Link :
http://bit.ly/1CJwOnM
BT's Patterson: Why splitting the company is without merit
Gavin Patterson says he will make “a strong case for the status quo” despite the challenges gripping the sector
If Gavin Patterson, the chief executive of BT, is worried then he is a fine actor. Even as Ofcom announces it is considering stripping his company of control of its best asset – the national telecoms network – he reclines in a leather armchair in his office and maintains a posture so relaxed he looks as though he might slide on to the floor.
Nevertheless, the suggestion by the regulator, with Sky, TalkTalk and Vodafone cheering it on, that BT could be forced to sell off Openreach, the £5bn-a-year wholesale business behind Britain’s broadband infrastructure, has not gone down particularly well.
In telecoms industry jargon, a potential split of BT is termed “structural separation”, as opposed to the current regime of “functional separation” that obliges Openreach to wholesale to BT’s rivals on equal terms to its own retail business.
“I don’t know what problem structural separation is meant to solve,” says Patterson, 47, who took the top job at BT two years ago and has been at the company more than a decade.
“The risk as well if we do follow this path is that the business gets separated and you’ll never be able to put it back together. It would be one way, and there are no successful examples of this anywhere round the world.”
Sky and TalkTalk argue that a split would curb BT’s growing power in the market and deliver better service from Openreach, which has a poor, albeit improving, record on fault repairs and new line installations.
Patterson concedes Openreach needs to improve its performance on service, but knows he has an arsenal of weapons with which to discourage Ofcom from forcing a sale.
He threatens a legal quagmire and a resulting decade of under-investment in Britain’s internet infrastructure, and problems with filling the £7bn black hole in BT’s “monster pension fund” – a liability ultimately underwritten by the taxpayer. An independent Openreach, a business that would produce highly reliable cash, would also be a target for private equity owners, claims Patterson.
“At the end of it, and if we’re meant to be looking at the next 10 years, what do you want to look back on?” he asks, in an apparent aside to George Osborne and Sharon White, the recently installed chief executive of Ofcom. “Do you want to see the UK still at the forefront of the internet economy, with the most developed online economy in the world by some definitions? Or do you want to look back at 10 years of litigation and arguments?”
The Cheshire-born executive rejects suggestions that BT’s ownership of the national network and the cash it produces gives BT and unfair advantage over rivals. Instead, he claims, Openreach and its infrastructure benefit from being tied to the company’s other businesses.
“Openreach benefits from being part of the wider BT group, it’s not the other way round. Its rivals seems to be framing it as somehow Openreach funds the BT group. It’s quite the opposite.
“Openreach benefits from the balance sheet of the BT group, the scale of research and development in BT, and from the ability to ensure there is a customer who will buy its services.”
BT’s next investment in Openreach will be “ultrafast broadband”, using so-called G.fast technology pioneered in its own labs. It will mean another capital outlay “on the same sort of magnitude” as the £3bn spent on superfast broadband, but Patterson will not sign the cheque until Ofcom has ruled out structural separation.
It is a form of ransom of the digital economy, which will need higher internet access speeds and quality as the demand for data balloons, but Patterson is unapologetic.
“With some regulatory certainty, we will be incentivised,” he says. “With the alternative – down the path of separation – we won’t have that certainty, so it won’t make sense. It’s what our shareholders would expect and it’s not an unreasonable position to take.”
The motives of Sky, run by his Surrey neighbour and fellow Procter & Gamble alumnus Jeremy Darroch, and TalkTalk, run by Dido Harding, in calling for the split of BT are questionable, he suggests. Patterson also attacks their record on investment as compared with BT’s £3bn spending on superfast broadband upgrades over the past five years.
“People forget five years ago, Dido, Jeremy and others who are arguing that Ofcom should push for separation. These are the people who said the country does not need fibre, their customers don’t need fibre. The hypocrisy is quite staggering,” he says.
“It’s not that there aren’t issues, I’m not saying that. There are things we could do better. But it seems the risk is we don’t look at this in the whole and become obsessed with one component of the market, which is the component that works the best.”
As well as putting the structural separation of BT formally on the regulatory agenda, Ofcom’s publishing of the discussion paper last week on the next decade of the communications market dealt a blow to the company effort to curb Sky’s dominance of the pay-TV market. The watchdog said it will look at how the distribution of television affects the market for bundles of communications services, but stopped short of a full review of how Sky is kept in check.
Patterson is disappointed, but not giving up. He wants the creation of an Openreach-like structure for content, ensuring that all providers can access sport and films on the same terms.
“Ofcom could, and in fact I think they should, have gone further on pay-TV. They’ve not been clear enough,” Patterson complains.
“We get intense scrutiny and regulation and there has been innuendo and accusation that we are somehow prioritising our own retail units, which have a 33pc share of the market. Contrast that with virtual zero-touch regulation in TV where Sky have 64pc market share.
“You can argue the toss on the nuances of the differences between the two, but at a fundamental level that’s the elephant in the room.”
The Ofcom process is just the latest iceberg Patterson must circumnavigate in a year that has already included a record-breaking Premier League rights auction, where BT managed to emerge without paying much more for a similar share of matches, in contrast to Sky which paid throughout the nose to maintain its dominance.
There has also been a triennial reassessment of its pension deficit and merger mania in the telecoms sector, kicked off by BT’s own takeover of EE.The landmark deal is under scrutiny from the Competition and Market Authority, but Patterson is confident it will go through.
“We think the case is a strong one. There is no reduction of competition. We’re a committed wholesaler. EE is the biggest mobile wholesaler and we’ll stand by that and build on it.”
BT’s return to the mobile market heralds the arrival of “converged” services that allow subscriber to buy internet connectivity packages that are is agnostic to whether they are on a fixed line or mobile network. Patterson says the company is still working through how such services will work, but it ongoing talks between Vodafone and Liberty Global aimed at combining the mobile operator UK network with Virgin Media, the cable operator, indicate his £12.5bn bet on EE was right.
Again, the biggest challenge if the deal goes through will be service. Both BT and EE score worse than most of their rivals for retail customer service. Patterson says it is a “perception challenge”, although more call centres will come back on shore.
“It’s not to say we don’t have an operational challenge, but I think the perception is that there are concerns in that area. I think we’ve got our work cut out to really demonstrate that service is at the heart of this.”
One consequence of the deal will be Deutsche Telekom, one of the current owners of EE, taking a 12pc stake in BT and a seat on the board. It is widely seen in the industry as a potential prelude to German takeover of Britain’s former state monopoly, as part of an expected cores-border telecoms consolidation in Europe. Patterson is already preparing for the next wave of mergers.
“BT is a very attractive business for a number of reasons. It has a consistent track record on delivering its promises on investment and financial results.
“So if there is a consolidation, I think we can play a role somewhere. It could be that we’re the consolidator. It could be someone decides they would like us to be part of another group.
“Do I think consolidation of this next 10-year period is inevitable? I think it’s a high likelihood that Europe goes from 400-odd providers to something a lot less. I hope we don’t go to the low numbers you see in the US because that is not good for choice and competition.”
The next few months though are about a battle at home and despite the changes gripping the sector, Patterson says he will make “a strong case for the status quo”.
Although economic forecasters are expecting a September lift off, this starting date is still not fully priced into Fed funds futures (see Tim Duy.) What really matters, however, is whether the Fed then embarks on a medium term tightening path that persistently surprises the markets in a hawkish direction.
That is what has happened in each of the three previous tightening cycles, which were periods when fixed income traders consistently lost money by taking long positions at the front end of the yield curve. The current market pricing for forward short rates, which remains far below the Fed’s “dots” for the next three years, suggests that there is a strong possibility that this accident could repeat itself in the coming tightening cycle.For about three decades, it has generally paid for traders to assume that the Fed will deliver a path for short rates that is lower than that built into the forward curve for interest rates at any given time. Maybe that partly reflects the fact that a risk premium is normally priced into forward interest rate curves. But, in addition, interest rates have been on a long run downtrend, with the Fed repeatedly choosing to deliver easier monetary policy than the market has expected. “Never underestimate the dovishness of the Fed” has usually been a profitable motto for traders.There have only been a few brief exceptions to this rule. As the graph on the right shows, the forward money market curves for short rates (the grey lines) have generally been well above the path for short rates that has actually transpired (blue line), so traders holding long positions in short rate contracts to maturity have made profits.
The exceptions to this rule, however, have come when the Fed has embarked on a path to raise rates, in 1988-90, 1994, 1999-2000, and 2004-07. In those periods, the market did not believe that the Fed was really serious about tightening monetary policy, and lost money by betting on a dovish central bank.The question now is whether we are entering another of those exceptional periods during which the Fed surprises the markets by tightening more than expected. This depends on two factors: the date of lift off, and the speed of rate increases thereafter.The date of lift off is still a matter of contention. Recently, the IMFhas argued that it should be delayed until next year, and Paul Krugman has said that the costs of wrongly acting too soon are much smaller than the costs of making the opposite mistake.
For a long while, Janet Yellen seemed sympathetic to this asymmetry of risks, but lately she seems to have shifted her stance. Her recent message has been clearly tilted towards a path for rate increases that is “early and gradual” rather than one that is “later and steep”.Last week, she went as far as to say that “the economy cannot only tolerate but needs higher rates”. That is an unusually hawkish choice of words for a Fed Chairman who is usually viewed as a dove.Ms Yellen has been supported in this shift by her main lieutenants, including Stanley Fischer, William Dudley and John Williams. Paul Krugman says that the reasons for this shift are “mysterious”, and certainly they were not fully spelled out in last week’s Congressional testimony, which focused on the usual debates about the labour market and inflation.
But Ms Yellen outlined her underlying case much better in her important speech on the “normalisation” of interest rates on 27 March. She believes that rates are now well below “normal” while the economy is virtually at normal. Here, “normal” for rates is defined as the equilibrium real rate, which Ms Yellen expects to rise as economic “headwinds” diminish in the next few years.As this blog has argued before, analysis of the Fed’s forecasts shows that it is this rise in the equilibrium real rate, rather than the projections for inflation and unemployment (which are both assumed to be “on target” by next year) that drives the upward path for rates in the medium term.
Ms Yellen continues to argue that the upward path will be “gradual”. In an illuminating interview with the FT on 28 June, William Dudley explained that he interprets this to mean that rates will rise by 25 basis points four times a year, or at alternate FOMC meetings. That would be about half the pace seen in the 2004-07 tightening cycle, but it would still be much faster than the pace currently built into the market forward rates.Wiiliam Dudley also emphasised that the comment about gradualism should not be regarded as a “pledge”. It is just a central expectation, based on the Fed’s current forecasts for inflation and unemployment. If the economic outcome differs from the forecasts, then so too will the the paths for equilibrium and actual interest rates. That is what the Fed means when it says its actions will be “data determined”.That uncertainty gives the markets just about enough reason to adopt a much lower path for forward short rates than shown in the Fed’s current view of the future. But, at this stage of the cycle, the markets have often been wrong about the Fed’s readiness to tighten policy, and they may well be making the same mistake again.
