BT turns to IT to keep revenue growing

By DAILY MAIL REPORTER
Updated: 04:38 EDT, 22 January 2007

When the first wave of internet businesses took off, established giants worked themselves into a frenzy to turn the new technology to their advantage.

This often ended in grief, as in the botched Time Warner-AOL merger, as older companies struggled to change their culture.

Eight years on, can BT turn itself from a shrinking telecoms monopolist into a growing technology business? The cultural obstacles have been formidable. Yet BT has come a long way in a short time. Its debt mountain, £30bn when Sir Christopher Bland took the chair, is down to a manageable £8bn.

How it fares is important for 1.4m shareholders (including me). Many signed up at privatisation and have seen the shares rise and fall. Any BT customer could tell you that parts of the group are still in decline. Its share of UK household fixed line calls has dropped from 70% to 57% in three years. Few people who switched to cheaper rivals are itching to return.

Wholesale profits may also be squeezed. The competition authorities have forced it to open its local phone exchanges to allow rivals access to UK households over BT lines.

As this happens, price cuts are likely across its wholesale operations, which were earning fat 70% margins. Analysts fear this could wipe £200m off profits.

What retail customers may not see clearly is how far BT has progressed in developing new growth areas. Its broadband offer is growing strongly as the number of UK users tops 10m, or 13m including cable connections.

BT claims 25% of the market - more than 3m customers. They pay an average £254 a year and it hopes to lift this with new services; wire-free calls in and outside home, online games, home security, and 'catch up' TV where you order the programme you missed. Broadband is growing explosively - UK subscribers could top 20m by 2010.

The most important growth area though is business customers. BT has set out to build its IT and telecoms networks offer to businesses such as HSBC, Pepsi, Unilever, Barclays, and Reuters on a global scale. This division earns half of BT's revenues and £1bn profits. It has nearly £2bn of contracts with the NHS, a reminder of the risks. But it is crucial to BT's future. The target is to lift its operating margins from 10.6% to 15%.

BT is a massive business, but is it truly on a growth path? Finance director Hanif Lalani points out that the 'new wave' businesses now earn 35% of total turnover, up from 13% four years ago. That turned revenues upward to £19.5bn in 2005/6. Earnings per share have risen 18 quarters in a row.

Some parts of BT are under fierce attack from new and nimble rivals. Broadband is hugely competitive, with over 100 firms flogging it to a confused UK public. But in this fragmented market, BT's brand is a strength.

Valuing BT is tricky. Awareness of how it is changing has lifted the shares to 310p, where its market value is £25.7bn. Brokers expect earnings per share of 22p in the year to March, 22.5p in 200⅞ and 24p the following year. Trend growth seems to be about 8% a year.

BT promises to pay out 67% of earnings, and is already at 61%. Assuming a 14.2p dividend this year and 15p next, the yield is an attractive 4.6%, rising to 4.8%. At 310p BT sells at just 14 times next year's earnings, about right for a telecoms company - but not for an IT business.

Lalani says 'BT has transformed itself from an old-fashioned telco into a modern global communications service provider'. One measure of change is that voice calls, still most of the revenue of its European rivals, are just 18% of BT's sales. The global networks side competes not with telcos but with IBM and Cap Gemini. IBM sells on 15 times, Cap on 19.5 - though both are growing faster.

The local loop network, BT Openreach, is essentially a utility that can be geared up with debt. Taking recent utility bids, it is arguably worth £15bn, not the £10bn often assumed..

On a sum of the parts basis, I think BT is worth more like 350p than the current price. Some smart folks in the industry agree. If it gets IT and broadband business firing on all cylinders, there could be further upside.

This is an industry with relentless innovation and price cutting, but BT looks a buy.