Through years of hard work, BT has transformed itself into one of Europe's best managed telecoms companies. And it has played a key role in giving Britain some of Europe's lowest-cost and highest-quality communications services. The best reward for those hard-won achievements? To break BT into half a dozen pieces. For what BT has so far achieved is to bring itself to the forefront of the 20th-century telecoms industry. To lead in the 21st, it will have to reshape itself completely.
Telecoms markets are disintegrating. When BT took its present form, telecoms meant telephones - in black bakelite - and the only company providing these telephones was BT itself. Today email, video-conferencing, computer data, fax, voice, the Internet and a raft of other services all jumble together on BT's lines, while a growing number of competitors are trying to lure away the most profitable of BT's customers. A break-up represents the best chance that BT - and, with it, Britain - have of prospering from this change, instead of being over-whelmed by it, for three reasons.
Firstly, breaking up BT will create smaller companies that fit their markets - be they selling telephones for the home, or global data networks to giant firms. Secondly, breaking up BT is the best way to resolve the regulatory stalemate between Ian Vallance and Peter Bonfield, BT's chairman and chief executive respectively, and Oftel's Don Cruickshank. Why? Because only break-up can really separate BT's infrastructure businesses (eg, the wires), which will have to remain regulated for the foreseeable future, from its service businesses (eg, the software that routes telephone calls over wires), many of which could be deregulated immediately. The third and final reason for breaking up BT is simply that, depending on how BT structures the deal, it could make the company a lot of money - enough to pay the £15 billion bill for wiring every British home and office with fibre-optic cable.
To understand how this windfall would be created, and how much it would benefit both BT and Britain to create it, you have to look at the underlying values of BT's constituent businesses. Valuing a company, or part of a company, is a relatively straightforward process. First find out how much the company earns. Shares typically trade at a more or less constant multiple of earnings. The trick is to find the multiple appropriate to the company you are trying to value. Fast-growing companies in dynamic markets command high price-earnings multiples; slower growing ones don't. We assume that BT contains six distinct businesses. This is not the only way to break the company up, but it does capture the big differences among the markets in which it competes:
BT Loop is a tightly regulated business which provides connections between homes and businesses and anyone who should want to sell them a telecoms service - be it telephony, Internet access, alarm monitoring or whatever. Britain has 26 million telephone lines. We assume that service providers will pay about £40 for each connection, and that 25% of customers will connect to more than one service provider. (Erring towards the conservative, we disregard any potential revenue from cable television and other high-bandwidth services which future companies might wish to squeeze down existing copper telephone lines.) This gives BT Loop annual revenues of about £1.3 billion. We assume net profits of about £160 million.
BT Trunk is another tightly regulated business which provides large chunks of long-distance transmission capacity - much of it to other telecom operators. Sales are about £3 billion: £1 billion from leased lines for data networks and other private circuits, £1 billion from international traffic and £1 billion from facilities provided to other telecom operators. Net profits are about £350 million.
BT Home makes use of the connections supplied by BT Loop - or rivals like COLT and Energis (see box) - to give homeowners basic telephony and extra services like call waiting and Internet connections. In the not-too-distant future, it could also offer cable television and interactive multimedia entertainment, but we base our estimates on sales and earnings of existing services only. BT Loop would start life with 20 million subscriber lines. We estimate sales of £180 a line, and net profits of £40 a line, which is less than the estimates of actual sales and profits made by Cruickshank's office at Oftel and by Analysys. We further discount those profits by 30% to allow for the inevitable loss of customers as competition to BT heats up. We calculate profits of £560 million. BT Business provides telephones, data transmission and other services to businesses.
Serving demanding customers requires high levels of professional expertise. So this is a higher overhead, higher service business than BT Home. With about 6 million lines and a net profit of about £80 a line, BT Business has profits of £480 million a year. BT Private Networks provides computer-systems integration services through joint ventures called Concert and Syntegra. These companies create and manage complex networks. They combine voice and data, and may effectively allow companies to run private telephone networks far more advanced than those BT offers its own customers. Investments: BT holds a 60% stake in Cellnet worth about £3 billion, a 20% stake in American telecom giant MCI worth about £2 billion, and other odds and ends - notably Yellow Pages and telephone-equipment sales - worth about £2 billion.
Apart from the investments - which are simply worth their open market value - we use two very different valuations for these business. We assume that the infrastructure businesses - BT Loop and BT Trunk - should trade on a price-earnings multiple of about nine. This is the average multiple of London Electricity or Seeboard, which do for elec- tricity what BT Loop does for telecoms, and of the National Grid, ditto for BT Trunk. On that multiple, BT Loop is worth about £1.5 billion and BT Trunk is worth about £3 billion.
There is no reason, though, to value BT's service businesses like the boring old National Grid. These are fast-growing businesses in dynamic markets. While exact comparisons are hard to find, a price-earnings multiple of about 25 would put the businesses squarely in the middle of companies like BSkyB (35), Reuters (25) and high-tech consultant SEMA (25) - and well below high-flying new media companies which command multiples of over 50 (see the table on page 43). Valued on that basis, BT Home is worth about £14 billion, BT Business £9 billion and BT Private Networks about £2.5 billion.
Tot up the value of all of these separate businesses and they total £37 billion. Throw in real estate or any fraction of the revenues that BT is likely to gain from new markets like interactive television and it gets even bigger. Given that BT itself, the sum of all these businesses, is valued at only £23 billion, this leads to an obvious question: what happened to all the value?
The simple truth is that BT's investors neither believe that BT will be allowed to compete vigorously in new markets, nor, for that matter, that BT will allow itself to compete. Breaking up BT could overturn both judgements at a stroke - and convince investors to give BT billions of pounds into the bargain.
Relations between Cruickshank and BT have sunk to an all-time low largely because Cruickshank is determined to ensure equality between BT itself and the companies renting BT circuits to create their own services. For without access to BT's wires and other infrastructure, competition could proceed only as rapidly as other companies duplicate BT's huge investments in wiring Britain - that is, at a snail's pace.
Monitoring equal access, however, requires Cruickshank to gather reams of statistics to ensure that BT is not secretly favouring its own service business. Recently, for example, he asked Vallance to monitor hour-by-hour how he spends his day so that the cost of the chairman could be properly allocated. Even worse, in Vallance's eyes, Cruickshank wants to use that information to decide what services BT should offer at what price - which is what Vallance and Bonfield reckon they are paid to do.
Splitting BT's infrastructure and services businesses would resolve this impasse. Monitoring the prices charged by the infrastructure companies is as easy as checking their billing records. BT Loop and BT Trunk would have no incentive to cheat. On the contrary, they would prosper by offering everybody - BT and competitors alike - the transmission capacity needed to create the best possible services. Making that capacity not just available for new services, but positively eager to lure new services on to its wires, could create a wave of innovation in both British telecoms in general and BT in particular.
By helping BT to focus on specific sets of customers, break-up could help it solve its own most pressing strategic problem - where, and how quickly, to innovate. BT knows it must leap to the forefront of the cataclysmic change sweeping across telecoms markets. Yet it does not want to leap over its own oldest and most loyal customers. Today, BT must try to satisfy everyone - and has to resolve any conflicts internally. The results are often clumsy compromises which frustrate all concerned. At the heart of the problem is the basic conflict between BT's infrastructure business and its services. The watchwords of the infrastructure business are ubiquity and quality; everybody needs a connection and they need it to work. This is not a part of the business that can easily tolerate any risk of failure. In the service businesses, however, those who do not risk failure are not moving fast enough.
Historically, and often for the best of reasons, BT has been ruled by the cautious philosophy of the infrastructure builder rather than the go-get-'em business spirit of the service provider. It did not market advanced services like call waiting and call for-warding for years after they were technically available because, as not all of its exchanges were digital, it could not offer them everywhere - and BT "did not feel right" about offering services only to part of the country. In Internet services, BT waited until February of 1996, when 1.5 million Britons had already been connected to the Net by small, entrepreneurial companies - most of them using infrastructure from BT's rivals - before even dipping a toe into the market.
In other countries, telecoms giants are already breaking themselves up, both to capture unrecognised value and to sharpen their strategic focus in fast-changing markets. In America, regulated local telephone services were split off from unregulated long-distance ones by the court-mandated break-up of AT&T in 1982. Japan's government now proposes a similar break-up for NTT, the world's largest telecoms company.
Some American local telecoms companies are breaking themselves up even further - with encouraging results. Pacific Telesis, Silicon Valley's local phone company, split its (relatively unregulated) wireless telecoms business to form AirTouch in early 1994. In 1995, US West spun off its interests in interactive television and other multimedia services. While the parent companies trade on a price-earnings multiple about the same as BT's, the spin-offs have achieved valuations three or four times higher than the conservative estimates we have made for a BT break-up, and both are engaging in the sort of hectic deal-making and innovation needed to justify that valuation by staying at the forefront of their markets.
Breaking up BT would be messy, expensive, painful and well worth it. No other option offers to eliminate so many of BT's problems - regulatory, strategic and financial - at a single stroke. By negotiating a break-up on their own terms, Vallance and Bonfield could christen BT Loop with an investment programme that would do both the company and Britain proud.
For years, BT's bosses have been wondering aloud about how they will get the £15 billion needed to bring fibre-optic cable to every British doorstep. Typically, this musing is linked to a request for new privileges from the regulator - like being allowed to raise prices or to offer cable television. But the money is right under their noses. One way that BTcould break itself up is to swap one share in each of the six new companies for each existing BT share. Then shareholders would reap the value. But BT could also sell off new companies, and keep the money for BT Loop. Then it could christen it with a fibre-optic network that would propel BT and Britain to the forefront of the digital revolution.
Charles Haslam (10042.1411@compuserve.com) is a director of Bridge, a telecoms consultancy. Paul Grover is a freelance journalist. Together they wrote "Beyond the Internet: Restructuring the Communications Market", published by Analysys.
Energis, a subsidiary of the National Grid which runs telecom lines alongside the power cables, already demonstrates how separating telecoms infrastructure from services can make money and encourage innovation. In late 1994 it struck a deal with Demon, a leading Internet service provider, which enables Demon to provide nationwide service without a nationwide network. Energis uses its infrastructure to collect local phone calls from across the country and deliver them to Demon headquarters in London. Energis exploits its infrastructure, and Demon concentrates on its service business; both win. Energis has also signed up Microsoft Network, Planet Internet and UK On-Line.
Meanwhile COLT (City of London Telecoms) has for the past five years been digging up the streets of the City of London to lay fibre-optic cable. Initially, it used that investment mostly to cherry pick high-volume, high-profit customers along its route. More recently it has begun to offer other service providers access to its infrastructure and its customers in return for a share of the revenues. Business is booming.
Competition is coming at BT from all directions. On March 26th, a new telecoms life-form will be created when Ionica begins rolling out a nationwide network of wireless phones. It's not just BT's services which face competition, now it's the wires too. Ionica's service is basically a digital version of cellular phones, except cheaper and more reliable because it doesn't have to be mobile. The capital investment needed to connect a home to its network is under £10, compared to more than £500 to bring wires to the door. And while BT employs tens of thousands of people to maintain all of its wires, Nigel Playford, Ionica's founder, reckons he will be able to keep his wireless network running with a fraction of that. The result is high-bandwidth (up to ISDN-speed) residential service across the whole of BT's network, at prices well below BT's. And while Ionica focuses on homeowners, NTL (National Transcommunications Ltd) is using similar technology to offer cheap voice and data services for business. For BT, it's adapt or die.
break-up brigade: the world's telecom companies
Company Revenues* Net Profit Market Cap** P/E ($ million) ($ million) ($ billion)
BT 22,520 2,806 35,000 13 NTT 65,569 960 61,000 64 Nynex 13,306 792 22,000 21 Pacific Telesis 9,235 1,159 12,000 12 Air Touch 1,235 98 16,000 126 US West 10,953 1,426 16,000 13 Comms US West n/a 276 10,194 72 Media Deutsche 41,920 -205 n/a n/a Telekom
*All results for years ended December 31st 1994, except BT and NTT, which are for the year ended March 31st 1995, and US West Media, which is an estimate for the year to December 31st 1995.
**As of February '96.