• The London Finance Journal

BT: Buyers Sniffing?

Updated: Sep 8, 2020

By Yogen Mudgal, BSc Accounting and Finance Student at Warwick Business School

The mighty British Telecom has always been in the centre of the action. It was the flagship privatisation from the Thatcher-era; and its monopoly-like features, combined with its importance in Britain’s digital infrastructure, have made it the City’s darling, at least until recently. Indeed, the occurrence of crises, first in 2001 and then in 2008 when its international business ran into trouble, has weakened the company's former state monopoly and led to its share price plummeting by 80% in the past five years. In less than one year, it has witnessed the full scale of the political spectrum: from prospective renationalisation under a Corbyn-led Labour government to now being on the radar of private equity shops like KKR.

Much about BT can be summed up in two words: FTTP and Openreach. Openreach is the most valuable segment of BT, valued at more than £20 billion. To put that into context, the entire market capitalisation of BT is about £10 billion. Openreach connects more than 3 million premises to the superfast fibre broadband (FTTP) network and BT intends to invest about £12 billion to expand that network to £20 million by 2025. Openreach drives solid revenues and has been dubbed the ‘family silver’ thanks to its profitability and growth prospects. The conversation surrounding BT remains focused on whether such a business can thrive under a private equity buyer.

Aside from the optimistic outlook at Openreach, much is not well at the namesake for British telecoms. The heavy capital expenditure has been weighing on the stock price and the company cancelled its dividends for the first time since privatisation this year. The £10 billion hole in its pension scheme and over £18 billion in debt also point to a lack of financial prudence. In addition, its Italian operations took a big hit in 2017, BT sports remains lacklustre in the age of COVID-19 and growing competition in both its broadband and mobile business has killed its monopoly. Even the now stabilised global services might find it hard to grow in spite of offering services in increasingly attractive technologies like cloud infrastructure.

The brewing situation at BT points to a need for better financial and operational management. It builds a case for taking the company private and operating it away from speculation and scrutiny of the public markets. Preliminary calculations from Reuters suggest that the BT’s enterprise value is nearly £50 billion, which put its equity at three times the current value after deducting debt. Assuming a consortium of investors can get their hands on BT at roughly £15 billion, there is significant money to be made from the deal, whether by selling the company for parts or holding onto assets that will generate solid cash flows for potentially decades, or a combination of both.

The value of telecom infrastructure like Fibre Networks has exploded in recent years thanks to the high cash generation from such assets and this makes a solid case for targeting Openreach. Many smaller networks (altnets) in the UK have been acquired by long-term infrastructure investors like KKR, Goldman Sachs and Macquarie at steep valuations. For the most part, PE ownership has not hit their ability to keep high capital expenditure. Goldman Sachs’ owned CityFibre, for example, hopes to reach 8 million premises by 2025 and has been adding tens of thousands of jobs to support its growth. However, BT is not just a telecom infrastructure firm and the examples of telecom conglomerates that successfully separated their infrastructure and consumer business far and about.

Effectively, BT’s buyout could work in two different ways. The first is that the entire company is taken private and it would be naïve not to recognise that its PE owners would then most likely sell it for parts and might keep Openreach’s assets for the long-term. This is an unlikely option for several reasons, the least of which is that the management has hired Goldman Sachs to prevent such a hostile takeover. It would also mean having to deal with the pension deficit and huge public and political repercussions. BT operates a lot of critical national infrastructure and is also key to fulfilling the Prime Minister’s manifesto promise of 100% FTTP coverage by 2025.

The second and more likely scenario is one in which BT decides to spin-off Openreach to pay for the capital expenditure and costs in restructuring its other business. While the management has so far avoided this, the FT reported back in May that the company was in preliminary discussions with Macquarie to move ahead with that. The decision will most definitely be welcomed by shareholders who have criticised the speed at which reforms have taken place at BT and want the company to start delivering for them. The management has been trying to fight the need to sell-off Openreach, but it seems more of an eventuality now.

The bottom-line is this: BT needs to act because the cost of inaction can mean it ceases to exist as a publicly traded company. It cannot keep pretending that the government will block any PE deal because these funds have proven their ability to run telecom infrastructure assets well and they can strengthen their hand by bringing a sovereign wealth fund into the mix. Unless the management can start delivering shareholder value, it will remain on the radar of private equity companies in spite of all its liabilities and perils. Investors believe that it is already too late for reform and restructuring and perhaps the best way forward is to split the difference and allow Openreach to be owned by private funds, without risking the future of the entire group.

By Yogen Mudgal, BSc Accounting and Finance Student at Warwick Business School

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