Outlook What is to become of poor old British Telecom? It was only eight years ago that Britain's incumbent telecoms operator, groaning under a £30bn mountain of debt, had to be rescued from oblivion by what was then a record-breaking £6bn rights issue.
For a while, BT seemed to recover and even prosper anew, but now it's been floored again, this time by a combination of the company's ballooning pension liabilities and what was meant to be its big hope for the future, the Global Services division.
Global Services, which helped to push the company into overall loss for last year, is presumably a temporary problem which has now been lanced for good with the provision of £1.6bn against unprofitable contracts. We must hope so, in any case. Ian Livingston, the chief executive, meanwhile insists that his other three business lines are performing well, despite intense competition and the challenging economic environment.
But the pensions problem is permanent and shows no sign of getting any better. Like Royal Mail and the big American auto companies, BT seems to be turning into one of those organisations that works wholly for the benefit of its pensioners, present and pending. This might seem like a proxy for the country as a whole, with its burgeoning public sector pension liabilities, but BT is a quoted company that relies for its capital on the markets and must pay dividends to stay in business. It cannot just raise the money from downtrodden taxpayers.
The size of the pensions deficit is put at £2.9bn net of tax on an accounting basis in the latest results. This might seem quite bad enough but unfortunately it very substantially understates the true size of the deficit as measured for actuarial purposes. For the time being this is being kept under wraps while the Pensions Regulator vets the assumptions used for the triennial review to make sure they conform with the regulator's latest thinking. Assumptions on longevity, inflation and asset values can make a big difference to the outcome.
Most City analysts reckon the actuarial deficit will eventually emerge at around £7bn, though some outside pensions experts think the true size is much larger. What has been agreed with the regulator is that BT will up its deficit contributions to £525m per annum for the next three years, at which time the position will be reviewed again. For any company, that's an awful lot of cash flow to be kissing goodbye to every year.
BT's top line revenues are meanwhile under intense pressure from competitive and regulatory forces. Mr Livingston expects this year's revenues to fall by 4-5 per cent. It is possible that this rate of decline will continue into following years. Mr Livingston's predecessor, Ben Verwaayen, hoped that the broadband revolution and rapid expansion into Global Services would make BT into a growth stock.
On both counts, those hopes have been dashed. With Global Services (providing IT and telecoms support to big organisations) the dash for growth has only succeeded in piling on loss-making contracts, while with broadband the prices are falling faster than the volume can grow.
Earnings growth therefore has to come from cost and capital spending cuts. There were another 15,000 job losses announced yesterday. Nobody believes that's the end of the cull. BT must shrink to survive.
When all is said and done, Mr Livingston expects free cash flow going forward to be more than £1bn a year, or enough to pay the enhanced pension fund contributions and a slimmed-down dividend. It's better than nothing, and BT is plainly not in as bad a position as it was back in 2001, when acquisition-fuelled debt threatened to sink the company in its entirety.
But it is questionable whether the model is sustainable in a world where rivals in the mobile phone, pay TV and retailing industries without any of BT's legacy costs can bundle broadband in with other services. BT is one of Britain's key infrastructure companies. Everyone else in telecoms piggybacks off its backbone network. Yet it may struggle to perform this public service while the pension liabilities continue to weigh like a millstone around its neck.
The pension fund already carries a crown guarantee, a leftover from the company's days as a nationalised industry. It may not come to this, but in extremis, BT may eventually need to be broken up and its pension liabilities returned to the public sector. In any case, if BT gets into financial difficulties again, the City won't bail it out a second time, and in such circumstances, radical restructuring may become the only option.