Fool's Eye View

[ December 1, 1999 ]

Redstone Gets Ready

By Stuart Watson (TMFTiger)

With all the excitement surrounding the recent Internet flotations, a small company in the telecoms sector seems to have slipped onto the market relatively unnoticed. The company is question is Redstone Telecom (LSE: RED), whose head office is just a couple of miles from my front door. Despite its low-key profile the share price has been doing its best to attract some attention. The issue was priced at 120p but finished its first day of trading around the 200p mark. Helped by the publication of its interim results on Monday the shares have now hit the 350p level, valuing the company at over £300m.

Despite the leaps and bounds in the share price our message board for this company has been strangely quiet. Applying the Eighth Rule of Thumb of Foolishness, which states that the number of message board posts is directly correlated to the relative increase (or decrease) in the share price, you'd expect the Redstone board to be bustling.

Along with operators such as Kingston Communications (LSE: KCOM), Redstone is expected to be one of the key beneficiaries of yesterday's confirmation that BT would have to unbundle the 'local loop', as covered in last night's Fool's Eye View. Redstone owns the sixth biggest national network in the UK providing telecoms services to businesses and consumers using what is known as a Smart Build CLEC model.

This means that rather than the expensive laying of cables undertaken by other operators, Redstone's network is made up of switches in key locations that route calls around existing systems. Their switches are even accused of being intelligent, offering additional services and functionality. Redstone offers features such as Personal Numbering, allowing users to have their calls re-routed to their mobiles or another fixed line. Given a recent battle in our Staff Investment Club, I hesitate to say that these switches were provided by Nokia, by a division that appears to have been recently acquired by Marconi (LSE: MNI).

So rather than spending hundreds of millions on infrastructure, Redstone can offer a similar service by piggybacking on other networks. This raises some interesting questions about barriers to entry in the telecom business. They could be considerably lower in the next few years meaning that today's healthy margins are slowly chewed away. Redstone make a play on offering cheap services and their gross margin was just 8% for the last six months.

At the moment, the company's two key target audiences are small mobile-office users and large companies with multiple sites. But once the unbundling of the local loop comes along Redstone believe that the wider telecoms market will also be their hunting ground. It cites its main competitors on a national basis as BT (LSE: BT.A), Cable & Wireless (LSE: CW.) and Energis (LSE: EGS). In the key London market Colt Telecom (LSE: CTM) provide formidable opposition whilst in Yorkshire, Kingston Communications have a strong presence. Redstone is setting out its stall as the alternative provider of choice, emphasising reliability and low cost. Earlier this week, I sent off for some brochures but unfortunately my doormat is still empty, although I have received last year's annual report.

In the next few months they will be introducing services such as Voice over IP. This will allow a customer to receive both voice and Internet calls at the same time. Say you are working on your PC and someone is trying to call, then a box will flash up on your PC screen. You can then either take the phone call in the normal way, or speak to them via the PC. Very cool stuff! Trials for a high-speed Digital Subscriber Line (DSL) service are expected before turkeys hit the table later this month.

But what have they achieved so far? Their latest annual turnover came in at just £23.1m and naturally the company is still loss-making. Although, if turnover growth continues, it is expected to become profitable a couple of years before the likes of Colt or Energis who are still counting the cost of their heavy upfront investment. Redstone's interim results showed turnover up to £14.4m, representing growth of 34% over the previous year. Given the company's small size and growth in the previous year this increase looks to be on the low side. Nevertheless the company said it was in line with expectations and call traffic did increase by 87% to 67.1m minutes. Perhaps that is a more reliable measure of underlying growth? Given the limited track record it is too early to call either way.

One factor that has attracted many investors is the management's experience of working in larger telecoms companies. Unfortunately we don't have a copy of the prospectus to hand so we don't know how high these positions were, or for how long there were held. But obviously the team saw potential to exploit the rapidly changing telecoms market.

Redstone put their position in context of the UK telecoms market being worth £23.8b, and still growing rapidly. In other words they are saying that at the moment they have a market share of 0.1% but they see the potential to grab a lot more of a much larger pie. Just how much more is the key question!

Let us know what you think on the Fool's Eye View message board.

Related Links

Redstone Telecom message board
Fool's Eye View - Unbundling BT
Sector Dissector - T'rrific Telecoms
Redstone Telecom website