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Deja vu at BT

Created:

15 April 2009

Written by:

Alistair Blair

BT shareholders will have raised their eyebrows briefly after hearing this week that Tech Mahindra, an Indian company 31 per cent owned by BT, had won an auction to acquire Tech Mahindra's much larger competitor, Satyam Computer Services, with a bid likely to cost it ultimately $500m (£376m) in cash and which "far exceeded rival offers" including one from IBM. Satyam's founder recently confessed to having cooked its books for years. It is therefore unsurprising that it said to have provided little in the way of reliable accounts to bidders. Moreover, it faces multiple class action suits from US investors. Fortunately, Tech Mahindra won't be looking to BT for any of the funding - which has been wrapped up by an investment bank called Kotak Mahindra.

Perhaps Kotak Mahindra could do something on behalf of BT, where cash is a distinctly scarce commodity at present. Momentum is even scarcer. Since its near-death experience in the tech crash - averted by a £6bn rights issue at 300p a share - BT had begun to look like a fairly steady performer. But over the last six months it has hatched its own scandal within a division called Global Services, which provides networked IT and all sorts of accompanying kit and services to big companies all over the world.

Global Services had been BT's star performer during its comeback since 2002, providing growth to offset the inevitable shrinkage in traditional UK revenues, which suffered the onslaught of the new generation of telecoms companies. Global Services sales grew from £5bn in 2001 to £8bn last year - approximately 40 per cent of BT's total. But last year, BT's new chief executive and chairman found themselves having to reassess some of the huge multi year contracts entered into by the division.

Last October, the divisional boss departed. In January, BT said it had totted up that £340m of special charges were needed to address the fact that costs on these contracts were and would remain higher than expected when they were won. And it hadn't finished the totting. That process is supposed to be complete about now, and will emerge in three weeks' time with BT's fourth quarter results. The chatter is that the further bill for recognising Global Services’ problem contracts will be around £1.5bn. Call it £2bn in all, or broadly speaking, a year's profit after tax, or an awful lot more in terms of free cash flow. BT has net debt of around £10bn, and last year paid £1.2bn in dividends. It won't this year.

And then there's the pension fund which has gone the way of all pension funds over the last 12 months and will certainly need major new commitments from BT, even as its liabilities are trimmed as a result of staff negotiations.

All this has been disastrous for the share price, which is lower now than in the teeth of the tech meltdown six years ago, and is way below the 1984 flotation price. A quarter of a century is a long time to spend going nowhere (even if we recognise that O2 was spun off to shareholders in 2001).

Perhaps the worst aspect of BT's current woes is that it has been in this exact spot before. In the late 1990s BT created its Ignite division, an amalgam of business telecoms customers and small acquired IT services operations spread around Europe. When last reported as an individual unit (in 2002), Ignite reported losses of £392m on sales of £4.5bn. BT also created in 2000 a disastrous and short-lived joint venture with the US operator AT&T, in which the two merged certain of their foreign assets. This was unwound two years later, with BT's share going into Ignite. This was all small beer in the context of the telecoms bust of 2000-2001. It was also the unit that was renamed Global Services and seemed to be making decent headway under ex-chief executive, Ben Verwaayen. Now, it's clear they simply weren't doing the sums right.

It's hard to escape the conclusion that BT is still a plodding incumbent - numbed and overladen with old baggage, including all those scattered IT acquisitions which simply cannot be melded into a sensible whole within Global Services.

Sir Michael Rake, BT's chairman, points out that when he ran accountants KPMG, he sold its IT services division. Given current market conditions, he reckons a sale is not an option for the problem asset he's looking after now. He's probably right, but BT shareholders should hope that, confidentially, that's the ultimate plan.

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