BT (BT.A) investors faced a second disappointment in less than two weeks earlier this month when reports that it was in discussions to sell a multi-billion-pound stake in Openreach were dismissed. The Financial Times report boosted the telecoms group's share price by 9 per cent, after the market value had sunk to a near-11-year low on the back of management's decision to suspend its annual dividend until 2022.
However, the rumours were quashed by Openreach chief executive Clive Selley in an internal memo to staff. Mr Selley wrote that the entity, which maintains the UK’s telephone and broadband network and is already legally separate from BT, would stay in BT Group, after he had spoken with its chief executive, Philip Jansen. Indeed, Mr Jansen had acquired £2m-worth of shares only a few days prior to the FT report – which would have not been possible under insider dealing regulations if discussions were material.
However, the sharp rise in working from home among the nation's employees has highlighted the importance of upgrading the UK's creaking broadband infrastructure – arguably the case for a stake sale or complete spin-off of Openreach has never been stronger. It is not a new idea: in 2017 the division was targeted by institutional investors. And it has long been a question for shareholders: why has BT chosen not to unlock the value of the company?
Why did the market think it was good news?
The market was upbeat on the news that the group might be selling a stake in Openreach – evidenced by the sharp share price movement – and it is not hard to understand why.
A cash injection from a stake sale would help BT’s balance sheet – which is being stretched to its limit by higher investment commitments as the UK grapples with its shoddy telecoms infrastructure. The current network is caught up in what analysts at Deutsche Bank describe as “a once-in-a-multi-generational investment cycle to replace the copper network (which lasted more than a hundred years) with a glass one (which will last longer)”. So the company has to balance a huge national investment programme and the fact that normalised free cash flow dropped by almost a fifth in 2020.
What’s the task?
The transformation from copper to glass has not been easy. The UK government’s track record in investing in fibre broadband has been poor, as it steadily decreased investment in telecommunications in the years after 2005, the year prior to Openreach’s legal separation, according to data from the Organisation for Economic Co-operation and Development (OECD). The compound annual growth rate (CAGR) in telecommunications investment between 2005 and 2010 was a negative 15.9 per cent in the UK, whereas the CAGR for OECD countries in aggregate over the same time period was flat. And this lack of investment has caught up with us: the UK now lags severely behind other developed peers.
It is little wonder that the issue has surged up the political agenda. It may feel like a lifetime ago, as a tidal wave of emergency measures have been introduced since, but in the March Budget only two months ago Chancellor Rishi Sunak committed £5bn to develop “gigabit-capable” broadband networks. Now higher levels of remote working have revealed the weak spots across the country’s networks. Even beyond lockdown, changes to our everyday way of working are likely to stick. Take Twitter (US:TWTR), which has told its employees that they can continue to work from home "forever" if they want.
How will BT cope?
It is no wonder, then, that BT has had to prioritise its fibre-to-the-premises (FTTP) and 5G mobile roll-out, although it had to sacrifice its dividend to fund it. Now its FTTP target stands at 20m premises by the mid-to-late 2020s, from an earlier goal of 15m – including a “significant build” in rural areas. But with one step forward, the government has pushed the group two steps back: the UK has reportedly now committed to a three-year plan of removing Huawei equipment from sensitive parts of the national network. BT estimated that complying with the 35 per cent cap on Huawei’s market share would cost the group £500m – and that is not to mention the progress that will be erased from the rollout of 5G.
An extra bit of cash would not be amiss. It would support BT’s investment in broadband, as well as help maintain the group’s dividend in the future, which was suspended for the first time in 19 years.
What is holding BT back?
BT has an enormous operating model – it runs the development of the UK’s internet access, provides retail mobile coverage, runs a sports channel – the list goes on. So what is making the group hesitant to slim down its operations by selling off at least part of Openreach?
“It comes down to the pension,” said James Barford, head of telecoms research at Enders Analysis. BT is weighed down by the need to service a hefty pension deficit, which sat at £1bn net of tax at the end of March, down from £6bn a year earlier – but the group noted that interest rates have been volatile, and its deficit will have worsened since then.
“If you’re the pension scheme, what you care about is that BT is there in order to plug any pension deficit shortfall. ” At the moment it would be difficult to compensate the pension fund for the loss of Openreach as a cash asset. “The covenant is stronger with BT together.” said Mr Barford.
