Carphone Faces Broadband Hiccups

Carphone Warehouse Group plc (London: CPW)'s free broadband offer has turned out to be a costly venture for the U.K. operator, which said today it will take an additional £20 million ($37.23 million) hit this fiscal year as it struggles to cope with greater-than-expected customer sign-ups.

And the company may have added to its headaches with the acquisition today of AOL (UK) Ltd. for £370 million ($688.79 million) in cash. (See Carphone Acquires AOL UK.)

In its second quarter trading update, Carphone Warehouse revealed it now expects its broadband rollout to cost £70 million during the 2006-2007 financial year, up from its previous guidance of £50 million. (See Carphone Updates on Q2.)

The operator touched off a fierce battle in the U.K. with the launch of a "free" broadband bundle in April (customers pay £20 per month for a fixed-line phone service and get broadband thrown in), one of the factors behind AOL's exit from the market. (See Free Broadband Comes to the UK and AOL Mulls Euro Broadband Exit.)

But Carphone now admits it has become a victim of its own success, signing up 625,000 customers since it announced the service. It has so far connected 421,000 of those to its TalkTalk voice and broadband bundle with an average 5 week wait, while 78,000 people have given up waiting and canceled their orders or found they can’t be processed.

Carphone now has an additional 1.5 million broadband and 600,000 dialup customers from AOL to deal with, which it says will have the option of switching to the TalkTalk service from January. The operator is also introducing a broadband only service to hold on to those customers who don’t want voice.

The deal will make Carphone the number three broadband provider in the U.K. behind ntl group ltd. (Nasdaq: NTLI) and BT Group plc (NYSE: BT; London: BTA), news that drove its share price up 30.5 pence (9.15%) to £3.64 on the London Stock Exchange.

The losses Carphone is incurring on its free broadband offering are driven by three factors -- higher wholesale costs from having a larger customer base, the unexpected recruitment of hundreds of additional staff to handle customer service issues, and delays in unbundling BT exchanges.

Carphone has so far unbundled 370 of the 1,000 exchanges it has targeted for switchover by May 2007 and only 20,000 of the 421,000 customers connected are on unbundled lines. Until customers are switched to Carphone’s network, it’s paying BT to provide them with broadband through its IP Stream wholesale service, which is more expensive than Carphone’s unbundled product. The companies are working to accelerate the switchover process to cope with demand.

When Carphone Warehouse announced the service in April, CEO Charles Dunstone threatened to sue BT for the money it would lose on delays, but in a Webcast presentation to investors and analysts this morning, he sounded a more conciliatory note: “We chase them very hard on the repairs. I spent most of yesterday AOLing with Openreach [BT’s wholesale arm] going through all of these issues. They are absolutely committed to fixing it and doing it right... It’s just an enormous organization trying to do something on an industrial scale that it’s never done before.”

He added: “I think to be honest if we went to Ofcom or had a big standup row with them it would actually be very destructive to the process of everybody trying to make it work.”

Dunstone made sure to defend the operator’s customer service record after it was featured on the BBC’s Watchdog expose program last week with complaints from subscribers who have been caught in the backlog or disconnected from the service.

“I feel that we’re getting a lot of kicking for these things and actually you need to put what we’re doing in perspective with the rest of the industry,” he said. “We’re working very hard not just to catch up with where we think it ought to be, but we know we’ve got to over-index our service to restore our reputation. I think very importantly the momentum in customer recruitment remains very strong and people are amazingly resilient in signing up to this service whatever is on TV or whatever might be written.”

The presentation was delayed as Carphone scrambled to change its progress report in light of the AOL agreement, which it says will boost pre-tax profits for the year by about £10 million -- restoring its original forecast that would have been swallowed up by the additional broadband losses.

The acquisition, for which Carphone beat off Sky , includes a revenue sharing agreement with AOL and Time Warner Inc. (NYSE: TWX) for advertising on a jointly-branded content portal. Executives said the deal will bring in incremental revenue since Carphone never planned to offer content.

CFO Roger Taylor said Carphone will be also be looking at “how we can develop that together as we then put a similar environment in terms of joint portals out to our own customers who currently don't have any of that experience -- we just simply leave them loose on the Internet.”

— Nicole Willing, Reporter, Light Reading

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