Outlook: Dixons makes way for higher margin eateries

BT's future; Inducement fees
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The Independent Online

Dixons is one of those companies with a quite remarkable ability for reinventing itself every so many years. Thus it was that just as everybody began to believe the company would be made largely redundant by internet retailing (remember those heady days?), up popped Sir Stanley Kalms, then chairman, with Freeserve, one of the most innovative new product developments - albeit briefly - of the internet age.

Now the company is planning to slash a full one-third of outlets from its original Dixons high street format. At first glance, this might seem symptomatic of a company in crisis, but in fact it's just a timely piece of corrective action by Sir Stanley's trusty successor at the checkout, John Clare. Just to put the numbers in context, the stores in question amount to just 2 per cent of Dixons' total floorspace and only 3 per cent of group sales. All of them are loss-making on any proper allocation of cost, and Mr Clare is confident he can reclaim the lost sales elsewhere in the group.

The closures say as much about the changing nature of the high street as they do about Dixons. Surprising though it might seem, high street rents are rising strongly, which spells trouble for a low-margin format where price deflation has for long been the order of the day. For Dixons, the economics of sustaining a high street presence is becoming ever more challenging, especially in smaller outlets incapable of providing the product range and choice shoppers demand. Rents are rising because there's a whole new generation of higher margin businesses queuing up to take Dixons place - coffee shops, exotic eateries, fashion outlets, mobile phone service providers, and so on and so forth.

Instead, Dixons must concentrate on larger outlets, both on the high street and out of town, and on the continued growth of its other formats, from PC World to the Link and Currys. The worry remains that the internet may one day disintermediate a lot of what Dixons does. My son wouldn't be seen dead in a Dixons. Everything he buys is through the internet. This generational change in shopping habits poses a growing threat to the likes of Dixons. Yet so far, Mr Clare has proved adept at managing his brand to respond to a fast-changing world. Yesterday's stitch in time gives cause to believe he can remain so.

BT's future

Few if any of those involved in the privatisation of British Telecom 20 years ago could have imagined the scale of structural and technological change that has swept through the industry since then - the birth of the internet and mobile telephony to name just two of the most striking developments. But nor would they have dreamt that 20 years after supposed liberalisation of the industry, economic regulation of BT and others would remain as omnipresent and all powerful as it still is.

At the time of privatisation, it was envisaged that much of the detailed telecoms regulation introduced to protect consumers and encourage competition would by now have become redundant, with vibrant competition substituting for price controls. Instead, it continues in robust health, never mind that BT does not. Now dealt with under the umbrella of the Government's new communications super regulator, Ofcom, telecoms regulation is still more of a growth than a declining activity.

On one level, then, Ofcom's strategic review of telecoms regulation, which began yesterday, is very much to be welcomed. As Ofcom's chief executive, Stephen Carter, points out, the telecoms industry has changed beyond recognition, yet the paraphernalia of telecoms regulation surrounding it remains largely untouched by the passage of years.

How much regulation does this industry really need? Is the market power of incumbents still too entrenched to allow for a partial or complete dismantling of price controls. How much further can competition be expected to increase? These are all good questions for the telecoms review to address. Yet the regulator remains "genuinely agnostic" on the one we all really want to know the answer to, what Mr Carter refers to as "the elephant sitting in the corner of the room". This is whether the problem of regulating BT might best be addressed by breaking BT up through the separation of its wholesale network from its customer facing retail business.

BT has long contended that any such "solution" would be too complex, costly, high risk and time consuming to pass muster. The public interest benefit would be questionable and in BT's view it would destroy more value than it created. On both counts, it is hard to agree. The technological barriers to separation are significant but not insurmountable. Freed of the purpose of complementing an incumbent retail operation, the wholesale network could devote itself full time to providing top notch infrastructure for all comers. Competition would blossom and Ofcom's job would be largely done.

Nor would the separation be as difficult as BT maintains. Under a former BT chief executive, Sir Peter Bonfield, it was once postulated as official company strategy. The wholesale operation was to have become a separately listed stock. With the arrival of new management under Sir Christopher Bland, the plan was binned, but Sir Peter's proposals demonstrate that the Siamese separation must be surgically possible.

Ofcom has got off to a poor start as a telecoms regulator. It's handling of BT's price response to carrier pre-select competition was utterly shambolic, and it is not clear that, even if it has the powers to break up BT, it could credibly make the public interest case for doing so. If Britain were to go this route, it would be a pioneer. In no other country in the world has the incumbent been forced into such a separation.

Yet it is often forgotten that when the former British Gas embarked on a similar break-up into Transco and Centrica, it did so for value creation reasons, not because it was being forced to go that route by regulatory diktat. True, the break-up was a response to the regulatory straits the company found itself in, but it was of the company's invention, not the regulator's.

The same value creation case can be made for a BT break-up. Cost of capital could be substantially reduced by making the wholesale network more heavily debt-financed than it is. This would also allow for the release of surplus equity to shareholders. In BT retail, the company is insufficiently innovative to compensate for the decline in its traditional business of switched voice telephony. To become so, it needs to be freed from the regulatory shackles that bind it to BT wholesale. The model is Centrica, one of the most unlikely business success stories of the last ten years. BT Retail could easily duplicate that success.

The BT share price has gone nowhere for two years now. Shareholders need to start asking why.

Inducement fees

Permira's due diligence at WH Smith is not going well - in fact it is not going at all. Before starting, Permira wants WH Smith to agree a break fee of 1 per cent of the value of its bid. This would become payable if, at the end of Permira's due diligence, WH Smith turns round and says it cannot recommend the offer. Alternatively, it would become payable if WH Smith induces a higher offer from someone else.

This is a quite ludicrous demand and should be given short shrift by the WH Smith board. Permira says any offer would be conditional on board recommendation, so it would be unfair to expect it to shoulder the expense of the due diligence if eventually its 371p a share offer is rejected.

But actually what's happening is that WH Smith is being asked to fund the costs of Permira's offer, which on one interpretation would be a breach of the law that prohibits companies from providing financial assistance for the purchase of their own shares. Of course, Permira is careful to construct its proposal in a way which doesn't fall foul of the Companies Act, yet the whole thing is a demand too far. WH Smith has already agreed to open its books to Permira. What more does Permira require? A legally binding guarantee that the business is worth at least three times what Permira is proposing to pay? Give us a break.