BT (LSE: BT-A) (NYSE: BT.US) is currently in the headlines as a result of it launching a SIM-only mobile phone plan that costs as little as £5 per month. This is clearly a disruptive move by BT and comes as it is in the process of acquiring 4G network, EE, for £12.5bn as it seeks to make its mark in a big way as a quad play operator (mobile, pay-tv, broadband and landline).
However, is BT expanding too quickly, too fast and leaving itself in a vulnerable financial position? Moreover, is key rival Sky (LSE: SKY) now behind the curve and worth avoiding in favour of BT?
A Changing Company
In recent years, BT has changed considerably. Not only has it waged war on Sky via its free BT Sport channel, it has moved into pay-tv in a big way and has beaten Sky to exclusive content such as Champions League football, Premiership rugby and also shows a number of Premier League football games, too.
Furthermore, BT has seemingly decided that its main goal is to dramatically increase its number of customers, with it offering considerable discounts on its services, notably superfast broadband, as well as various freebies including shopping vouchers and, as mentioned, free BT Sport for broadband customers.
In response to BT’s aggressive pricing and diversification into new product areas, Sky has sought to differentiate its offering from rivals. For example, it has invested heavily in producing its own programmes, as well as a major advertising campaign that sought to paint Sky as the better quality option for pay-tv, broadband and landline services.
This is a shrewd move, since it allows Sky to maintain higher margins than it perhaps would have been able to, with customers perceiving that they are receiving superior service than elsewhere. And, with Sky now set to move into mobile phone services (so that it becomes a true quad play operator), it appears to be taking the right decisions for long term bottom line growth.
Financial Standing
While BT’s strategy has been successful at winning customers, it is risky. In fact, if the EE deal does go ahead then it seems likely that the company will need to launch a rights issue and also potentially take on more debt. Furthermore, its pension obligations remain onerous (and looks set to for some time) and this could cause investors to become somewhat concerned regarding its future stability.
Meanwhile, Sky has strengthened its financial standing via the merger with Sky Deutschland and Sky Italia, which appears to be a logical move given that the European media sector is becoming increasingly integrated. In addition, it should provide Sky with additional financial firepower moving forward.
Valuation
Although BT’s strategy is risky and its finances appear to be less robust than those of Sky, its current valuation provides investors in the company with a wide margin of safety. For example, BT trades on a price to earnings (P/E) ratio of 15, which is much lower than Sky’s P/E ratio of 18.4. This shows that there is scope for BT’s rating to move higher versus its key peer and, with it seemingly a step ahead regarding the move into quad play and it being relatively successful at gaining market share through winning new customers, BT seems to offer more long term potential than Sky at the present time. As such, and while both companies appear to have bright futures (albeit in a competitive quad play space), BT has the greater potential to deliver strong returns as an investment.
