BT (BT.A) is finding it hard to keep everyone happy. Its fibre-optic business Openreach needs to fend off competition from alternative networks (AltNets) while speeding up its own rollout. Meanwhile, BT needs to keep producing cash to fund its capex requirements in the face of rising inflation. On top of this, it is all being done under the watchful eye of the regulator.
The plan management has settled on is to cut wholesale prices for its newest, fastest full-fibre broadband offering to Openreach wholesale customers, while increasing them for customers on most existing BT plans that use copper broadband connections. BT doesn’t want to lose wholesale customers, but it is happy to shed a few retail customers along the way if it has to.
Retail price rises
BT chief executive Philip Jansen is planning to cut prices for its wholesale customers through a program named Equinox 2. This plan followed an original round of price cuts, Equinox 1, that was pushed through last year. However, last week Ofcom said Equinox 2 could not be introduced on 1 April as planned because it was assessing whether Openreach’s “practice of repeatedly amending its fibre-to-the-premise prices could act as a barrier to AltNet entry and expansion”.
Numis analyst John Karidis has always been critical of the anti-competitive nature of BT’s pricing strategy. “As soon as Equinox 2 is launched, BT will start negotiating on the next set of price cuts, which means there is never an end point and adds to the inertia of changing providers,” explained Karidis.
Karidis recently downgraded BT to a ‘sell’ and has been consistent in his criticism of the company. His concern is that BT will lose retail customers as it sweats them for cash to boost Openreach investment. BT’s latest increase sees retail prices rise by 14.4 per cent, which is well ahead of the market and consumer price index (CPI) inflation, but in keeping with its contracts’ stated ability to raise prices by CPI plus 3.9 per cent each year – the provider previously upped prices for most customers by 9.3 per cent in March 2022. Despite these increases, BT pro-forma retail service revenue only increased 4 per cent in the nine months to December.
That leads to the question of whether pushing away customers is worth it. Sky is one beneficiary of BT’s aggressive pricing. Sky ‘only’ increased prices by 8.1 per cent in the past year because it doesn’t have the same infrastructure expenses as BT. Yet it is also one of Openreach’s wholesale customers, so has been receiving the Equinox price cuts. In effect, BT’s wholesale price cuts are undermining its own retail business by lowering the cost for its rivals. In Karidis’ words: “Sky is having its cake and eating it.”
Rising capex costs
It is not just the Equinox price cuts that other BT customers are subsidising. BT needs increasingly more cash to meet its capex requirements due to wage and energy inflation. In the nine months to December 2022, normalised free cash flow was down £0.8bn to £0.1bn due to increased capital expenditure, which was up 19 per cent excluding spectrum payments.
Admittedly, this extra spending is going towards something. Openreach is now extended to more than 10mn homes with a plan to add a further 6mn. The quicker it can transfer customers to Openreach, the faster it can raise prices and block out rivals.
The slight irony here is that in 2016, when the telecoms industry was pushing for BT to be broken up, the fear was that Openreach cash flows would be used to subsidise other parts of the business. A parliamentary report at the time said the structure “allows BT to use Openreach’s utility-type assets to cross-subsidise riskier activities elsewhere in the group, while significantly underinvesting in the access infrastructure and services on which a large part of the public rely”.
The ’riskier activities’ referred to included the lossmaking BT Sport business. BT has now spun it off in a joint venture with Discovery. Stripping out the BT Sport costs coupled with the consumer price rises enabled BT to increase adjusted cash profit by 3 per cent to £5.9bn in the nine months to December despite flat revenue. In effect, the whole business is now being geared towards building out Openreach as fast as possible and fending off the AltNet challenge.
Jansen is unconcerned about his plan to use its other customers to fund Openreach. In a recent analyst call, Jansen said that the money made from the consumer price rises would go on capital expenditure. He also said BT had “support from both the government and Ofcom to keep going down the path we are”.
When asked about this statement, Ofcom said the ‘support’ Jansen refers to is only in reference to infrastructure investment. While the regulator has recently launched a review of telecoms’ inflation-linked price rises, ultimately its main cares are the rollout of full-fibre broadband, and to prevent there being one single fibre-optic provider. This latter point is probably why Equinox 2 is having such a hard time.
CityFibre, a rival provider, has launched an appeal against BT’s Equinox 2 price cuts and argues that BT is planning to price its services at a lossmaking level to drive competition out of the market. “Equinox is just one of those levers – a pricing policy designed to lock in its near-totally dependent customers and prevent them switching to faster, cheaper and more reliable competitors,” said CityFibre chief executive Greg Mesch.
Karidis says BT is unable to compete on a level playing field because it must pull up its old copper wiring before placing the fibre optics. “AltNets are building faster networks and can price them 10 to 30 per cent lower than BT and still make a profit”.
Instead of using pricing, VirginMedia O2 is adopting an acquisition strategy to knock out the AltNet threat. Earlier this month, The Telegraph reported that Liberty Global-owned VirginMedia O2 is in talks to acquire CityFibre. However, broker Jefferies thinks this deal is unlikely to go through because it would undermine Ofcom’s stated aim of having at least three competing networks across one-third of UK premises.
…but BT’s cash flow remains
CityFibre may have lower fibre-optic costs, but it doesn’t have the multibillion-pound business of BT to fall back on. Meanwhile, CityFibre must also face wage and energy inflation and, with its fibre optics only covering 2.5mn premises, it has a lot of building of its own to do.
Rising costs, increased competition and regulatory scrutiny have all been dragging on BT’s share price, which is down 25 per cent in the past year. However, despite these troubles, it is still the dominant fibre-optic provider in the UK and a highly cash-generative business. The drop in its market cap means it is trading on a FactSet consensus 2024 free cash flow yield of 6.2 per cent and a dividend yield of 5.5 per cent. In a world of permanently higher interest rates, this sort of consistent cash is of value.
These yields are tempting for some. Patrick Drahi, chief executive of French telecoms giant Altice, increased his share in BT to 18 per cent just over a year ago. Whether Drahi ever sees a big return on this stake comes down to whether BT can tread this difficult path between its retail customers, the AltNets and the regulator.
If it can, then the current forward price/earnings ratio of 7 must make BT one of the cheapest monopolies on the market. But don’t hold your breath. Karidis certainly isn’t.
