Opportunistic value investors sensed a trading opportunity in BT (LSE: BT-A) after a £530m financial fraud write-off coupled with a profit warning sent its shares into a 20% free fall earlier this month. The shares are now trading on a P/E of 10,, with a yield of more than 4%, indicating there could be a value opportunity in the short-term.
I reckon the company may not beat the market over the next decade or so, however, due to some other underlying issues in the business that could hamper performance.
A Competitive and Expensive Commodity
A lot of the services offered by BT are becoming commoditised, meaning there are often offerings of equal quality and value available to consumers elsewhere. A quick visit to moneysupermarket.com reveals a number of viable options for Internet or TV services. This intense competition is unlikely to dissipate in my view and could result in a “race to the bottom” on prices.
In recent years, BT has turned to buying sports TV rights to gain an advantage over competitors like Sky. BT paid a whopping £960m for three years of Premier League TV rights, which equates to around £7.6m per game, and another £897m for exclusive Champions League and Europa League rights. There is no guarantee that BT will win the next bidding war, which could see the appeal of their broadband and TV offerings significantly reduce for a number of customers.
On top of that, another one of BT’s key competitive advantages is currently facing some uncertainty. Openreach, which is a part of BT Group, develops and maintains the countries main telecoms network, which is used by providers like Sky, TalkTalk and Vodafone. BT has been accused of running Openreach in a biased fashion, favouring its own operations.
Pension Payments and Cash Flow
Competitors want Openreach to be spun-off into a completely separate entity. This looks pretty unlikely, but Openreach is the company’s biggest source of cash-flow and any complications here could put pressure on the payments to cover its £10bn pension deficit. BT also faces accusations of under-investing in our country’s infrastructure. Only 2% of premises have access to fast fibre connections — the remainder are stuck on old-fashioned copper connections.
It seems likely that Openreach will be forced to increase capital expenditure above and beyond the £6bn planned over the next three years. This, combined with the aforementioned £530m write-off, potentially increased pension payments, and increasing competition, could place pressure on free-cash-flow and thus the dividend.
There’s also a significant debt-pile alongside the pension deficit for the company to worry about. If cash-flow is seriously crimped by the above factors the company would have to either cut the dividend or take on more debt to pay it, which could dent its credit rating, thus increasing the costs of financing its £10.9bn net-debt pile.
BT is one of the world’s premier telecommunications companies and has an enviable competitive position in a number of its businesses. That said, there’s too much uncertainty hanging over the balance sheet and the sustainability of these advantages for me to consider buying the shares.
