Did Bt Miss The Boat?

It may float some units, but the prices won't be juicy

How quickly the mighty fall. Just seven months ago, British Telecommunications was mulling a bid for Spanish rival Telefonica, whose lower market value made it tempting prey. But even as BT's bankers were running the numbers, Telefonica was mounting a defense. To boost its market cap, the Spanish company was leading European telcos in a strategy of New Economy spin-offs, from its Internet offshoot,

Terra Networks, to its booming mobile-phone business. This not only raised money, it showcased the tech gems in Telefonica's portfolio, helping to support its stock while the rest of the industry swooned. Few suffered more than BT. "BT is noticeably behind the game in Europe," says John Tysoe, telecom analyst at WestLB Panmure in London.

BOARDROOM BATTLES. Now, BT is belatedly following Telefonica's example. For months, it has been studying plans to separate its slow-growing domestic fixed-line business from the more lucrative Internet, broadband, and cellular units, including the flotation of Yell, its international directories and e-commerce business. The restructuring was in response to BT's results for the year ended Mar. 31: Sales were up 10.4%, to $27 billion, but pretax profits fell by 32%, to $4.2 billion. And next year isn't looking much better. Pretax profits seem set to drop 40%, to $3 billion, analysts say.

More bad news could force BT to float other units, such as its wireless business, before the end of the year. The only trouble is that everyone else is doing it. In the coming year, five out of Europe's six largest telcos will take their mobile-phone businesses public.

Meanwhile, the company has been hit by talk that its board is in disarray. Long-time finance director Robert Brace resigned on Oct. 6, but BT denies reports that strong-willed Chairman Sir Iain Vallance, a 34-year company veteran, is on the way out because of a strained relationship with CEO Sir Peter Bonfield.

Investor anxiety has reached a fevered pitch these days. Ballooning debt levels approaching $43 billion and a perception that BT is a latecomer in wireless communications and the Web have damaged the company's standing among investors. In the past year, BT's share price has fallen by more than half, wiping a hefty $72 billion from its market value. Worse, persistent rumors of a merger with AT&T, which Bonfield has recently publicly denied, leave investors cold. To them such a union looks like two dinosaurs mating. Meanwhile, BT's once unassailable credit rating has been lowered by both Moody's Investors Service and Standard & Poor's Corp.

It's a saga of strategic blunders. Early in the year, money was easy, and European telecoms--former monopolies and upstarts alike--were racing to buy new turf. But BT was slow out of the starting block. Hampered by a bureaucratic management structure and boardroom battles, it didn't use its stock for acquisitions when the share price was high. It sat on the sidelines when British upstart Vodafone snapped up Germany's Mannesmann to become Europe's largest company. Meanwhile, Continental rivals invaded its home turf. France Telecom acquired British cell-phone operator Orange in May, and Deutsche Telekom bought One 2 One in August, 1999.

BT seems stuck with its legacy businesses: It still derives most of its revenues from its traditional local and long-distance networks, which are under intense pressure from increased competition. BT is struggling to eke out additional returns from these fixed-line operations, whose $8.5 billion in turnover accounted for nearly one-third of BT's entire sales last year, while investing as much as possible in wireless. This year, BT spent $6 billion on a new British mobile-phone license and $1.4 billion to upgrade its network to accommodate the huge volumes of Internet traffic. But it has done nothing like the Orange purchase to vault it into the super leagues of cell-phone operators.

BT has not even profited from the tech euphoria of last winter. Other European telcos have invested just as much in wireless as BT. But, says WestLB's Tysoe, "at least the other carriers have something to show for it." Rivals such as DT and Telefonica raked in billions of dollars earlier this year by spinning off New Economy subsidiaries when prices were at a peak. In April, Deutsche Telekom raised $2.8 billion by spinning off its T-Online Internet unit.

BT is unlikely to reap such rewards. The market for telecom assets has cooled off completely. BT's wireless unit, which is responsible for the bulk of BT's debt, is expected to have sales of close to $10 billion next year, with estimated pretax profits of $1.3 billion. Some analysts say BT could bring in as much as $8 billion from a partial IPO of the wireless operations. But it probably would have fetched twice as much earlier this year. And the cell-phone franchise is likely to face intense competition as a number of rivals bring cellular issues to market. A partial breakup of BT may cheer investors. But this turnaround is going to be long and hard.

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