BT Group plc shares rise 5% on very good news from regulators

Shares of BT Group (LSE: BT.A) are up around 5% in early trading after Ofcom and the company finalised their agreement over just how separate the Openreach subsidiary should be. On the face of it, the stipulation that Openreach will be a separate company, with its own board of directors and management team that will set an independent business strategy, would appear to be bad news for BT.

But BT will remain its 100% shareholder, and considering that rival telecoms giants were lobbying hard for Ofcom to have Openreach spun-out completely from its parent, this is actually good news indeed.

Why is this agreement so important for BT? Because Openreach, which owns the vast majority of fixed line telephone and broadband infrastructure in the UK, is an absolute gold mine.

In the quarter to December, Openreach provided 36% of group EBITDA and a whopping 60% of BT’s free cash flow, despite only accounting for 20% of revenue. This explains why management fought tooth and nail to hold on to the lucrative subsidiary to the maximum extent possible.

Crisis averted

Looking ahead, this takes a huge weight off the shoulders of BT’s management at a critical juncture for the company. There is the £530m writedown related to fraud at its Italian subsidiary that has also forced management into conducting a sweeping review of other operations that could turn up further malfeasance.

On top of this attention-grabbing problem, the company is also investing very heavily in its efforts to transform itself into a consumer-facing telecoms giant. This has involved paying £12.5bn for mobile provider EE, £1.2bn for three years of Champions League rights and £960m for three years of rights to 42 Premier League matches per annum.

All of these big cash outlays were designed to make the company’s quad-play mobile, broadband, pay-TV and fixed line option a serious competitor to Sky and Vodafone. And even before the latest £1.2bn payment for Champions League fixtures, these purchases had sent net debt up to £8.9bn. For the time being this is a manageable figure, but if the company had lost the substantial free cash flow that Openreach provides it would have been disastrous.

Not the end of the saga

This agreement doesn’t mean Openreach will never be completely taken away from BT in the future, should politicians and competitors continue to accuse it of stifling investment in broadband infrastructure in order to maximise short-term cash flow. But, for the time being at least, it looks like this hugely cash-generative subsidiary is here to stay.

This is particularly good news for income investors who are attracted to its shares’ 4.4% yielding dividend. Without Openreach, it’s unlikely the company could have continued hefty shareholder returns alongside massive investments and debt repayment.

But if the company’s big bet on consumer-facing business pays off, the combination of the steady cash flow it should generate, together with Openreach’s substantial contribution,  should make management’s promise of a 10% increase in dividend payouts in the next two years very viable indeed.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.