Revamp for Racal Telecom

News analysis: Sir Ernest's flotation plans have been set back once again
IS RACAL ELECTRONIC chairman, Sir Ernest Harrison, throwing good money after bad? That could be the blunt reality for Racal Telecom, the division of Racal Electronics that the 73-year-old executive remains determined to float in a bid to release one final star-burst of shareholder value to cap his glittering 33-year reign.

That could also be the catalyst to Racal's defence and industrial electronics interests being absorbed by larger competitors - in effect, wrapping up the company.

After turning down a pounds 700m offer for the business in February, investors were promised that a chief executive would be recruited as a prelude to building up the unit for a lucrative initial public offering. That rosy scenario was pushed back indefinitely yesterday when Racal unveiled a re-organisation of the telecoms operation designed to bolster its disappointing growth rate.

Yet rather than poaching an outsider with up-to-the-minute commercial experience in the fast-moving telecoms market, Racal has stuck with Martin Lea, 41, who will remain deputy managing director of telecoms services. Mr Lea, a veteran Racal executive, moved into that post 14 months ago, after a stint heading the European arm of Racal's data operation.

On the surface, the company recovered strongly in the year to March, bouncing back into the black with pre-tax profit of pounds 80.8m, compared with a pre-tax loss of pounds 205.2m a year earlier, when the group incurred a pounds 234m charge relating to a disposal. But that ostensible recovery hid plunging earnings in telecoms services and a flat performance in the industrial electronics business.

Against the spiralling revenue and cash flow growth of competitors like Colt Telecom,Racal Telecoms' record is dismal. Full-year turnover grew a paltry 9.6 per cent to pounds 296.8m, while operating profit virtually halved to pounds 22.2m. This, remember, is for a business that should be capitalising from the rapid spread of the Internet.

The finishing touches to Racal's revamp of its telecoms arm are the result of a review begun in December. The new structure throws up three operating divisions, each with independent management, and its own strategy for growth.

Racal Telecom - the core operation - will attempt to branch out beyond its traditional government and railway company customer base into the high-growth market of providing telecoms services to companies. This is largely the business Racal acquired from British Rail Telecom, whose network is strung along the rail network. The second division is Racal Translink. It provides infrastructure services, customer information systems and project support to rail and transport companies such as Railtrack and London Underground.

The third division is Racal Fieldforce, which provides field service support for the periodic repair and maintenance needs of the rail industry and other telecoms customers.

Among investment analysts, there is clear respect for Sir Ernest - he, after all, successfully floated mobile phone giant Vodafone in 1991 and spun off security services firm Chubb in 1992 - though concern is mounting over whether telecoms services will justify the cash being spent on it. Last year, Racal invested pounds 70m in the division and is planning to spend an unspecified, but higher, amount this year.

While City analysts support Racal's belated move to aggressively target the market for business telecoms service and, in particular, areas converging on the Internet, there is also a realisation that the group trails rivals such as Colt and MCI WorldCom.

A particular fear is that Racal's better second-half growth rate came from selling low margin "dark" fibre optic capacity rather than from more value-added applications.

The apparent lack of bids for the unit, given the deal volume in the telecoms sector, also worries. "The business has clearly been up for sale, and nobody's bought it," said ABN Amro analyst, Sandy Morris. "Yet they just keep throwing money at it. That's the scary thing."