Imagine you owned £34b of assets. Scary thought, I know, but just imagine it. You personify the corpus of shareholders of British Telecommunications (LSE: BT.A).
As the owner of the business you delegate the management to other people, and you pay them handsomely for it. These manager chappies had been hinting in the last few months that things hadn't been going quite so well of late, but not to worry about it.
Anyway, last week they told you the full story. Apparently you started 2000 with £22.7b of capital in this business, but these guys spotted a couple of good deals and spend £19b scooping up some bargains. They didn't actually ask you if they could spend the money and, yes, they knew it was a lot, but they had a cunning plan to sort that out. Rather than pester you for the money they went to the bank which was delighted to lend the money. Now of course the bank is charging interest on all this debt, a short £28b, and quite frankly, £1.3b every quarter is a bit painful. Trouble is, the things they bought won't come good for a few years yet, so there is no additional income to pay the increased interest bill. Just to make matters even worse the managers had decided by the end of the year that these things were worth a bit less than they had paid: about £3b less, in fact.
So, along with the full story last week, they wanted to know if you wouldn't mind putting your hand in your back pocket and stumping up a few quid to help them out. About £6b should do it. And, to add insult to injury, they said you wouldn't be getting any cash out of the business this year via the dividend. Last year that amounted to £1.4b so really you're down about £7.3b.
All in all, you are a bit peed off with these guys. For the last 16 years everything has been going OK but now it's come to a sticky end: no income and a request for a handout. The temptation is to sell the lot and be done with it. The snag is that the business is only worth about £32b now. Last year you could have got three times that.
Nevertheless, in the short term you have to address the issue of giving them a sub to keep going or the whole thing could be worth even less. Looking at the numbers for last year in more detail you note that the profits actually declined, even before the interest charge. Stripping out all the funny factors in the accounts the business made a profit of £2,664m against £3,198m the year before. Not very impressive, but how does that stand up in terms of return on capital employed? Because the business expanded so much during the year it makes sense to use an average of the capital employed to see how productive it really is. In fact it works out to a return of 9.5%, a lot less than the 14.1% it made the year before. The reasons for that are not hard to find.
The business seems to eat capital. Last year it spent £5b on capital expenditure over and above the fancy deals, and this year it plans to spend another £4.9b. But the existing capital base is suffering from increasing obsolescence as asset lives shrink, as proven by a rising depreciation charge. On top of that the growth rate of its core business, calls using the fixed network, has shrunk to only 2% from 7% a year ago. Add falling prices to that and the reason for the 4.3% fall in turnover is obvious. Unfortunately costs are not going the same way. They rose 17% for a variety of reasons that included interconnection and pension expenses.
All this shows up clearly in the £5.9m cash flow from operations, no higher than the previous year, but only a bit more than the routine capital expenditure. That leaves precious little for things like tax, interest, dividends and so on. No wonder it has passed the dividend this year. When it is restored it will certainly be at a much lower level.
In summary this is not a growth business anymore, but neither is it generating enough cash to make it an income stock. The evidence from the falling returns on capital indicate that BT is no longer a good home for additional capital and, for that reason, provides no incentive to give it any more. Until it can demonstrate that it is using its own money more efficiently I see no reason to give it more of mine. So vote bear: don't take up the rights, and sell the shares.
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