BT and the Art of the Deal
Gavin Patterson, BT Group Plc's CEO, is grappling with the first crisis of his four-year tenure: an accounting scandal at the telecommunications giant's Italian unit. He now needs to rebuild investor trust.
The best way to do that? End the two-year battle with British regulators over Openreach, the bit of BT that operates the nation's internet infrastructure.
Patterson could do this and still keep growing the dividend, even if it would be at a slower rate than the 10 percent annual growth he promised.
Uncertainty about the future of Openreach, which rivals like Sky Plc and Vodafone Group Plc rely on to serve their own customers, has contributed to a 31 percent drop in the shares in the past year. BT is the worst performer among European telecom carriers.
Since the unit generates 40 percent of BT's Ebitda and half of free cash flow, regulatory decisions on everything from how much it can charge rivals for access to the network to the pace of technology upgrades go to the heart of the company's valuation.
Ofcom wants to force BT to give Openreach more operational and strategic independence. The company has deep misgivings, saying it must protect shareholders' interests. If the two can't come to an agreement, Ofcom will refer the matter to the European Commission, which can impose the changes.
Patterson must avoid that. The process would take years, miring BT in uncertainty just as Britain prepares to leave the European Union. Even government officials are urging the two to reach an agreement rather than go to Brussels, according to the Telegraph.
There's a deal Patterson should offer. BT could spend 200 million pounds a year more rolling out fiber all the way to an additional 500,000 homes and businesses annually, according to analysts at Jefferies. The company would still be able to increase its dividend by 5 percent a year instead of the 10 percent Patterson promised, they argue.
Such an increase would be modest -- BT's annual capital expenditure has stagnated at about 2.5 billion pounds since 2010 -- but it should be enough of a gesture of good faith to head off Ofcom before it goes to Brussels.
BT could still go further on network investments. Its capex-to-sales ratio still trails France's Orange and Spain's Telefonica, according to Bloomberg data.
Reaching a deal on Openreach would be a win for BT as it heads into its three-yearly review of its 47 billion-pound pension plan, which is deeply in deficit. To plug that gap, BT may have to increase the contributions almost threefold to 688 million pounds by 2018 -- or about 20 percent of free cash flow -- according to Bloomberg Intelligence analyst Erhan Gurses.
If the company's cash generation potential becomes clearer, the program's trustees are less likely to demand a big top-up payment to the pension fund to compensate for uncertainty on future cash flows.
Investors are already factoring in a degree of capex and pension risk to BT. Making Openreach predictable again would be a step towards recovery.
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