Jeremy Warner's Outlook: A great time to be a broadband consumer. But for Sky's investors, it's still jam tomorrow

Casualties of an online muddle; Why FSA listing rules are in the dock
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The Independent Online

Consumers, if no one else, are having a field day. Cut-throat competition to pipe broadband into your home means the price is falling like a stone. If you happen to have Sky or are a subscriber to Orange, you ought to be able to get the service at close to free. Everyone wants their share of this fast-growing market, and they seem prepared to pay dearly to get it. This beggar thy neighbour "landgrab", reminiscent in some respects of the dot.com boom, is great news for customers. What it means for investors is another matter.

BSkyB yesterday became the latest new entrant to set out its stall. The offer is a compelling one from a customer perspective, yet even on the company's own projections, the damage to profits at £400m over three years looks punishingly high. Whether in practice that's where the haemorrhaging is stemmed is anyone's guess. For what it is worth, Sky expects the broadband unit to become profitable in its own right by 2010. In the meantime, the progressive dividend policy stays, but investors can presumably kiss goodbye to prospects of a resumption in the share buy-back programme. Has Sky got its approach right, or should it have left the broadband space well alone?

Certainly not the latter, for the truth of the matter is that Sky had little option but to wade on in. The only real mystery is why it's taken so long to do so. Quite apart from the obvious convergence of broadband with multichannel TV, offering the opportunity for video on demand and much more extensive interactive services, Sky has begun to hit a brick wall in terms of growth from its existing business.

The success of Freeview has caused once unstoppable expansion to decline precipitously over the past year or two. Sky Plus and the recent launch of high definition television have taken some of the sting out of the slowdown, but the numbers signing up for these premium services are still relatively small, and there is little doubt that Sky would have struggled to meet its target of 10 million subscribers by 2010 absent of some fairly radical new initiative.

The fairy dust chosen is broadband. The approach is different from rivals in that for the time being the service is confined to Sky subscribers only, and again, the free broadband is initially only offered to subscribers within range of an exchange which Sky has already "unbundled". This amounts to less than a fifth of the total.

Much as Sky would like to, the offer cannot be further confined to new subscribers only, for this would risk alienating existing customers. One of the downsides of having a big legacy customer base is that the proposition has to be offered to all, which is plainly where the really big costs to Sky of free broadband lie. Sky assumes that only 30 per cent of customers will take up the opportunity. Furthermore, it believes that about a half these customers will upgrade to higher bandwidths, which require some payment, or avail themselves of the paid-for telephone service, thus enabling the business eventually to become profitable in its own right.

These are big assumptions, but then any new market is bound to be largely guesswork to begin with. The biggest danger, it seems to me, is that of damage to Sky's otherwise faultless reputation for customer service. Then again, execution has not been a problem for Sky in the past, so there's every reason to believe that even in broadband, it can achieve high levels of customer satisfaction.

The negative reaction in the BSkyB share price yesterday is powerfully illustrative of how little appetite there is in the stock market these days for even the most meticulously planned growth strategies. It's always the same with Sky, investors complain, with at least a little justification: great reward is promised, but somehow the boat never seems to come in. There's always some new project, some new obsession in Rupert Murdoch's mind, requiring huge amounts of capital investment and a further delay in payback time. Yet isn't that what successful companies are meant to be about?

Casualties of an online muddle

So now we know why Michael Jackson, former chairman of Sage, and Brian Larcombe, former chief executive of 3i, were paid an astonishing £1.5m and £1m respectively just to join the board of PartyGaming in a non-executive capacity. It wasn't to add a veneer of respectability to what many would regard as a disreputable activity. In fact it was danger money.

There are plenty of reasons for believing the online gaming industry's insistence yesterday that the charges levelled in the US against 11 executives of BetonSports were company specific, and not part of an industry wide crackdown, but I'm not sure that if I were Mssrs Sage or Larcombe, or indeed anyone else associated with online betting, I would risk going to the US right now. My guess is that the whole industry is now under threat, regardless of whether it is sports, cards or casino betting that is being undertaken.

With its colourful founder, Gary Kaplan, and overt US presence, BetonSports has made an easy target for Federal prosecutors. Whereas most of the online gambling sites can reasonably claim that their legal status in the US is ambiguous, there is not much doubt about BetonSports' position.

It operates in the US, has employees and subsidiaries in the US, and what it does, telephone betting for sports events, is specifically banned by the 1961 Wire Act. The position of poker and casino sites is less clear cut. Most online operators are in any case careful not to have any physical presence in America even though that's where most of their money comes from.

Yet I see no reason why US prosecutors should stop with BetonSports. The inconsistency of such an approach is only too obvious. The authorities are never going to rest easy as long as there are offshore operators carrying on an activity that is banned among US companies.

The obvious way to deal with the problem would be to legalise, tax and regulate an activity for which there is obviously a big demand, yet US lawmakers seem in no mood to see common sense. To the contrary, most of them want to see the law further tightened up.

Until the Justice Department's position becomes clearer, no online gaming boss in his right mind would travel to the US. Just look at poor David Carruthers, the chief executive of BetonSports. With bail denied, he appears to be in an even worse position than the NatWest Three.

Why FSA listing rules are in the dock

The High Court's refusal to grant a judicial review of the Financial Services Authority's decision to allow the Rosneft flotation raises the question of just when a listing does become unacceptable. You might have thought that when ownership of the company's assets are in vigorous legal dispute, as with Rosneft, that might count. Or as with PartyGaming, when the bulk of the profits come from an area of the world where the activity is regarded as illegal.

Going back 25 years I'm not sure either of these companies would have passed the Stock Exchange's suitability tests, where in the perceived interests of investor protection, a whole series of rules would have to be satisfied before a single share could be traded. Today, the FSA applies the more American approach: so long as all the risks are adequately laid before investors in the prospectus, almost anything goes. Philosophically I don't doubt this is the right approach. How capital is allocated should be determined by investors, not interfering bureaucrats. But where do you draw the line?

Should, for instance, the Medellin drugs cartel be allowed to list on the London stock market? No, seriously. It ticks many of the right boxes - quality product of indisputably high growth potential, gigantic cash flow and unchallenged track record. Asian markets yet to be properly tapped. What's more, it's illegal, making it immune to possible class action from nasally damaged Americans. One hundred pages of health warnings ought to more than do the trick. You cannot say you were not warned.

j.warner@independent.co.uk

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