecasting $6 billion to $7 billion of free cashflow by 2010 (compared to $4.55 billion in 2006), which suggests that unless something goes horribly wrong, dividends are unlikely to fall.

"Ultimately, the dividend depends on how profitable the company will be," Heffernan says. "But even if it were to fall to, say, 20 or 22 cents, the yield on Telstra would still be better than that for most other companies."

T3 is by no means a set-and-forget stock. Martin Lakos, a divisional director with Macquarie Financial Services, says Telstra is operating in a very competitive and highly regulated environment. It is significant that the prospectus devotes seven full pages to listing the risks to the business - including regulatory risks, risks with the company's transformation strategy, market and operating risks, and more general risks. Yield-focused investors would do well to heed the warning that reduced dividends are listed as a risk. The forecast 28 cent dividend in 2007 is based on the assumption Telstra will suffer no further adverse regulatory outcomes.

Macquarie is one of the few firms not selling the stock. Lakos says it has a neutral view of Telstra and, while the yield on T3 may be good, he doesn't see it as a growth stock. "We think it will be a non-performer rather than an outperformer," he says. "Earnings growth is likely to be fairly flat, in the order of 2 to 3 per cent, while the major banks, for instance, are looking at growth rates closer to double digits."

Macquarie estimates earnings per share will drop by 8 per cent next year before rising 0.1 per cent in 2008, and accelerating to grow by 10.7 per cent in 2009. Lakos says there is potential upside for Telstra if it is able to achieve greater efficiencies, but he doesn't see that happening at the moment.

Hilton says he believes Telstra's management is on the right track, but just maintaining market share would be a big outcome for the company. He says initiatives such as the new joint venture in China may yield results, but the turnaround will take time.

'The ship is going to turn slowly, if indeed it turns, and you're not likely to see much in the way of fruits of management's strategy by the time the second [T3] payment is due," he says.

While some investors have pointed to the fast recovery of other small-investor stocks - such as AMP - after a big fall, Hilton says you can't assume the same will happen with Telstra. "[A fast turnaround] is a possibility but the challenges for Telstra are greater," he says. "At least AMP had the benefit of the mandated 9 per cent compulsory super contributions to help it. The only mandate for Telstra is increasing competition."

Heffernan has a more optimistic view. "I don't think you should underestimate the benefit of not having the Government looking over its shoulder," he says. "It will finally be able to act for its other shareholders." Heffernan says Telstra is one of the few telcos in the world with a full suite of communications businesses and he believes it is possible ordinary Telstra shares could be worth $7 in three to five years if management's plans play out.

On the regulatory front, Telstra and the ACCC are still at a stalemate on the introduction of Telstra's fibre-to-node network. Budde says Telstra has also stopped progress on regional initiatives, such as expanding broadband access, and he believes its squabbles with the regulator are inhibiting both the development of communications infrastructure in Australia and Telstra's own transformation.

"Telstra has left it very late to do what overseas telcos were doing three to five years ago," he says. "It's now compressed into changing in a situation where revenues are going down, the Government is finally getting serious about competition, and T3 is complicating the whole thing."

The other consideration for potential T3 investors is how the market will view both T3 and ordinary Telstra stock during the instalment period. While Hilton says there is a risk that institutions will push the price up in the coming weeks, the Government has done its best to structure the offer to avoid a repeat of T2.

The threat of an overhang of the shares being transferred to the Future Fund has been pushed into - well - the future, thanks to a two-year escrow period. This means these shares won't come onto the market until after the T3 period. The loyalty shares should also discourage investors from selling T3 after they have collected their dividends.

Ultimately, you're buying shares in Telstra. If you wouldn't consider Telstra shares, you probably shouldn't consider a leveraged investment in the telco, which is effectively what T3 offers. Any bad news for Telstra will be even worse news for T3 investors.

While T3 offers a high yield, Hilton says it is not like buying a bond, and investors shouldn't just be thinking about cash flow. He says the one certainty is that Telstra's share price will move one way or the other in the next 18 months. "There will be a lot of water under the bridge before the second instalment is due," he says. And while that tasty yield will cushion some of the pain of any fall in T3's price, there is no guarantee its price won't fall. Thanks to the inherent gearing in the instalments, a slump in Telstra's share price could result in an even larger percentage loss for T3 holders.

If you want exposure to Telstra in the next 18 months, however, Hilton says it makes more sense to hold T3 than the ordinary shares. For this reason, he expects some investors to sell Telstra shares to buy T3 instalments in the coming weeks.

An investor with $5000 of Telstra stock, for example, could sell that to buy $5000 of T3, giving them a greater exposure to any Telstra turnaround - or they could free up some cash by reinvesting in the same number of T3 instalments and keeping the difference between the value of the shares and the value of the instalments. Depending on the investor's tax situation, selling Telstra shares could also generate a capital loss to offset gains on other investments.

Heffernan says he expects T3 to be especially attractive to superannuation funds as, on their 15 per cent tax rate, the yield on T3 will actually be closer to 20 per cent after taking into account the franking credits on the dividends. "As long as the share price doesn't fall by 20 per cent, that's very good," he says.

The author owns Telstra shares.

T3 - KEY DATES

October 9 Prospectuses launched
October 13 Record date for determining Telstra shareholders eligible for a T3 entitlement
October 23 Retail offer opens
November 9 Retail offer closes
November 15 Institutional offer opens
November 17 Institutional offer closes
November 20 Final instalment price announced
November 20 T3 instalments list on ASX
May 15, 2008 Record date for final payment
May 29 Final instalment due

Your key questions answered
What will T3 instalments cost?

The first instalment - to be paid when you apply for the securities - is $2. That's a 10-cent discount on what the institutions will pay. The second payment won't be determined until November 20, well after the retail offer has closed. It will be determined by an institutional bookbuild (in which institutions will bid for shares). As a protection, retail investors won't pay more (in total) than the average Telstra share price in the three trading days leading up to the final price being determined. So it will depend on Telstra's share price over the next six weeks and the level of institutional demand.

When do I have to apply for my T3 instalments?

The public offer will open on October 23 and close on November 9. In the unlikely event T3 is oversubscribed, it may close earlier.

How many shares is the Government selling?

It is selling $8 billion worth, or 2.15 billion shares - a third of its remaining 51 per cent stake. The rest will be placed in the Future Fund. If there's a lot of demand, the Government has reserved the right to increase the offer by 15 per cent.

Do I get a discount on my final payment, as I did with T2?

There is no cash discount, but if you hold your shares for the full T3 period, retail investors will get one bonus Telstra share for every 25 T3 instalments they own. So if you bought the guaranteed general allocation of 2000 T3 instalments, you could convert them to 2080 shares in May 2008.

What is the minimum investment?

The minimum application is 500 T3 securities ($1000) and there is a maximum retail limit of 200,000 instalments - if you're really keen.

Am I guaranteed a shareholding?

There is a general guaranteed allocation of 2000 T3 securities. If you own Telstra shares on October 13, you'll be guaranteed at least 3000 shares or one T3 instalment for every two Telstra shares you own - whichever is greater. Brokers' clients may also receive a firm allocation.

Will I get a dividend?

You'll get three in the instalment period ­- in April and October next year, and again in April 2008. The combined value is estimated to be 42c, giving you a yield on your initial investment of about 14 per cent a year. However, Telstra has not given any guidance on whether it can sustain its dividends past 2007. The dividends will be fully franked.

How will the T3 instalments be listed on the sharemarket?

They will be listed separately to Telstra shares until the final payment is made. But you can still buy and sell them, as with ordinary shares.