Carphone Warehouse is transforming itself into a one-stop-shop telecoms company. It has a clear vision of what it wants to be. Will it succeed?
Falling margins, increased competition and fickle consumers are the oft-cited reasons for the falling profitability of telecommunications companies.
Carphone Warehouse
(LSE: CPW)
obviously thinks there isn't much to this, or else it wouldn't be turning itself from a vendor of mobile phones into a telecoms company that offers mobile, fixed-line and broadband.
The interim results released today are excellent. Revenue is up 40.7% and underlying earnings per share up 67.3%. Basic earnings, though, plummeted 97% to almost break-even. The reason for this disparity is one-off costs associated with its telecoms business. None the less, to show the faith the board has in the business model, Carphone is increasing its interim dividend by 33%.
Companies have tried to muscle in on BT's
(LSE: BT-A)
fixed line business before. They have all come a cropper. Can anyone remember Mercury?
Things are different today, though, because the regulatory and business climates have changed. Ofcom, the telecoms regulator, has set out a framework for local-loop unbundling and BT is having to let third-parties into its exchanges.
However, entering a new market and grabbing market share can be expensive. In its 2005 annual report, Carphone Warehouse said:
"Short-term, the costs of recruitment will be high, as a significant proportion of customers will be loss-making for us before they are migrated onto unbundled lines: we anticipate a total operating loss from the project of approximately £50m in the year to March 2007 with free cash outflow (after capex and the full cash costs of acquiring customers) of around £110m."
This morning's results show the telecoms business making a loss of £22.5 million. This loss arises from costs associated with TalkTalk's 'free' broadband offer and with Virgin Mobile France. Many of these costs should only be incurred in this current year according to the trading update that Carphone issued on 11th October.
In pursuance of its telecoms strategy Carphone has been buying up other telecoms companies. The biggest deal has been the acquisition of the Internet access business of AOL UK. The deal is costing it £370 million. It should give Carphone an additional 2 million customers and is making Carphone the third-largest broadband provider in the UK. Carphone is hoping that the scale will create "operating efficiencies".
Trying to break into a new market is always expensive and can be risky. Carphone is spending a lot of money trying to do so. With directors owning over 55% of the shares, the motivation to succeed is great.
However, on a historical price/earnings multiple of 26 and a forward one of 17.7, the shares look expensive to me, especially given the risks inherent in the strategy. If it is successful though, investors will be rewarded.
