MARKET COMMENT
BT vs. Cable & Wireless

By David Kuo (TMFDragon)
December 11, 2003

In the 1990s, investors were falling over each other to hand out their cash to just about any business connected with the telecom sector. After all, the deregulation of telecommunications industry meant cheaper phone calls, and as prices fell, everyone thought demand would rise and more capacity would have to be created.

Oh how wrong we all were!

In fact, an oversupply of capacity has meant that many companies have not been able to generate a decent return on their investments at all. Additionally, miles of fibres still lie unlit, waiting for customer demand to make its entrance.

Cable & Wireless (LSE: CW.)(NYSE: CWP) is one company that fell into the trap of believing that demand for telecom services would be almost unlimited. Its once high-flying share price provided it with a cheap source of funds to invest in the telecom dream that eventually turned into a broadband nightmare.

That said, C&W is slowly putting to bed its bad experiences of the past. It has savagely trimmed capacity in line with demand and reassuringly put its loss-making US operation into bankruptcy protection.

That should be good news for C&W investors, given that a life-saving tourniquet has at long last been applied to a badly haemorrhaging part of the company's business. However, C&W has still to address its next pressing problem, of how to resurrect its European operations.

Nevertheless, C&W reckons that it has done enough for now in terms of restructuring to start generating a healthy cash flow. It believes it will be able to pay a dividend by the financial year-end. A dividend payout of 1.88p per share has been pencilled in for this year, rising to 3.4p in 2005.

C&W shares currently trade at 139p, which values the company at 40 times expected 2004 earnings, falling to a more respectable valuation of 22 times earnings in 2005. The yield for the current financial year is a modest 1.4% rising to 2.5% in 2005.

Paradoxically, BT Group (LSE: BT.A)(NYSE: BTY) was also caught up in the telecom quagmire but seems to have emerged from the swamp smelling of roses. Clearly owning a legacy network of pre-privatisation copper cables has been a godsend.

Unlike C&W, BT has a huge pool of inertia-bound customers that total some 20m business and residential clients. These subscribers help the company generate over £18.7b in turnover and £1.8b in pre-tax profit. The operating margin is a healthy 15%, too.

BT's main worry is the sustained pressure on 'voice' revenues, and whether its broadband rollout will be able to compensate. The group could also come under pressure from the aggressive rollout of broadband services by rivals. Interestingly, BT is reacting positively to broadband competition and recently launched a consumer VoIP, or Voice over Internet Protocol, that will piggyback on its rivals' broadband services.

BT shares currently trade at 175p a share, which values the company at 10 times projected 2004 earnings. A dividend payout of 8.29p per share has been pencilled in for the current financial year, suggesting a prospective yield of 4.7%.

Personally, I see BT as a less risky investment than C&W. I see its 20m customer base as a source of comfort that should underpin revenues. Growth may not be at a rate of knots, but its 4.7% dividend yield rising to 5.8% in 2005 is a good compromise.      

The author owns shares in BT Group.