BT's Pipeline To The Future

Can a grand broadband network keep an old-line telco growing?

The telecommunications business is mighty ugly. Across Europe, icons such as France Telecom and Deutsche Telekom (DT ) watch in dismay as their traditional, fixed-line voice revenues shrivel. Local and long-distance competition from newcomers such as Sweden's Tele2 (TLTOB ) is only part of the problem. Carriers also contend with the rise of free phone calls made over the Internet and an inexorable shift from wired to wireless calling, especially among young people. In short, the business that provides most of the sales and profits at Europe's big carriers is fading like mist on a summer morning.

Bernardus J. Verwaayen knows all about that. The chief executive of London-based BT Group (BTY ) PLC, the former British Telecommunications monopoly, has fought valiantly against the tide since he was hired to rescue BT in early 2002. In the past two years he has grown revenues a hair, to $33.8 billion, boosted margins, and restored positive cash flow. But Verwaayen has one arm tied behind his back: Unlike Europe's other telecom giants, BT has no mobile network, having spun it off in 2001 to pay down debt accumulated during the boom. That's a problem because wireless is the main growth engine for most telcos. Morgan Stanley (MWD ) figures fixed-line voice revenues at Europe's top eight carriers (excluding BT) will be 6.3% lower in 2008 than they are today, while mobile services will surge 21% -- accounting for 93% of revenue growth.

To fight back, Verwaayen has launched a bold plan. BT's biggest asset is the 29 million phone lines it owns that run into virtually every home and business in Britain. Verwaayen is upgrading all those wires into high-speed data pipes that can carry digital phone calls and video, as well as provide Internet access. To transport all the new media, he's building a faster, more efficient backbone network based on Internet technology. Eventually he aims to proffer all manner of sexy services over the new infrastructure, from TV-on-demand to home automation. He's convinced those products will drive higher revenues per customer. Analysts applaud the ambition. "There's a limited future in plain old phone service, so BT has to move to something else," says Mike Cansfield, research director for telecom consultancy Ovum Ltd. in London.

To be sure, BT isn't the only telco betting its future on broadband. But the company is moving faster than most. By 2008, Verwaayen aims to lure a majority of BT's subscribers off today's conventional phone system -- which still uses the circuit-based design invented by Alexander Graham Bell more than a century ago -- onto broadband connections. "Some people have the luxury of postponing this shift because they own mobile businesses," says the 52-year-old CEO. "We don't." His ultimate goal: to retire the old network entirely between 2011 and 2014. No other telco has made such a promise.

Getting there won't be cheap. Verwaayen is boosting BT's capital spending 10% this year, to $5.5 billion, with two-thirds of it for his 21st century broadband network, dubbed 21CN. All told, BT's makeover could cost upwards of $18 billion over the next five years, but the payoff could be big. Verwaayen estimates that by 2008, 21CN will save $1.85 billion in annual costs, thanks to the elimination of redundant equipment and facilities. More important, it will provide a foundation for cutting-edge services. "BT has a vision for the future, and it's laying the groundwork now," says David Mercer, principal analyst with the digital-consumer practice at researcher Strategy Analytics near London.

HIGHER DEMAND

The potential is clear. On July 15, BT kicked off consumer-broadband services that go beyond anything offered by rivals in Britain or Europe. The company's Communicator product, developed with Yahoo! Inc. (YHOO ), offers a host of features -- Web surfing, e-mail, instant messaging, and an online address book. But what really sets BT Communicator apart is that customers can make phone calls over the Internet for free to other Communicator users or at normal dial rates to conventional phones. Although BT gives up some revenue in the process, it figures higher demand for broadband and digital media will more than make up the difference. "We expect BT Communicator to be a major revenue driver," says Pierre Danon, CEO of BT Retail, BT's consumer unit.

Still, analysts aren't sold on BT's future. Despite the broadband push, they predict a slow revenue decline over the next four years, to $33 billion in 2008. Things would get worse, though, if BT sat on its hands. Verwaayen is also reselling wireless service and pushing into IT consulting and global data networking. That, plus the shift to broadband, gives BT a shot at holding its ground. If consumers go wild for broadband, BT will be in a position to grab the next wave. "Lots of operators are pursuing similar visions," says Niel Ransom, chief technology officer for Paris communications equipment maker Alcatel (ALA ), a major supplier to BT. "But those doing it with less urgency could be a dying breed."

The Dutch-born Verwaayen has put BT into overdrive in the past two years. When he arrived from telecom equipment maker Lucent Technologies Inc. (LU ), BT had $19.5 billion in debt -- a hangover from the 3G mobile-license frenzy -- and its shares were 83% below their December, 1999, peak. Verwaayen cut expenses, returning BT from a net loss of $4.6 billion in fiscal 2002 to a $2.6 billion profit in 2004. Improved cash flow has let him trim debt 40%, to $15.7 billion. He aims to pare it to $13 billion by 2006. The turnaround helped lift BT's stock 8% this year, vs. a 2% decline for the S&P Europe 350 Telecommunications Services index.

With BT's financial house in order, Verwaayen can turn to innovation. Typical of his out-of-the-box thinking is a new product, code-named Project Bluephone, that could revolutionize telephony by erasing the gap between fixed and mobile service. With a single specially equipped handset -- the initial model comes from Motorola Inc. (MOT ) -- customers will be able to roam around as with any wireless phone. But when they're in their homes or offices, the signal will be automatically rerouted through a broadband connection at low fixed-line rates or even for free. The combination means customers will have just one phone number and one bill, avoiding the hassle of juggling different address books. And corporate customers could eliminate desktop phones while saving millions in mobile charges.

Project Bluephone isn't expected to become commercially available until early 2005. But it's another example of how Verwaayen is leading BT out of its dark days into an era of renewed confidence and ambition. "Innovation is the only asset we have," he says. That, and a CEO with keen determination to ensure BT a place in the future.

By Andy Reinhardt in Paris

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