BT shares surge as broadband strategy pays off

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Ben Verwaayen, BT's chief executive, did not enjoy the Champions League final. But the devoted Arsenal fan can take solace in the knowledge that investors are starting to notice that BT is looking in good shape compared with some of its European rivals.

BT shares surged yesterday on the back of strong fourth-quarter results and a confident outlook. After four years of reticence, its management is comfortable enough to admit it is likely to grow in fiscal 2007. With television and innovative telecoms services to be launched soon, BT could be set for a bumper year.

City analysts have often been slow to praise BT, focusing instead on declining voice-call revenue, its lack of a mobile network infrastructure and its pension fund deficit. Yet the fourth-quarter strength was enough to change a few minds, particularly as BT's revenue growth is well ahead of European rivals such as France Telecom and Deutsche Telekom.

"These are strong results across the board from BT. It is a positive light in an underperforming sector," Chris Alliott, at Nomura Securities, said. He argued that BT's success in stemming earnings erosion in one of Europe's most competitive markets could have a positive knock-on effect for the rest of the European telecoms sector.

Cazenove, BT's house broker, upgraded its rating on the stock to outperform from in line as the results beat its expectations. "Underlying revenue growth of 5 per cent is right at the top end of BT's European peer group," the investment bank said in a note.

Mr Verwaayen has steadfastly refused to provide growth forecasts since 2002 after the company missed targets he had publicly set. Since then, he has focused instead on the company's transformation from a dowdy telecoms company into a leading-edge IT services and broadband provider.

After nine consecutive quarters of revenue growth, BT may have shed that image. Strong fourth-quarter figures show steady growth in broadband, mobile and IT services. BT derived only 9 per cent of its revenue from its residential voice services, and even there the decline was a modest 3 per cent.

It proved to be BT's best quarter in four years. Revenue grew 7 per cent to £5.1bn while earnings per share, before exceptional items, grew 8 per cent to 5.7p. Importantly, the company turned the corner with underlying earnings growth of 1 per cent. It is the first time in three years BT has grown that metric and it suggested the turnaround will be sustained.

Significantly, BT provided an outlook statement. It said it will continue to grow revenue, earnings and dividends in fiscal 2007, confidence that pushed up its share price. The 8.1 per cent, or 17p, rise to 226.25p was the stock's biggest daily rise since March 2003.

The confident outlook suggests BT is not concerned about the impact of increasing broadband competition. Carphone Warehouse has ruffled feathers in the market by offering free broadband to customers who subscribe to voice services. It is an approach that could be adopted by the likes of Orange and BSkyB, companies that have started eyeing broadband as a future source of growth. BT is often singled out as the company most vulnerable to bundled services and price competition.

However, Mr Verwaayen argued there is more to broadband competition than cheap deals, pointing to BT's online security products as something customers may value more than cheap prices. Broadband prices have come down significantly over the past year, but that has yet to hurt BT. It is still early days but Mr Verwaayen said Carphone's free broadband offer has had no effect on BT's growth over the past two months.

Indeed, BT increased its market share in the three months to 31 March, taking 31 per cent of all new broadband customers compared to 28 per cent in the previous quarter. Mr Verwaayen argued that despite all the price pressure in the broadband market, BT's market share of retail customers has remained relatively stable over the past three years.

BT's market share has fluctuated but the sharper market share gains and losses have predominantly been among cable broadband providers and rival internet companies. BT is also quick to point out that some broadband players have exited the market. There are more than 200 internet service providers in the UK and most use BT's network to offer services under another brand.

BT is also feeling more confident it will be freed from the regulation of its retail activities during fiscal 2007. Because BT owns the UK's dominant telecoms network used by other companies that offer internet and voice services, it is highly regulated at the retail level. BT had 7.9 million broadband users on its network at the end of March, but only 2.58 million of those used BT as their supplier.

Ofcom, the telecoms regulator, has decided to stimulate competition in the broadband market by encouraging other telecoms companies to invest directly in BT's local exchanges. The process, local loop unbundling, means other internet providers can offer unique services to users and take a larger share of the revenue derived from each customer. There were 356,000 such lines at the end of March.

Once BT's competitors have invested in opening up 1.5 million lines, BT's retail arm will be freed from regulation. That means it can start bundling fixed-line, mobile, television and broadband products as it sees fit. BT will be more able to withstand the threat posed by big-name players. It expects to hit that landmark this year and has already opened talks with Ofcom about deregulation.

BT's success is also the result of its investment in IT services. Unlike traditional IT services companies, BT focuses on delivering services that corporate customers require through the network. In the fourth quarter, the Global Services division grew revenue 10 per cent to £2.4bn as it continued to win business across Europe and North America. Importantly, some of BT's major customers, including Unilever, have started contracting BT for additional services on top of the original agreements.

BT is also preparing to launch internet-based television in the autumn. It has been busy signing up content partners such as DreamWorks. BT's television service will allow customers to watch programmes when they want but will also enable interactive services and self-generated content.

Even plain-old voice is set to be transformed. BT is testing a high-definition voice product that uses its new network capability. It plans to launch the technology this year, meaning the quality of voice calls will improve massively. BT also has 30,000 subscribers to its innovative Fusion service which combines fixed-line and mobile technology.

With revenue, earnings and dividends set to rise in the current year, it appears the transformation of BT is paying off. Mr Verwaayen described BT as "a bouquet" when addressing investors yesterday. Rather than focusing on one part of the business, he said BT should be viewed as a whole. It might fanciful, but with broadband, mobility, IT services and other new services growing rapidly, investors might yet be wooed.