Outlook: Light at the end of the tunnel, but is it an oncoming train?

Pru/dividends; Nokia/Vodafone
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The Independent Online

It's summer and the economy is in the doldrums. Time, n'est pas, for the latest flowering of that hardy perennial, the Eurotunnel financial crisis? Over the course of the project's 20 year history there have already been so many of these that it's hard to keep count, yet despite revenues which have again fallen to a level where after other costs they cannot pay the interest on the company's debt, Richard Shirrefs, the chief executive remains confident that this time the company will survive without need of another debt for equity swop.

This is partly because the last refinancing back in 1997/8 was, like the tunnel itself, built to last all that could be thrown at it with the stipulation that if the company cannot pay its interest costs in cash, it can do so instead in "stabilisation advances" eventually convertible into equity. The arrangement lasts until 2006, allowing a good few years yet before the company again hits the financial buffers. All the same, the position is once more starting to look worrying enough for holders of Eurotunnel's £4.8bn of senior and junior debt, never mind the shareholders, who are so used to taking a financial beating that another one scarcely seems to matter.

Operating revenues in the first half were down 7 per cent, mainly because of sharply lower prices on the shuttle, and the company isn't expecting much better for the year as a whole. Mr Shirrefs acknowledges that the results are a disappointment but dismisses them as "a cyclical issue". As evidence of a possibly more prosperous future, he points to gains in market share with truck traffic up 3 per cent, car traffic up 4 per cent and coach traffic up a further 15 per cent. But for the price war, the results would have looked reasonably healthy.

As it is, Eurotunnel has been able to continue paying off debt - £90m in the first half - by utilising its tax losses to buy in lease companies at a profit. Financial engineering, maybe, but it's cash, it works, and the process has a while to run yet before it ceases to be tax efficient. None the less, Eurotunnel needs the European economy to start growing again soon, and quite strongly too, to underwrite its long term future. The other thing that comes to an end in 2006 is the minimum usage charge that the railways still pay to guarantee them a part of the tunnel's capacity. This is still worth around £70m a year to Eurotunnel, or about a third of the total revenue it derives from the railways. It can readily be seen that rail traffic will have to grow by a lot over the next four years to make up the difference.

Eurotunnel is working hard on various projects to improve the flow of rail freight through the tunnel, including the proposed construction of a Continental gauge freight terminal within its Folkstone complex and the opening up of a freight route from Lille to Daventry. Yet after nearly a decade of use, and with countless billions of its original cost either written off or converted into equity, Eurotunnel is still struggling to pay its way.

The bottom line is that the company still has too much debt for the amount of revenue it generates. It seems hard to believe that volumes and revenues will grow sufficiently between now and the witching hour of 2006 to stave off another reckoning. Sooner or later, this structural mis-match will have to be revisited.

Pru/dividends

We've known since February that Prudential will probably cut its dividend this year, but it is still going to be a bitter pill when, as seems likely, the cut is finally confirmed with the interim results next week. The stock market has been promised clarity on dividend policy going forward, and given that the Pru has already half prepared the ground for a cut by saying the old, progressive approach may no longer appropriate, it would be amazing if we did not get one. The arrival of a new chairman in the shape of David Clementi, former deputy governor of the Bank of England, in any case makes this an easier nettle to grasp than it might otherwise have been.

None the less, it will still be something of an event. This is apparently the first dividend cut from the Pru since the First World War.

Having survived the stock market crash of 1929, the great depression, the Second World War and the oil shocks of the mid-1970s without need of a dividend cut, why now? OK, so in terms of its duration, this latest bear market has been a serious one, but it is nothing the Pru hasn't weathered before without upset. What's more, the company reaffirmed its commitment to a progressive dividend policy less than a year ago, and to make matters worse still, one of its very own directors, Michael McLintock, wearing his hat as chief executive of M & G, wrote an open letter to the City a while back imploring companies to think long and hard before cutting their dividends.

With low inflation, he said, markets would deliver much lower rates of return going forward than investors had come to expect during the 1980s and 1990s. In such circumstances the dividend would become a big component in total return. And therein lies the problem for life assurers like the Pru.

Lower rates of return has forced the Pru and others to slash bonuses to policyholders. This in turn cuts the cash flow the life assurer derives from the life fund. So it not only looks inequitable for life assurers to keep increasing dividends when they are reducing bonuses, it also becomes progressively more difficult financially. According to some outside estimates, the cash flow Prudential receives from its life fund might be reduced by as much as £100m this year, substantially reducing the amount of capital Pru has got to underwrite business growth in the Far East and elsewhere.

The Pru therefore faces a stark choice. Either it must stop writing new business, or it must have a rights issue, which inevitably would be seen as a "rescue rights issue", or it must cut the dividend. Legal and General, with results later this week, cleverly managed to nip in with a rights issue just before the stock market plunged into the abyss. HBOS too managed to raise a billion pounds through a share placing for unspecified business expansion purposes, half of which ended up being injected into the flagging life fund. Aviva went the dividend cut route and got hammered by financial commentators for its pains. Yet the two things basically amount to the same thing and it can reasonably be argued that to cut the dividend is the more open and honest approach.

L&G is being accused of the old trick of raising money from shareholders in a rights issue just to pay it all back to them through an unsustainably high dividend. Maybe, maybe not. David Prosser, the chief executive, must address that issue when he announces his results on Thursday. But it is an interesting question as to which route the Pru would be taking if a rights issue were still in any way an option.

Nokia/Vodafone

Nokia and Vodafone are so much a part of each other's success that like motherhood and apple pie, it's hard to imagine them apart. So it comes as a bit of a surprise to hear Sir Christopher Gent, Vodafone's outgoing chief executive, suggesting the partnership may be reaching its natural end.

Vodafone's own branded, picture messaging phones, produced by Japan's Sharp, are apparently "flying off the shelves" with such speed that they are now outselling Nokia. For the Vodafone networks, Sir Christopher sees Nokia's position being steadily eroded..

That's obviously more bad news for Nokia, whose market share has long been indefensibly high but may now be facing a meltdown. It also tells us quite a lot about the evolution of the mobile phones market, with the big network operators increasingly determined to monopolise the value chain with their own label products. The handset, and what it does, is too important a tool of service differentiation to leave to the manufacturers, Vodafone and others figure.

jeremy.warner@independent.co.uk

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