The Anglo File: Followers Losing Faith in British Telecom

LONDON -- British Telecom's (BTY Quote) decision early today to buy out E.ON's stake in its joint venture Viag Interkom is further proof of the faith the telco has in the future of wireless. Investors, however, appear to lack similar conviction in British Telecom.

"There's a lot of uncertainty about [third-generation mobile telephony]; British Telecom's debt is increasing; and there's not a lot of confidence in management," was how one analyst summed up the telco's troubles.

British Telecom announced Thursday morning it is buying German utility E.ON's 45% stake in their Viag Interkom joint venture. E.ON said it was selling so that it could concentrate on its core energy operations. But it is widely assumed that E.ON believed the 8.45 billion euros ($7.69 billion) Viag Interkom bid for a German, third-generation mobile-phone license was too much and told British Telecom it wanted out of the venture.

"British Telecom has almost been backed into this," says Bill Dixon, an analyst at Robertson Stephens, who has an underperform rating on British Telecom. "They feel they've gone too far in the German auction to drop out now, so they gritted their teeth and paid up." (Robertson Stephens does not have an investment-banking relationship with the company.)

According to reports in the German press, British Telecom and E.ON had agreed even before the auction began that there would be a certain price threshold where the energy conglomerate would no longer be willing to help shoulder the burden.

Although analysts generally view the 6.65 billion euros, or about 7,400 euros per subscriber, that British Telecom will pay for the 45% stake in Viag Interkom as reasonable, the telco giant's shares tumbled 5.1% to 788 pence ($11.82) in London trading on Thursday. By the close, the shares had managed to recover to stand almost unchanged at 814 pence. But even at this level, they are still down 45% from this year's highs.

It isn't hard to see why investors are losing faith in British Telecom.

Calling in the Debts

British Telecom relies on fixed-line, voice telecom service for almost all its profit, yet this part of the business is fast disappearing. As a result, the company must borrow massively to fund its participation in universal mobile telecommunications services, or UMTS, which won't generate any revenue for years to come, if at all.

Following the Viag Interkom announcement, Justinian Clifford-Bowles of Commerzbank calculates British Telecom's pro forma debt for 2001 will be 28.5 billion. The company will have debt-to-equity ratio of more than 2.2 to 1 and interest coverage of just 4.1 times EBITDA . This is a high debt-to-equity ratio for a company of British Telecom's size, while interest coverage of below 5 is low for such a large telco. Clifford-Bowles has a hold rating on British Telecom. (Commerzbank has no investment-banking relationship with the company.)

And this debt load exists even before the cost of rolling out the UMTS infrastructure is factored in. Ratings agency Moody's Investors Service reckons these costs will amount to about 150 billion euros over the next three to four years. Moody's warned in a recent report that the high cost of obtaining UMTS licenses in Europe could lead to significant rating pressure on the credit quality of some of European telecos.

British Telecom does not share Moody's concerns. "We'll be keeping an A-grade credit rating," a company spokesman told TSC.

Why so confident? "The Viag debt won't show up until next year and by then we will have completed a number of disposals and IPOs," the spokesman said.

British Telecom announced earlier this year that as part of a restructuring plan it would split along product lines into four divisions, in some or all of which the company would sell minority stakes. The comments appeared to indicate that the telco is now prepared to either go further in its restructuring plan than initially anticipated, or speed up the process.

True, British Telecom has a number of assets it could sell or spin off. There is the wireless division Cellnet, which is the U.K.'s second-largest mobile operator behind Vodafone AirTouch (VOD Quote); there is British Telecom and AT&T's (T Quote) global networks business Concert; and British Telecom has already announced its intention to float its Yell directories business in the fourth quarter, which should raise around 1 billion.

However, Wednesday's fall in telecom shares in London shows just how tender investors are feeling at the moment toward the sector. British Telecom would have to spin off these divisions just at a time when the market's enthusiasm for the sector is waning. Therefore, it is not certain that British Telecom will be able to successfully float off these assets or get as much money as it is counting on.

Although some investors feel that British Telecom is at last doing something by pushing aggressively into wireless and the continent, many feel the company lacks a coherent overall strategy. "There is a sense of urgency but no sense of purpose," says Robertson Stephens' Dixon.

And if British Telecom lacks purpose, then investing in the company would appear to be a matter of blind faith -- not something the market is well-known for.