Breaking up is so very easy to do

Click to follow
The Independent Online

Big, it seems, is no longer better in telecommunications. That conclusion, however prosaic, still stands in stark contrast to the logic that has driven hundreds of billions of pounds worth of telecoms deals in the last three years.

Big, it seems, is no longer better in telecommunications. That conclusion, however prosaic, still stands in stark contrast to the logic that has driven hundreds of billions of pounds worth of telecoms deals in the last three years.

Tomorrow British Telecom is likely to unveil a restructuring that will begin to reverse the company's conglomerate-like structure, resulting in several more focused entities which may eventually be given separate stock market listings. BT will not be alone in initiating such a process, even if it goes against the management ethos that prevailed throughout the industry during the 1990s. AT&T is doing it, WorldCom is doing it and to some extent even the Continental former state monopolies are doing it.

On the predicament facing BT, John Tysoe, telecoms analyst with investment bank WestLB Panmure, notes: "BT is being hounded in a number of directions. It had not expected the next generation mobile auction process to be anywhere near as expensive as it was. And they weren't expecting anywhere near the competitive pressures that they've had."

That pressure, analysts say, is the root cause of the upheaval now affecting not only BT, but US giants AT&T and WorldCom, both of which have reversed aggressive acquisition strategies to announce break-ups during the past fortnight.

All three companies face a growing number of niche competitors and must somehow adjust to plunging tariffs in their core consumer phone businesses. Although those businesses continue to throw off billions of pounds of free cash, the decline is far more rapid than was foreseen just one year ago. That makes servicing the debt load each telco is carrying far more problematic than had been expected.

A fund manager with a several hundred million pound stake in BT observes: "The old-style core business is deteriorating fast. The new businesses aren't there yet. Hence the earnings and cash flow gap."

The size of that "gap" became starkly apparent in February when BT shocked investors with a quarter-on-quarter 24 per cent slump to £651m in pre-tax profit for the last three months of 1999. That created the impetus for BT to begin redrawing the company's structure.

Thus, in April, BT unveiled plans to create four new internal business units. In addition, BT moved to split its UK fixed-line business, which accounts for around two-thirds of its annual sales of £17bn, into wholesale and retail arms.

Dividing the fixed line operation is wholly endorsed by Oftel on the grounds that splitting wholesale and retail will increase transparency - long a key goal of the telecoms regulator. It is possible, if unlikely, that BT will seek to spin-off the heavily regulated wholesale arm into a separate company. Were BT to do so, it would leave a branded retail arm that would access the wholesale network on the same terms as the dozens of competing telecoms service providers that have sprung up in Britain.

Aside from whatever plans chief executive Sir Peter Bonfield and chairman Sir Iain Vallance unveil about possible spin-offs and flotations, investors, for the first time, will be provided with breakdowns of divisional operating results for the four new business units. This could help clarify the value of BT's divisions and perhaps begin to close the gulf that has opened up between the company's lagging market capitalisation and the attributed value of its main businesses.

Among the four divisions, BT Wireless is the leading candidate for a spin off. Not only is it the most capital intensive of the group's operations, it is also the company's most valuable unit with estimates of its stand-alone worth ranging between £35bn-£50bn. Wireless comprises all of BT's mobile phone interests including Cellnet, Britain's second biggest operator, and a portfolio of businesses in North America, Asia-Pacific and Europe, notably the 90 per cent stake in Viag of Germany.

On a conceptual level, perhaps the most difficult unit to categorise is Ignite. It operates BT's broadband internet protocol business, delivering a range of services from data transport to web hosting. Ignite also embraces Syncordia Solutions, which specialises in the provision and billing of value-added voice and data services, and Syntegra, which develops and integrates network platforms for business customers.

Outside, but adjacent to Ignite, is Concert, BT's equally owned joint venture with AT&T, which provides services to multi-national corporations in over 50 countries. Some consideration has been given by the partners to floating Concert, but that is believed to be far down the current list of priorities. What's more Concert has been caught out by the rapid spread of internet protocol technology and the rise of dozens of firms specialising in narrow product niches, often on a worldwide basis.

Perhaps the least developed unit is BTopenworld, the mass market internet business which has just begun to offer high-speed, always-on internet service using ADSL or asymmetric digital subscriber line technology. BTopenworld groups together all of the company's internet service brands and portals, as well as its minority stake in Open, the interactive digital television platform controlled by BSkyB.

The final unit being split out is Yell, BT's directories and related e-commerce business. It is, so far, the only operation that the company has announced plans to float. Although valued at over £5bn earlier in the year, the nose-dive in telecoms and internet stocks may force BT to cut Yell's float price.

What will guide tomorrow's presentation is a pressing need to cut debt. The £15bn price tag for next generation mobile licences in Britain and Germany, including the cost of doubling its stake in Viag to 90 per cent, has left BT with an impending £30bn debt mountain. This is at a time when interest rates are rising and competition is paring earnings. The resulting crunch, fuelled by high levels of telecoms debt, has raised alarm bells about credit quality throughout the industry.

One institutional investor believes this is the key factor to be addressed tomorrow. He says: "The first and foremost thing is they have to sort out the debt situation. That's unavoidable. There's not a problem with the gearing, but there could be with the rating. There may be surprises when they announce what they're going to sell or float."

Forecasts released last month by AT&T chairman and chief executive Michael Armstrong underscore the deteriorating business conditions that telecoms giants face. As recently as 1997, 82 per cent of AT&T's revenue came from voice long distance charges. Next year, Mr Armstrong said, voice long distance is expected to account for only slightly more than 50 per cent of revenue before sliding to around one-third of sales in 2002.

Mr Armstrong's response was to spend $100bn (£70bn) on buying two of the largest US cable groups, Tele-Communications Inc. and MediaOne. The vision? Offering consumers a bundle of services ranging from fixed and mobile voice and long distance to high speed internet access and cable television.

Last month, however, AT&T abruptly reversed course. Beginning next year, the company will begin a transition into four separate AT&T branded entities: Broadband, Consumer, Business and Wireless. AT&T Consumer will milk the declining cash flow of the core consumer long distance business and continue to pay a dividend, albeit at a reduced rate. The other divisions will use flotations to fund the capital spending required to capitalise on their strong growth prospects.

The poor reception accorded to Mr Armstrong's latest grand scheme - AT&T stock has continued its year long slide - may bolster the hand of BT traditionalists like Sir Iain Vallance. That could see the company embrace only limited measures. WestLB Panmure's Mr Tysoe, for his part, foresees moderate, rather than radical change. "I would like to see them split into two companies. One old and traditional, the other forward facing. There's no reason why Ignite or Wireless should be in the same business."