BT's Patterson Feels Italian Heat

Shirt buttons undone, hair tumbling over his collar, BT boss Gavin Patterson usually cuts a dashing figure in the staid world of telecom. But he will do well to maintain his laid-back demeanor in the days and weeks ahead. Not only has the true cost of an Italian accounting scandal just become disturbingly apparent, but the outlook in the business and public-sector markets is grim. Analysts are worried. (See Dodgy Italian Job Savages BT Earnings, Share Price Tanks.)

BT's share price has lost about a fifth of its value since news of the dodgy Italian job broke this morning. Irregularities now look set to cost about £530 million ($663 million) in balance sheet write downs, up from an October estimate of £145 million ($181 million). A number of executives have either quit or been forced out. Others, including Patterson himself, could follow.

Not-So-Smooth Operator
Gavin Patterson, BT's CEO, is under growing pressure following revelations of an accounting scandal in Italy and some gloomy forecasts by the UK service provider.
Gavin Patterson, BT's CEO, is under growing pressure following revelations of an accounting scandal in Italy and some gloomy forecasts by the UK service provider.

Shares might have held up better had BT Group plc (NYSE: BT; London: BTA) not soured what was already an unpalatable serving with some rancid forecasts. BT's activities in business and public-sector markets are in for a torrid 2017, said the operator. Combined with the effect of write downs, that means revenues will not rise in this financial year (which ends in March) or the next one.

Shareholders are understandably concerned. BT already contends with a £9.5 billion ($11.9 billion) pension deficit that is a perennial source of worry to investors, and its net debt has ballooned to a similar amount since its takeover of EE, the UK's biggest mobile operator, last year. Suddenly, investors are being told that operating profits this year will be £300 million ($375 million) lower -- at £7.6 billion ($9.5 billion) -- than previously expected.

BT steered well clear of the "Brexit" word in today's statements, perhaps fearing any mention would cause further dismay, but UK's decision to leave the European Union (EU) may be partly to blame for a gloomy outlook in the domestic market. Several banks are planning to relocate large numbers of staff from London to Europe. Elsewhere, there are signs that businesses are cutting investments as Brexit looms. (See What Hard Brexit Means for Vodafone, BT.)

So far, there is no indication that consumers are slashing their spending on communications services. Indeed, consumer services, including broadband, mobile and TV offerings, remained an engine of sales growth in the months after the June referendum on Brexit. Yet this could easily change. The pound has sunk to a 30-year low against the US dollar, driving up the cost of imports. And as higher living expenses chew into household incomes, BT's customers may face choices about what to cut and what to keep.

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As BT's largest single shareholder, with a 12% stake in the UK operator, Deutsche Telekom AG (NYSE: DT) might also be weighing its options. The German operator has already been spooked by the Brexit vote, and it is also worried about calls for a BT carve-up from the incumbent's rivals. Concerned about BT's market dominance, regulatory authority Ofcom wants it to erect bigger walls between the Openreach infrastructure business and the rest of the BT Group. In November, it told BT it would force through a stringent form of such "legal separation" unless the operator came up with its own plan. (See DT's Biggest BT Bother: Break-Up, Not Brexit and Only BT's Dismemberment Will Sate Rivals.)

For Ofcom and government authorities, the troubling uncertainty is whether today's news about write downs has any impact on BT's spending. Telecom is a notoriously capital-intensive business, and BT last year invested about 14% of its revenues in capital expenditure. In all likelihood it will at least have to maintain those spending levels, if not increase them, to pay for a planned rollout of higher-speed services. Using G.fast, which boosts broadband speeds over copper lines, it aims to extend 300Mbit/s to 500Mbit/s services to about 10 million homes by 2020. Even higher-speed fiber-to-the-home technology will be used to connect another 2 million by the same date. (See BT Looks Beyond G.fast With PON Trials.)

Patterson has repeatedly insisted that only a united BT, in full control of Openreach, will be able to fund the broadband improvements the UK economy needs. As rivals that use BT's infrastructure continue to clamor for its complete break-up, he will be desperate to stay on track. But with his own future at BT surely on the line, that task just got a little bit harder.

— Iain Morris, Circle me on Google+ Follow me on TwitterVisit my LinkedIn profile, News Editor, Light Reading

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