Bet on bold BT

BT exited the UK mobile market when it sold Cellnet, now known as O2, in 2005. Its imminent return is aimed at completing its 'quad-play' offering of TV, broadband and both mobile and fixed-line telephone services. BT originally planned to launch a virtual mobile network early next year, but it is now in early-stage talks that could see it buy O2 from Telefónica (Sp: TEF), or EE from joint owners Orange (Fr: ORA) and Deutsche Telekom (Ge: DTE).

Purchasing a mobile operator would not only allow BT to cross-sell its fixed-line and broadband products to an established mobile customer base while benefiting from significant synergies, it would also spare it the cost and risks associated with starting from scratch. Broker Jefferies thinks buying O2 could save the combined entity £300m in capital spending and boost operating free cash flow by £700m a year. That would help to offset the cost of any additional debt BT may need to take on - buying either O2 or EE would set it back an estimated £9bn-£11bn.

A successful move into mobile should benefit BT's exciting consumer division, where first-half cash profit rose 19 per cent to £463m - 16 per cent of the group total - with the help of a 17 per cent increase in TV and broadband revenues. Free TV channel BT Sport, which has amassed 1m subscribers since it launched in August 2013 compared with Sky's (SKY) total TV customer base of 10.7m, helped drive demand. Together with strong broadband and fibre demand, the result was a 7 per cent rise in second-quarter average revenue per user to £404. And TV growth could accelerate further, as BT outbid Sky for the live UK broadcasting rights to the Champions League football competition for three years starting from 2015.

The strong consumer showing is bolstering more muted numbers being reported by BT's other divisions. Overall performance is being helped by a 4 per cent fall in first-half operating costs and management continue to see "hundreds of millions" of further savings. The threat of regulation appears to be dissipating as well: UK telecoms watchdog Ofcom dismissed TalkTalk's (TALK) complaint that BT's wholesale fibre pricing was anticompetitive earlier this year.

And there are signs of progress in BT's other divisions. For example, its Openreach division posted a 9 per cent rise in fibre broadband net connections to 344,000 in the second quarter, driving a 38 per cent rise in fibre broadband sales to £119m. Strip out currency effects and underlying cash profit at BT's global services division rose 5 per cent, reflecting strong international demand and contract wins with the likes of Deutsche Post DHL. BT's wholesale division posted a 61 per cent rise in second-quarter sales of internet services, benefiting from the launch of a cloud-based, unified communications service that can be accessed from any device in any location. And the introduction of an internet-connected voice service for smaller business customers, together with lower costs, meant second-quarter cash profit at its business division rose 4 per cent to £258m.

Those improvements underpin broker forecasts of solid underlying earnings growth in coming years. Trading at 14 times consensus next 12-month forecast earnings, BT's shares look cheap compared with TalkTalk on 17 times and Sky on 15 times. They also offer a prospective yield of 3 per cent, rising to 3.4 per cent in 2016.

Investing in BT certainly carries risks. The group's re-entry into the mobile market may provoke regulatory scrutiny and fierce reprisals from Vodafone (VOD) and Sky. BT could also get carried away and overpay in next year's Premier League rights auction. And the group's legacy pension scheme remains burdensome; analysts at JPMorgan forecast a £655m deficit payment in March, or more than double last year's outlay.