Outlook: Eddington fudges future size and shape review

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The Independent Online

Is it a bird, is it a plane or is it something more aquatic in nature? Rod Eddington's new-look British Airways is neither fish nor fowl. Everyone knew that his "future shape and size" review would come up with a smaller airline but the crucial question is whether it is aerodynamic enough to fly.

The market has its doubts. Despite yesterday's denials, the City still reckons that BA will need to jettison at least £1bn worth of debt through a discounted rights issue to get back on the flight path to profitability. And even if it does, questions are bound to remain over the long-term viability of the model BA has chosen to adopt.

With BA it is always a matter of the art of the possible. Mr Eddington will not have forgotten the destructive cabin crew strike that erupted when his predecessor, Bob Ayling, tried to push the cost cutting too far, too fast.

But the understandable caution of the BA board had produced a messy half-way house which promises to play to none of the airline's strengths. The radical option would have been to accept that BA will never make a profit on its short-haul European network and instead focus exclusively on serving the long-haul market from Heathrow. BA rejected this so-called BOAC option on the grounds that no self-respecting flag carrier could be seen to be abandoning its own backyard.

The other option would have been to accept that the only way to compete with the likes of easyJet, Go and Ryanair is head to head. This would have entailed ripping out the curtain and perhaps the galleys too and operating a single-class, single price, no-frills service across the entire short-haul network.

In the end BA decided that both approaches were a bridge too far for the workforce, not to mention the balance sheet, which in the short term at least might have been strained to breaking point. Mr Eddington has therefore compromised. He is turning BA into a low-fare European carrier but the extent of the cost cuts hardly look deep enough to sustain it. Even after the latest round of 5,800 redundancies, Mr Eddington will still have 30 times more staff than Ryanair's Michael O'Leary but will fly only six times as many passengers.

The sums just don't add up and the way things are going Mr Eddington may find himself in the ejector seat before his chairman – the great survivor, Lord Marshall.

"NOT US" was the almost universal response of British telecommunications companies yesterday to the allegation that they've been inflating their numbers through use of an accounting device known as "hollow swaps". So and so down the road might be up to such practices, but round here it's kept to a bare minimum, almost everyone said.

Unfortunately the stock market is in no mood to believe them, and given how liberally such practices seem to have been applied in the US, where accounting standards on the realisation of revenue are a good deal tougher than they are here, it would indeed be surprising if there was no such nonsense going on at all on this side of the pond. According to some accounting experts, the industry as a whole may have overstated its revenues by as much as 15 per cent by using such techniques. No wonder telecom shares were among the worse performers in the stock market yesterday.

It's hard to know whether the expert guesstimate is exaggerated or not. Figures released by Cable & Wireless yesterday in an attempt to clarify the position might suggest it is, but then C&W is a long-standing FTSE 100 stock and it is reasonable to assume it would have been less aggressive in its accounting than smaller fast-moving rivals.

Even at C&W, however, the situation seems to have been quite bad enough. More than 4.5 per cent of total group revenue in the 18 months to the end of last September was accounted for by lease line sales of network capacity. How much of this was under semi-reciprocal deals with rival network operators is hard to tell, though for the record the company vehemently denies any straight barter transactions where no cash changes hands and the purpose is basically that of window dressing.

C&W admits the full cash value of the sales was taken straight on to the books, even though typically the capacity is sold under 20-year leases, but insists that since the cash is generally received upfront, this is an entirely legitimate way of accounting for it. Others would disagree, but then revenue recognition on lease transactions is, in a way, a different issue. The more serious allegation is the degree to which companies were selling each other capacity, not for anything as demeaning as commercial use, but merely for the purpose of inflating revenues and profits.

Like the dot.com scams that abounded in the late 1990s, in the worst cases of capacity swaps, no money would have changed hands and there would have been no intention of putting the capacity to commercial use. The value assigned would none the less have been booked as revenue for the sale side of the transaction, while the purchase of capacity would have been capitalised and then depreciated over a period of time. The effect of such treatment would be greatly to flatter performance, especially under the investment banker's favourite yardstick of Ebitda. Ebitda is profit before virtually everything, including depreciation.

Perhaps the most astonishing thing about the accounting fiddles that invariably run riot as a stock market boom reaches its zenith is that nobody – book keeper, finance director or auditor – stops to think that what they are doing may amount to deception or, if they do, the thought is lightly brushed aside because "everyone else is doing it", and to take the high ground would be only to lose competitive advantage. If you are struggling to meet your earnings expectations but the business is still in roll-out mode, the temptation to engage in a little window dressing becomes almost irresistible, especially if accounting standards don't specifically disallow it.

The Accounting Standards Board admits that there is as yet no accounting standard on these matters but points out that it issued guidelines in November 2000 in response to a series of dot.com scandals specifically banning the practice of revenue realisation on barter transactions. Only a fool would have thought the guidelines applied only to dot.coms, the ASB says. Unfortunately for all concerned the fools seem to have been in the assailant.

There are three reasons why broadband has failed in Britain. The first is that it is too expensive, the second is that it is difficult to buy to the degree that many prospective customers give up trying, and the third is that even when you've got it, there's not enough content to justify the product.

The Adam Smith Institute is no doubt right to suggest that forcing BT substantially to reduce its wholesale prices for broadband and other products would help matters, but of itself it won't solve the problem. Fast internet access is a vital competitive tool for most businesses these days, but for the Government's vision of broadband Britain to succeed requires householders to subscribe in their millions and, for that to happen, they need a good reason to buy. As things stand, it's hard to see what it is.

j.warner@independent.co.uk

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