MARKET COMMENT
BT Still Looks Expensive

By Stuart Watson (TMFTiger)
November 8, 2001

British Telecom (LSE: BT.A) has done a lot of good work to unwind its debt position in the last year. However, despite its best efforts at 330p, with a market value of £28.1b, it still looks expensive to me. The news that Philip Hampton, the current Finance Director, is due to leave the business before his contract expires in November 2002 is a further blow that BT could do without.

BT's interim figures are a mess. The disposal of operations like Yell and the closure of Concert and AT&T Canada make the detailed divisional numbers hard to interpret. But a broad-brush approach can still tell you a lot. Based on the latest quarterly numbers, the annual sales of the fixed line business, BT Group, are around £18b. The mobile business, mm02, has sales of around £5b.

BT Group is making operating margins in the region of 15%. This implies underlying operating profits of around £2.7b, on the generous assumption that there aren't any more nasty exceptional items lurking in the background. An interest bill of £1.3b on its £16b debt pile and a standard tax charge of £0.4b leaves you with earnings of £1b. What sort of price earnings ratio is appropriate? Profit margins continue to be under pressure, due to competition and regulation. In truth, the core BT is just a utility and a P/E or more than 13 or 14 would be difficult to justify.

That means that the current overall valuation of BT is based on the mobile business being valued at around £14b. It's still loss making, and is expected to be so for at least 5 years. The price tag looks difficult to justify. You can make some spurious comparisons to Orange, which has roughly double the sales and is currently valued at £28b itself. But mm02's businesses are far less impressive and such relative comparisons are always dangerous to make.

Unofficial dealings are expected to begin in mm02 tomorrow. This will give us a clearer idea of what sort of value will be attached to both bits of the business. The official split won't take place until Monday 19 November when shareholders will get one share in each bit for each BT share they currently hold. Depending on the relative valuations of the two businesses it could be a good time to say goodbye to one or even both of BT's offspring.

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