Tech

Leila Abboud is a Bloomberg Gadfly columnist covering technology. She previously worked for Reuters and the Wall Street Journal.

It's not every day that a business that accounts for just 1 percent of a company's operating profit triggers the biggest fall in the stock since 2008.

That's what appeared to befall BT Group Plc on Tuesday after it wrote down the value of its Italian operation after an investigation of the division's accounting practices.

Bad Neighborhood
European telecoms was the worst-performing sector last year, and BT under performed its peers.
Source: Bloomberg

In fact, Britain's largest provider of communications services used the bad tidings from Italy to bury even worse news: a profit warning. The bite from Brexit is translating into weaker demand from public sector customers in the U.K. and big multinationals overseas. It will take all of CEO Gavin Patterson's skills to win back confidence from shareholders, already bruised by BT's under-performance last year.

BT said underlying revenue for this fiscal year and next will be flat instead of its previous prediction of growth. Ebitda will be 7.6 billion pounds for the 12 months through March 2017, 300 million pounds less than former guidance, and flat instead of higher the following year.

Scaled Back
BT warned that its financial performance would be hurt by the Italy accounting issues and weaker outlook for the overall business.
Source: Company reports

All this will hit where it hurts most. BT expects free cash flow will fall at least 20 percent, or 600-700 million pounds, this financial year and at least 10 percent, or between 400-600 million pounds, next. That's a big deal given that BT, like other telecom operators, uses a generous dividend to attract shareholders.

The dividend should be safe: it's covered 1.5 times over by earnings this year and 1.7 times next year, according to Bloomberg Intelligence's Erhan Gurses. But the promise to lift the dividend, once one of the highest in the industry, by 10 percent this year and next may be difficult to honor.

Choices may have to be made given BT's upcoming obligations on pension payments and the prospect of more intense competition for its British consumer business now that pay-TV leader Sky Plc has launched in mobile, and Liberty Global's Virgin Media is building more fiber lines.

BT may well have less leeway to spend on renewing its rights to broadcast the UEFA Champions League in an auction coming up in March. It pays about 299 million pounds a year for those under the current three-year deal. Sky may use the opportunity make an aggressive bid to take back the rights to the Champions League, which would threaten BT's successful strategy of using premium sports content to attract customers to its broadband services. 

Beyond the financial pressure, the Italy episode casts doubt on Patterson's ability to manage a company with 102,000 staff and a global enterprise business. Patterson was preoccupied last year with trying to ward off regulatory pressure on Openreach, Britain's national broadband network that BT rents out to rivals. It looks like he took his eye off the business. The board also bears some responsibility.

BT says its remuneration committee is considering the implications of the Italian mess. Patterson's pay might be trimmed. That's scant consolation to BT shareholders.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Leila Abboud in Paris at labboud@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net