In December 1984, four months after privatisation, Labour MP Alan Williams decried the ‘criminal incompetence’ of the Government for having allowed British Telecom to be sold at 130p per share. Thirty-six years later, having fallen to around 110p per share, down from 500p in November 2015 and 44% YTD from 196p, there is a case to be made that the late Father of the House’s 1984 description of ‘under-valued BT shares’ equally applies today and that the long-term downwards trend may reverse in the near future.
Firstly, looking at the fundamentals makes CEO Philip Jansen’s £2 million purchase of shares in May very understandable. With a £1.7 billion profit in the 12 months ending March 31 2020, BT trades at a P/E ratio of 6.4, which is healthy compared to its historical average of 9. Looking at book value, we can see that the £14.8 billion gap between BT’s total assets and liabilities is a full £3.8 billion higher than its current £11 billion market capitalisation.
In addition, as the owner of EE, BT stands to benefit as a leader in the roll-out of 5G, having already launched in over 100 UK towns and cities. It also boasts exclusive Champions and Europa League broadcasting rights until 2024, which has the potential to increase the number of long-term customers to BT Sport.
There are also reports that this fall in share price is being noticed by potential acquirers. In late August, Sky News reported that BT had asked Goldman Sachs to update its defence strategy against a takeover bid, amidst rumours that several large private equity firms were considering joining forces for anacquisition. While the typical 30-50% takeover premium would provide a healthy return for investors, it must be noted that no firm evidence has arisen concerning a specific bid. In addition, if underinvestment and excessive cost-cutting were suspected, such a bid would undoubtedly face political obstacles.
However, there are a number of reasons to be wary of the telecommunications giant. The £31 billion O2-Virgin Media merger, has created a significant rival, whose competition may force a cut in profits. In addition, falling revenues (from £24.1 billion in 2017 to £22.8 billion last year) are undoubtedly a concern, although the improved services resulting from widespread investment in full-fibre broadband and 5G should play its part in halting that slide.
However, that hefty investment leads to the most worrying concern surrounding BT – debt. The £12 billion cost of the pledge to roll out full-fibre broadband to 20 million premises by 2030 (FTTP), on top of the estimated £500 million cost of the Government’s order to remove Huawei from all networks by 2027, is a significant commitment for a company that has £18 billion in net debt. Currently, the £757 million net interest charge that debt produces is manageable at 24% of its £3.1 billion operating income. The drop in BT’s pension deficit to £1.1 billion from £7.2 billion should free up funds for its investments and debt-servicing, however, they still represent hefty long-term costs that will dampen profitability.
So much so that with the added negative impact of coronavirus, the company cancelled its annual dividend for the coming year for the first time in its 36 year history as a private company. However, with a strong prior history of high dividend yields, the planned resumption for the 2021/22 financial year of 7.7p per share brings a very healthy 7% dividend yield at current share prices (in line with 6.8% and 6.9% in 2018 and 2019 respectively).
Therefore, whilst BT does have notable risks attached to it in the coming year, mainly in the form of increased competition and the effect on debt of hefty investment commitments, it remains a profitable company. The FTTP and 5G investment is both wise and unavoidable and will increase the likelihood of it maintaining or even growing its substantial customer base. What is more, with its new management signalling a willingness to streamline and raise cash through asset sales and efficiency savings, its debt problem can be addressed. At current share prices, if managed well, there is not only potential for decent capital gains over the next decade, especially given high increases in data usage, but for high dividend yields once they are resumed after the coronavirus threat has passed.
The Sweeney Club 