Cable & Wireless in crisis talks over £1.5bn telecoms tax threat

Cable & Wireless will today open talks with Deutsche Telekom over its potential £1.5bn liability arising from its 1999 sale of one2one, its mobile subsidiary, to the German telecoms giant.

The unexpected move followed the downgrading on Friday night of the British company's debt to junk status by Moody's, the credit rating agency. This triggered an agreement struck at the time of the disposal to indemnify Deutsche Telekom in the event of Cable & Wireless' debt rating falling below investment grade.

The British company, which recently unveiled a strategic review that will see it pull out of its US and Continental Europe operators, said it would talk to the German group about how "to mitigate the situation". Under the terms of the 1999 agreement, Cable & Wireless must borrow or ring-fence £1.5bn to cover the potential tax liability arising from the sale of one2one – recently rechristened T-Mobile.

A spokesman said: "I can't go into details. We will talk about procedures and timing for setting up either bank guarantees or an escrow account." He stressed that the company had been advised the sale was not expected to give rise to a tax liability, although he added that "the final clearing up of tax affairs [by the Inland Revenue] usually takes several years".

Deutsche Telekom, which recently appointed Kai-Uwe Ricke as its new chief executive, is labouring under a debt mountain of €64bn (£41bn). It is seeking a series of asset sales to cut debt to between €50bn and €53bn by the end of 2003, although T-Mobile has not been earmarked for disposal.

If Cable & Wireless, which was criticised by the City for not going further with its restructuring, is forced to set up an escrow account, the money will have to come out of its fast-dwindling cash resources. It has £3.8bn of gross cash, £2.2bn of net cash and about £470m of marketable securities that it could cash in if necessary, the spokesman said. However, £800m of that cash is already earmarked to cover the restructuring of Global, its international services division, which includes axing 3,500 jobs.

Cable & Wireless will also today continue crisis talks with its bankers about securing the £1.5bn loan guarantee. Its lead banker is Royal Bank of Scotland, although the spokesman said it would talk to a "whole range" of bankers about the possible terms, which could prove onerous. The group has already had some exploratory talks, he added.

This latest setback at Cable & Wireless is likely to increase shareholder pressure for the group to oust its chief executive, Graham Wallace, who presided over the sale of one2one as well as a strategy that has produced four profit warnings. The group has already responded to calls for a management shake up by parting company with its chairman designate, David Nash, who will step down from the board at the end of the year.

Moody's said the downgrade by two notches, which was more severe than expected, was prompted by "concerns over the cost of restructuring". It added that the "Ba1" rating (its highest junk rating) for the group's long-term debt reflected "uncertainties over the timing and size of potential additional unexpected costs and/or liabilities". It reiterated its negative outlook – even taking into account the expectation that the Global division will manage to become free cash flow positive in the year to March 2004.

Moody's move indicates that rival credit rating agencies Standard & Poor's and Fitch – which both also have Cable & Wireless under review – could downgrade their ratings on the back of similar concerns.