Is British Telecom a screaming buy?

1st Nov '08 by Stocktaculous

19 comments 5445 reads

So what are we to make of ALL THIS? This seems to be another example whereby the current gloom in the equity markets means that any piece of negative newsflow leads to a massive over-reaction and a flood of short selling. We seem to be as "exuberant" on the downside as we were on the upside in the heady days of the bull market. Clearly, this profit warning is ill-timed and comes on the back of disappointing first-quarter results (35% drop in profits). And, for sure, BT will suffer from the coming winds of UK and European recession as businesses and consumers cut back on costs and switch providers.

BUT, BUT, BUT...

BT is a vital part of the UK infrastructure
Revenues are forecast to be ahead of expectations.
The problem seems specific to the Global Services Division. All the company's other areas of operation performed as expected or slightly better.
Action has been taken in the problem area in that Chief executive of BT Global Services has been replaced by Hanif Lalani, currently Group Finance Director.
the new CEO, Ian Livingston, looks pretty kick-ass!
It's paying an interim dividend of 5% - not even a fully years dividend!
The business is hugely cash generative

Given the gloom in the markets, who knows what will happen in the short term but medium term, surely this stock is going to recover. BT's half-yearly results are due to be published on November 13.

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Stocktaculous

15th Nov '08

Pretty drastic action being taken by Livingston - he plans to axe 10,000 jobs in 2008-09, 4000 jobs from its workforce in 2008-09, and 6000 contractors. He's planning to reduce BT’s operating costs of £18.2bn by £1.25bn!

http://www.ft.com/cms/s/0/6d7470f4-b15a-11dd-b97a-0000779fd18c.html?nclick_check=1

Murakami

The reason the Global Services news hit the stock so hard is that this divison was supposed the growth engine/saviour of the firm. The rest of BT is legacy telephony that is just going to get eaten away by competition.

Gradders73

14th Apr '09

The short answer is no.

I worked for this company when I was a student many moons ago, and even then the warning signs were flashing red. When this company was privatised, it became the largest private employer in Europe (c. 250,000 workers) and there were so many inefficiencies it was unbelievable. I remember discovering the had whole departments producing reports that weren't actually sent to anybody, but printed and left sitting in the cupboard. They had an enormous property portfolio, which was sold off over the years as the workforce was reduced, and the government monitoring systems that were in the basements got moved elsewhere. But, they were the leading telco technology firm in the world and still had the legacy of Turing and the GPO engineers who developed the first electronic processing machine at Bletchley. However, you could tell that the MBAs in Paul Smith ties were taking over from the engineers and it was all about fancy new management speak. Ian Vallance decided that video phones were the future and spend a fortune on this, while they sold off the mobile business, the fool. The impact of the regulators (Ofcom) was terribly damaging over the years, so rather than competing on a global level, they concentrated on growing the UK market, while deliberately reducing their own share. (Unbelieveable to think that the regulatory requirement was for revenue to grow at RPI - 7.5%!)

Anyway, what you have today is a shell of the former company. They are competing vs mobile and Skype etc and although the product is still very good, in my view the gorilla in the room is the pension scheme.

As of 2008, the scheme had assets of £38 billion and liabilities of £36billion. Therefore the pension scheme is bigger than the company and is horribly volatile compared to the market cap. The analyst estimate that the £2bn surplus is now a £8bn deficit seems about right. I don't think there is any equity left in the business and when you buy a share you are actually buying an expensive out of the money call option on the FTSE-100. Clearly, plenty of investors own the share for the dividend, and despite the cut may not dump immediately because they don't want the capital loss and wouldn't get a better return buying cash, but there's the slow death of a concept here, both for employees and investors. There's talk of some businesses selling assets to contribute to pension schemes, but they don't have any left.

All in all, I find it rather sad and think there are many things still to admire about the company, I just wouldn't want to take any financial risk to them.

MrT

11th May '09

Speaking of the weight of the pension fund, it's rumoured to be cutting dividends (but not scrapping them) and slashing yet more jobs- more news later on Thursday this week...

Alongside dire full-year figures, in which pretax profits have slid close to £550m, BT will give itself up to two decades to plug Britain’s biggest occupational-pension deficit. Contributions will rise to £500m a year from £280m. However, the precise payment is yet to be fixed because the Pensions Regulator is intervening in talks to close a funding gap that has soared to between £6 billion and £8 billion

http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/5304694/BT-to-cut-jobs-and-dividend-after-pensions-shortfall.html

http://business.timesonline.co.uk/tol/business/industry_sectors/telecoms/article6256593.ece

emptyend

Action has been taken in the problem area in that Chief executive of BT Global Services has been replaced by Hanif Lalani, currently Group Finance Director. the new CEO, Ian Livingston, looks pretty kick-ass!

Both Lalani and Livingston indeed have kick-ass reputations. The basic question for me is this:

Is BT in such a structurally-weak position that this can go only one way - or can the problems be rectified with good management and cleaning out a lot of the remaining public-sector attitudes? AFAICS the employees at BT are certainly now feeling they are in the private sector - which is good re the potential financial results down the track. However, the pension fund is a potentially-serious problem....but, once that can be scoped, then BT would seem to have some gearing to a general recovery in the economy (assuming that we get one!).

On a three year view I'd say it is a decent punt at current levels.

14th May '09

Pretty much as bad as expected, with the additional news that revenue will be down 4-5% this year! Stock down 5% today. At some point, this will bottom out but I am not brave enough to go in yet...

http://www.stockopedia.com/news/announcement/BT.A/090514bt.a000881.htm

http://online.wsj.com/article/SB124228221512018707.html?mod=googlenews_wsj

The pension fund deficit was put at £2.9 billion as at 31st March. I'm not sure what the reason for this number being so low is, as they have assumed the assets dropped by only 10%. The spin is that the company has these "legacy" problems as a consequence of the privatisation and splitting of mobile. BT is a classic example of a good business with a bad balance sheet but I don't know how to fix it. They have to make large payments into the scheme as well as make payments to the Pension Protection Scheme, which will increase if the deficit increases or if BT corporate risk increases.

Another point worth mentioning that as dividends get cut across the board, deficits will rise as there's less income into the funds

In my view, there is only slight probability of BT existing in 5 years, they will either be broken up and sold, or sections may get renationalised.

The "bottom" for this share could well be zero, but I wouldn't recommend shorting it. If you want telco exposure, I'd look at something like China Mobile...

SW10Chap

There is only one solution for BT: it needs to be broken up.

Openreach is a regulated utility which could yield some fairly chunky savings and then generate a very good yield for someone with the expertise (MacQuarie?). Wholesale is now a slightly strange beast and arguably could have a similar future, albeit with a different owner. Retail could stand alone and own the brand to compete in the UK home and small biz market. Global Services needs to be sold off to one of its competitors pretty quickly - and undergo a serious leadership purge.

Of course, it will be hellishly difficult to pull off - both for the existing management (in the unlikely event they believed it would be a good idea) and any predator. The creation of Design and Operate doesn't help and any bidder wishing to give it a go would want to get their ducks in a row before mounting a bid: another difficulty.

SW10

hugoc

17th May '09

BT is a pension fund attached to a telecommunication business. Its pension fund has been behind the curve on increasing longevity for 20 years and probably still is underestimating it.

There are estimates that its deficit may be as high as £11billion but no one knows. If share prices fall and bond yields rise the BT pension deficit must rise further. It will certainly not then be a defensive, high yield, utility stock.

1 billion

18th May '09

Not quite true. If bond yields rise then the solvency test that applies to the pension fund will improve (though of course if the assets they are holding fall in value that would be negative].

Re longevity, the other factor at work is the extent to which future liabilities will be reduced by early leavers.......so I don't think one can make a cut and dried case. Certainly I'm personally aware of quite a few people who have left with 10 years or so to go to retirement.

rgds

The other thing not well understood is if a company defaults, the valuation methodology of the pension fund liabilities changes again. You know longer use a AA corporate bond (whatever that can is as there are huge differences) as a discount rate but you switch to a buyout valuation which uses a rate about 50bps lower, so the value of the liabilities increases by a couple of billion. Of course, that's for the bondholders to worry about, the shareholders are already wiped out...

loglorry

16th Jun '09

BT upgraded by MS today with target 150p

An extract on ft alphaville of the note is below:

http://ftalphaville.ft.com/blog/2009/06/16/57276/markets-live

Four Key Steps to the Bull Case. We see four key steps to
BT increasing its FCFE by 65%, and possibly more. We also
see four further positives that support the story. Most of these
positives consist of restructuring “self-help”, which, properly
executed, should be a more reliable source of share price
upside than valuation alone, in our view. Of UK telcos, we
continue to rate Vodafone OW for valuation and C&W EW.

The most important change has been in how management
is viewing its strategy. Over the last four years, we have
noted: “21CN” revenue opportunities and cost savings have
been hard to quantify; Global Services contract “J-curves”
could not be verified in the absence of more information; “new
wave” revenues did not generate significant EBITDA (with the
exception of broadband); dividend payouts were based on EPS
including pension “income” (so-called); and connection
revenue in Openreach was accounted as recurring. All of this
has now been jettisoned by current management. Cash
generation is now king. This is the first time in over four
years that we have rated BT shares Overweight. We upgraded
to Equal-weight (May 17, “Slate Wiped Clean”) when
management’s message became honed to pure cash
generation and a full acknowledgement of past mistakes

Price Target increased to 150p. We have increased our
price target, as we reduced our long-term capital intensity to
£2.66bn from £2.80bn. We do not expect management to raise
capex beyond the £2.7bn set for FY10e in future years, even
with VDSL (high speed broadband fibre to the curb) investment.
Our benchmarking against European peers (see page 9)
suggests this is a very realistic aim. We have not, for now,
made any significant changes to our operating and interest
expense forecasts, though there could be upside here too.

A structural winner? BT is perceived to be in long-term
decline, but to a large degree this is a function of the current
regulatory settlement. Actual copper lines (BT Retail lines +
WLR + FULL) are declining by only 1.5% pa – there is no
collapse of the wireline business into a mobile-only world. The
long-term future of Internet access in developed markets is
wired, in our view, and investment in VDSL could help lift retail
and wholesale market share. Over time, we think the current
ADSL speeds (particularly upload) will be regarded as archaic.
BT’s position in the high speed world will be significantly better
than in the low speed, both because of facts about the network
(more points of unbundling = much more capital intensity for
the competitive operators) and because of facts about new networks should
not be capped in the same way as ADSL).
BT could even move in some areas to fibre to the home where
topography and local public funding support merits.

Fangorn

In reply to loglorry (post #12)

BT is one I've been looking for the last couple of months - the big question is are the horrific losses at its Global Services unit fully priced in ( the rest of their businesses performed pretty well) or has this been oversold. Despite a divi cut the yield is still pretty respectable, and if they can get the problem division sorted then I think this is a reasonable investment for the medium term, The pension liabilities will remain problematic yes, the question is just how bad are they.

I'm inclined to tuck a few more of these away around the pound mark. They've had a decent rise today on the back of the MS note.

In reply to Fangorn (post #13)

the big question is are the horrific losses at its Global Services unit fully priced in ( the rest of their businesses performed pretty well) or has this been oversold. Despite a divi cut the yield is still pretty respectable, and if they can get the problem division sorted then I think this is a reasonable investment for the medium term

Hanif Lalani is extremely well-regarded internally and has now been there long enough to start to make an impact on Global Services. I'd think that current levels make BT a decent punt - though certainly the pension fund issue may have the capacity to dwarf others! Don;t forget, of course, that rising markets are likely to mean fewer solvency problems in the pension fund - and so BT should be geared to an economic recovery!

As the economy recovers credit spreads tighten and long yeilds climb with equities the pension deficit will not be a problem. I do recall at some point before the recession it was in supluss I think. Also global services can probably be fixed - one would hope so anyway and so looking forwards you have two big reasons why BT might improve.

Personally, I think 150p is realistic in a year or two and as you say it pays a decent enought dividend not to be sold in the interim. In fact I can see this as a reason for insto money sitting on the sidelines to invest.

In reply to emptyend (post #14)

Hanif Lalani is extremely well-regarded internally and has now been there long enough to start to make an impact on Global Services.

Lalani has been there six months now and by now should have been able to dig the oar in so bloomin' deep that GS would have displayed a significant lurch one way or the other - that's what it desperately needs.

We haven't see the appetite in GS to do that yet, and, assuming no-one replaces him in the short term, I still consider that the best option may well be to sell the division off to someone who really can do it.

In reply to SW10Chap (post #16)

Fair point re Lalani - it may well be that the irresistable force has been blunted by the immovable object - or that he's not as good or decisive as he had appeared to be. However......

.....perhaps this is actually the REAL agenda. Why would someone want to rock the boat too much if they were preparing to sell the operation? He was a finance guy, after all...

cheers

I am not of the view that the pension is problematic, but it is a 800lb gorilla in the room. As I have said before, the pension fund is actually bigger than the underlying business. Given other firms announcing they are closing their schemes, even to existing members, I would expect something in this vein for BT and BA (there is nothing legally to prohibit them doing so) and then, maybe, the underlying business can break free, but I still see this the unresolved issue being a major drag on the shareprice...

In reply to Gradders73 (post #18)

I think the sooner BT follow others down the route of closing their pension schemes as they currently exist the better. It's all pretty inevitable in that respect I feel. I'd still place the main priority as sorting out their global services division - once that's done I'd expect a decent rerating. If they were to then sort out the pension situation, well, I'm sure there would be plenty of buyers materialising. Definitely one to tuck away now in anticipation I suspect.

Is British Telecom a screaming buy?

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Stocktaculous

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