What are the reasons behind Carphone Warehouse's plans to split into two, and what does it mean for investors?
One thing I've always liked about Carphone Warehouse (LSE: CPW) is that it hasn't changed its name to pander to the whims of marketing gurus, and has steered clear of other such faddish and fashionable business practices. (And how many of today’s prime market for mobiles, young people, have even heard of a carphone?).
The company has basically just stuck to what it does well, which is telecoms, and grown its business from being, essentially, a carphone warehouse, to covering everything from the sale of mobile phones through to the provision, via its TalkTalk division, of fixed and mobile telephony and broadband services. In doing that, it has grown to become the UK's third largest broadband provider, behind the two primary network owners, BT (LSE: BT-A) and Virgin Media, which is an impressive act.
And despite the recent share price slump (it's lost more than half its value in the past year), Carphone Warehouse shares have done a lot better than BT over the past decade.
Why split?
So I have to say it was with mixed feelings that I read yesterday's news of the company's intention to split its mobile phone business from its TalkTalk operations, especially in the current economic climate with neither side of the business expecting any stellar growth in the coming year. Earnings for this year are going to be in line with expectations, and 2010 earnings are expected to be pretty flat too, though some improvement in operating free cash next year is likely.
So what is the reason for the split? Well, the company's statement that "We believe that a demerger will allow us to create two discrete businesses with distinct investment profiles and improved comparability with sector peers" doesn't really say much, and not much clarification is added by the fact that executive chairman Charles Dunstone will remain as head of both new companies.
Offload a millstone?
But there is perhaps a clue, as yesterday's release also tells us that "The Board is still reviewing various options in respect of the most appropriate allocation of existing debt facilities…".
At the interim stage in September 2008, net debt stood at £80m, and it was expected to be somewhere in the same ballpark by March this year. While that's not as bad as some, it could hinder the financing of any planned expansion in parts of the company's business in the future. So leaving the lion's share of the debt with one of the new companies could leave the other in a leaner and fitter condition to face the future more aggressively.
This is pure speculation, of course, and the intent might be far from this. But it wouldn't be the first time a company has split to relieve one of its divisions of a millstone.
BT did it
Part of BT's reason for spinning off its mobile arm to form the new O2 (since taken over, in 2006, by Spanish giant Telefónica) was to free its mobile operations from the yoke of the UK regulator. The result? Well, it's hard to assess how well O2 has done since, but immediately prior to the Telefónica takeover, O2 had 27 millions subscribers across Europe, with its main markets in the UK and Germany.
Meanwhile, BT's fixed line business has not fared too well. Lagging behind Virgin in the race for super-fast broadband, revenues to March 2009 are expected to come in significantly behind previous years, with 2010 only expected to do slightly better. The share price has suffered too, standing at just 85p today, which is a way down from the £3 level that it stayed above for most of 2007.
What to make of it?
The timing of the split hasn't been decided yet, and it will only go ahead if costs are favourable, but I have to say I'm really not sure what to make of it yet. Charles Dunstone doesn't strike me as the kind of company head who would do such things for cosmetic reasons (though many seem to think they need to be actively merging and demerging all the time if they're to look like proper managers), but the meagre words we have read so far don't really put much meat on the bones of the demerger plan.
We'll need to wait and see the terms, the costs, and the debt allocation. But in the meantime, I don't think I'd be either buying or selling the shares.
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