Out of the local loop: BT dials 'T' for trouble

Ben Verwaayen needs some quick successes if the telecoms giant is to overcome its mounting challenges

The night before Ben Verwaayen presents BT's annualresults on Thursday, the Dutchman's favourite team, Arsenal, play Barcelona in the Champions' League final. BT's chief executive faces a challenge every bit as big as the Gunners'. The last vestiges of BT's once-mighty monopoly are being eroded by new technologies and new competitors. Last autumn, after months of wrangling with the regulator, Ofcom, it agreed to create Openreach, a heavily regulated divisionthat gives competitors greater access to the last mile of BT's network. This allows them to pump better and cheaper services directly into people's homes.

BT, for so long a monopoly, now finds itself competing on multiple fronts: broadband, fixed-line phones, television over the internet (known as IPTV), phone calls over the internet (VoIP) and even mobile phones. Its only hope of survival is to establish new services quickly enough to replace its shrinking revenues from these legacy businesses. So will BT's Dutch revolution work?

Two thirds of BT's sales come from dial-up internet access and fixed-line telephones. As more competitors enter the market and new technologies emerge, these will keep shrinking. By the end of last year, BT's share of the fixed-line voice market stood at 58 per cent, compared to 63 per cent the year before and 69 per cent in 2003. BT reported earlier this year that for the third quarter, revenues from these services were 8 per cent below where they were a year earlier. It had only 750,000 dial-up internet customers left last December.

"The whole game for BT is to diversify away from traditional telephony and into new-wave technologies," says Sam Morton of Dresdner Kleinwort Wasserstein (DKW). These services include broadband. BT was selling broadband wholesale to just under 7 million customers in December last year. It was also retailing its own broadband to 2.3 million customers, around a quarter of the market.

But the scope for more growth in broadband is limited. A third of the population already has it, and margins are getting tighter - Carphone Warehouse recently threw down the gauntlet, offering its TalkTalk fixed line customers free broadband.

This market is also threatened by local loop unbundling (LLU). For years, rivals have complained that they have been denied access to BT's network. Openreach is designed to prevent this. Its engineers must unbundle the local loops, or last mile, of BT's network, allowing competitors to install their own kit in BT's exchanges. By the end of June, BT is also supposed to have upgraded its entire network. Rivals are preparing to unleash dozens of new voice and broadband products on to the market once this happens (Though some in the industry doubt that BT can meet this deadline).

To combat these threats, BT is also pushing new technology, such as BT Fusion. BT Fusion is an "intelligent mobile" which acts as a mobile outside the home, but routes calls via a broadband box, at a much lower tariff, inside the home. But BT Fusion customers must still have a BT line - and pay the £10 monthly rental fee - and it operates on only one network (Vodafone) and one handset manufacturer (Motorola). The company is adding about 2,000 customers a week to its BT Fusion service. Stuart Gordon from ABN Amro says that, it is not the answer. "There is no real proof or clarity on how successful they will be in replacing the falling revenue of its legacy business," Mr Gordon says. "As an incumbent, it has to maintain its market share by moving customers to new products, and I don't think that BT is showing that just now."

The other big hope for BT is television over the internet (IPTV). BT plans to launch its own service, BT TV, in the autumn for its broadband customers. If it works, it will reduce churn and increase revenues by charging for content. But BT TV presents a huge technical challenge, as the box will have to be able to stream live television as well as downloaded content, while the network will have to have the capacity to deliver this.

Scott Morrison, the research director at technology consultancy Gartner, says for BT TV to be attractive to customers, it must offer unique content. BT has already signed deals with Paramount, Warner Music, the BBC and Big Brother producers Endemol, but it faces stiff competition in the IPTV market from content-rich Sky, which will launch its television on the internet service with Easynet in the summer. "BT TV is not going fast enough or far enough in terms of offering unique content," says Mr Morrison.

BT's best chance of success in these new markets is to move quickly, he argues. "If it can sign up enough customers to its VoIP and BT TV services early enough, it will create a barrier to entry for other companies." But so far, this is not happening. A recent report from Continental Research found that BT has just 6 per cent of the tiny (but potentially huge) VoIP market in the UK, behind Skype (with almost half) and Microsoft, with a fifth.

Such doubts have raised the spectre of a private-equity consortium buying the company. BT's high cash flows (£5bn revenue last quarter) and its network, which could be used as collateral to raise loans, are attractive for buyout firms.

But DKW's Mr Morton says: "BT is a difficult asset. It doesn't have a break-up angle." Analysts say its revenues from old businesses are declining, and the new-wave revenues are unpredictable, making a highly leveraged bid risky.

Mr Verwaayen knows that if his revolution does not start bearing fruit soon, shareholders' loyalty to management will waver. And at BT, he doesn't even have Thierry Henry on his side.

Five issues to worry Ben Verwaayen

Fixed line decline: BT's traditional business of handling fixed-line voice calls is evaporating and will ultimately disappear. In the past two years, the former monopoly has seen its share of the market drop from 69 per cent to 53 per cent. Cheap phone calls over the internet (VoIP) cut further into the business and the growing primacy of the mobile phone means some people cut off their fixed-line services altogether.

Local Loop Unbundling (LLU): This process, mandated by Ofcom, obliged BT's chief executive, Ben Verwaayen to open the company's "last mile"to competitors such as Easynet and Bulldog, allowing them to offer their own upgraded broadband and voice services directly to customers in competition to BT.

Pension Gap: BT's pension deficit, though reducing, stands at £1.8bn. The Government issued a "crown guarantee" when BT was privatised in 1984, which is understood to mean that if the group goes bust it will cover up to 75 per cent of its pension liabilities. The clarification of the scope of the pension deficit could stimulate private equity interest in BT.

Television over the internet (IPTV): Analysts hail this as the big hope for BT. It aims to launch BT TV this autumn for its broadband customers, allowing viewers to watch streamed channels as well as downloaded content. But it faces stiff competition from the likes of BSkyB, soon to launch its own IPTV service.

Regulation: Despite setting up Openreach and quickening the pace of LLU, BT still faces regulation by Ofcom it sees as unfair. This was put in place when BT was still a monopoly.

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