BT struggles to justify international ambitions
Italy scandal puts Global Services unit in crosshairs of investors who want it sold
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BT investors had a Groundhog Day moment last month, when news broke of a blow-up at BT Italia, one of the larger wings of the company’s sprawling international business called Global Services.
BT’s international unit has been the subject of billions of pounds of writedowns since the turn of the century. The latest setback — an accounting scandal at the Italian division involving false invoices, third-party financing and off-balance sheet loans — has again tainted the City’s view of the business.
It has also put Global Services firmly back in the crosshairs of those investors who believe it should be jettisoned, as BT tunes its strategy toward the UK and its consumer operations.
Gavin Patterson, chief executive, told the Financial Times last month that although he still believed there was a strong opportunity for telecoms groups to sell to multinational companies and governments, BT had struggled to justify its international ambitions. “It is the part of our strategy that has the least support,” he said, before committing to a “fundamental” review of the division, adding: “I am not religious about any part of the company.”
Global Services was once part of the Concert joint venture with communications company MCI, under “Project Sovereign” — a ploy by BT’s management in the 1990s to transform its civil service-style culture to one of an international player.
The unit thrived once under its own steam and was primed to be BT’s growth engine, as it signed large deals with the UK’s National Health Service, Reuters and Italian carmaker Fiat. It was supplying what the industry calls “managed services” — for example, broadband, desktop phones, cyber security protection and access to cloud storage — to a host of multinational companies that were looking to sign one big deal to cover all their international offices.
Its reputation was tarnished in 2008 when the unit missed its targets for profit growth and cost cuts. A new leadership team was brought in at Global Services, which found that the value of the contracts it had signed had been overstated. Almost £2bn was written off the book value of the division, and BT entered a downward spiral as a result.
Global Services, which has expanded to 180 countries and has 5,500 corporate and government customers, has gradually recovered to a point where it is profitable and generating cash. In the last financial year, the £5bn in revenue generated by Global Services was only just shy of that reported by Openreach, BT’s biggest unit, and slightly more than EE, Britain’s largest mobile phone company, which BT bought for £12.5bn last year.
1. Jun 1994: BT forms Concert JV with MCI to target international business
2. Jul 1998: BT, having failed to buy MCI, teams up with AT&T
3. Oct 2001: BT and AT&T pull the plug on Concert at a cost of 2,300 jobs
4. Mar 2005: Global Services wins a $3bn Reuters deal
5. Feb 2009: BT profits plunge as it writes off £300m in Global Services contracts
6. May 2009: BT hit by £1.6bn writedown and 15,000 job cuts announced
7. Jan 2017: Scandal at BT’s Italian unit triggers £540m charge
Yet that masks the reality that Global Services has, according to one analyst, been “shrinking forever” at the revenue line and that its profitability is miles behind other BT units. The £601m it generated last year in earnings before interest, tax, depreciation and amortisation is by far the lowest in the group.
The Italian problems are set to exacerbate the gap between Global Services and the rest of BT. Barclays forecasts show an 11 per cent drop in earnings this year at the unit, while operating margins are expected to drop to 7.8 per cent. BT’s overall margin, according to Barclays, will be 31.7 per cent this year or 38.8 per cent stripping out Global Services.
Mr Patterson is adamant Global Services is not “broken” and says years of cost-cutting mean it is generating cash and profit. He argues that severing its international arm would leave the company as a pure-play UK business and unable to serve large British companies that have overseas offices.
“Global Services is representative of a textbook business dilemma: damned if you do, damned if you don’t,” says Dhananjay Mirchandani, an analyst at Bernstein.
Jerry Dellis, an analyst with Jefferies, says Global Services has been on a “relentless treadmill of cost reduction” that has left “no breathing space to take stock”. He argues that BT has worked hard and aggressively to boost cash flow and margins at Global Services, but that its legacy products such as connectivity are in “perpetual decline”.
Although there have been rumours in the past that BT may look to sell the unit outright, Global Services is a business that is devilishly difficult to unpick from the rest of the group. The division’s assets are effectively a bundle of large sprawling contracts with companies and governments, built on top of network infrastructure it owns in the UK but leases elsewhere.
The business has also become a net supplier of cash to the rest of BT, in effect contributing to the company’s push into sports rights and its re-entry into the mobile market. That, according to one former Global Services employee, has left it less able to invest in proprietary technology, products and services to layer on top of its network contracts with customers.
Although BT has worked hard to reduce the bleeding at Global Services, it has not moved to team up with continental rivals with similar assets — such as Deutsche Telekom’s T-Systems or Orange Business Services in France — despite both companies being shareholders in the British telecoms company. A senior source within BT says such a move has been resisted as the German company in particular is seen as hard to reform because of its position in the heavily unionised German market.
The BT Italia saga could force it to look again though.
“There are structural answers to this conundrum, though BT seems to have ignored these in the past,” says Bernstein’s Mr Mirchandani. “The Italian scandal could be the much-needed catalyst for change. T-Systems, that is one option. Orange Business Services is the other. And a three-way tie in the areas of international connectivity and infrastructure-based cloud services would be a winner in what is a terribly crowded market.”