BT Plunges After Cutting Outlook, Tripling Italy Writedown

  • Shares drop the most in three decades on $661 million charge
  • Company also says business deteriorates in U.K. on Brexit

BT Group Plc delivered a one-two blow to investors by disclosing deeper accounting errors at its Italian unit and cutting its outlook as the impact of Brexit works its way through government budgets. 

The stock dropped as much as 21 percent, the most since 1986. The U.K. telecommunications company said a probe found more faulty accounting and “inappropriate behavior” in Italy than the company first identified in October, forcing BT to triple the amount of a writedown to 530 million pounds ($661 million).

Gavin Patterson

Photographer: Chris Ratcliffe/Bloomberg

“We are deeply disappointed with the inappropriate behavior we found,” in the Italian business, Chief Executive Officer Gavin Patterson said on a conference call. “The extent and complexity of inappropriate behavior was far greater than previously identified.”

Patterson, in his fourth year as CEO, finds himself facing an expanding set of challenges, from the scandal unfolding in Italy to Brexit, rising competition in key businesses, a ballooning pension deficit and an escalating battle with regulator Ofcom. While consumers are holding up well, the U.K.’s decision to leave the European Union is stoking inflation and squeezing the budgets of BT’s clients, causing some of them to end contracts early, the company said.

“This is a profit warning across the board,” Saeed Baradar, a telecom sales specialist at Louis Capital Markets in London, said in a note. “This does not bode well for the Global Services division and implies pressures across the board and across all divisions,” he said, referring to BT’s international unit that provides communications services to multinational companies.

The accounting issue in Italy is the biggest contributor to the lower earnings outlook this year, while the weaker U.K. and international businesses are more to blame for the reduced forecast for next, executives said on the call.

They said BT is now unwinding improper loans taken out by the Italian managers which were used to pay suppliers. The loans used BT Italia’s accounts receivable as collateral, in a process known as factoring. There were also improper transactions involving the measurement of revenues, operating expenditures and capital expenditures, as well as sale-and-leaseback deals, they said.

The former U.K. telephone monopoly has contracts running communications and IT systems for public-sector clients up and down British government, from national agencies to local area councils. The June Brexit vote caused the pound’s value to drop, leading to the inflation that is driving costs within the U.K. higher.

“The outlook for U.K. public sector and international corporate markets has deteriorated,” the company said in a statement. In those markets, BT now expects “a double-digit year-on-year percentage decline in fourth-quarter underlying earnings before interest, taxes, depreciation and amortization.”

BT now expects revenue for the fiscal year ending in March to be flat, after forecasting growth as recently as October. For the coming year, BT reduced its target for normalized free cash flow by as much as 17 percent, to a range of 3 billion pounds to 3.2 billion pounds, from a target of more than 3.6 billion pounds issued in October.

BT joins U.K. outsourcing companies Mitie Plc and Capita Plc in reporting Brexit-related slowdowns. Mitie, which cleans London’s Heathrow airport, last week issued its third profit warning since September, citing “client deferrals and investment plan delays.” Capita, which operates London’s traffic congestion charging system, said it would cut more than 2,000 jobs as clients cut back on “discretionary elements.”

On the call, Patterson apologized to investors for for what he called “headwinds” that were stronger than anticipated in the U.K. public-sector business and in BT’s international global-services division.

The company will report results on Friday that will show that consumer and other parts of the business are strong, Patterson said. “It is a mixed bag of results that we’ll talk to you about later in the week.”

BT declined 20 percent to 305.15 pence at 3:50 p.m. in London, after falling as much as 21 percent to 301.40 pence. The drop eclipsed the shares’ worst decline during the 2008 financial crisis, making it the biggest drop since at least January 1986. BT went public in 1984.

Accounting Probe

The Italy writedown, an increase from a previous estimate of 145 million pounds, will reduce third-quarter revenue and Ebitda by about 120 million pounds, BT said.

BT’s Italy division made up about 1 percent of Ebitda in the year ended in March 2016. It’s part of BT’s continental Europe business that makes up about 13 percent of revenues, according to data compiled by Bloomberg. The investigation that included a review by KPMG found “improper accounting practices and a complex set of improper sales, purchase, factoring and leasing transactions” that led the company to overstate earnings in its Italian business over a number of years, the company said.

For Gadfly’s view on Patterson’s stewardship, click here.

“Given the modest scale of the Italian business, the magnitude of the hit it has caused is concerning,” said Richard Marwood, senior fund manager at Royal London Asset Management, which owns BT stock. “The warning that spending by government and corporate customers has shown some signs of softening is the sting in the tail of the announcement.”

Bloomberg News reported in September that BT had suspended two top executives while conducting the investigation, BT Italia CEO Gianluca Cimini and Chief Operating Officer Stefania Truzzoli, people familiar with the matter said at the time. The following month, BT said it was conducting an accounting probe at the Italian unit and was reassessing areas of management judgment after discovering historical accounting errors.

BT’s woes in Italy come as the company steels itself to defend its TV rights to European Champions League football over coming weeks, currently the company’s most valuable television content. It owns the rights through a three-year deal costing almost 900 million pounds, after beating the incumbent Sky.

“The auction will once again bring to focus the high cost of investment in content, returns from which can never be justified,” Baradar said.

BT is still assessing the impact of the adjustments on its current estimates and how they should be reflected in financial statements for prior periods. The company has appointed a new chief executive for its Italy business whom it didn’t identify, to start on Feb. 1.

— With assistance by David Hellier

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