Both Sky and TalkTalk have called for BT (LSE: BT-A) to be broken up after Ofcom launched a review into the structure of the telecoms sector this week. They particularly have BT’s wholesale broadband division Openreach in their sights. Sky CEO Jeremy Darroch said Ofcom must address “Openreach’s conflict of interest as a subsidiary of BT”, whilst TalkTalk’s CEO Dido Harding said it was crucial to “seize this opportunity to structurally separate” Openreach.
Openreach was created by the last Ofcom review in 2005 to create a level playing field between BT and other broadband re-sellers such as Sky, TalkTalk and Virgin Media. It owns and operates the network of cables that connect homes and businesses, and is obliged to treat BT and the other broadband companies at arm’s length. But critics argue that BT can manipulate pricing to benefit itself at the expense of competitors, and use Openreach’s cash flow to support its business.
There are good break-ups and bad break-ups
Shareholders in BT might well shudder at the possibility of a spin-off. Labour leader Ed Miliband’s plans to break up banks and energy companies has gone down like a lead balloon — as have the stocks of the energy companies.
But I think it could prove an enticing prospect.
Openreach would be an attractive investment if it were floated. Last year it made £1.2bn of operating profit, around a third of BT’s total. Its prices would no doubt be regulated by Ofcom, to enable it to make a fair return on capital and also invest in upgrading the nation’s broadband infrastructure. The security of its privileged monopoly position would enable it to gear up its balance sheet, boosting shareholder returns whilst remaining a safe, bond-like investment.
That’s remarkably like the situation of National Grid (LSE: NG) (NYSE: NGG.US) in the energy market. It’s no accident that the monopoly provider of high-voltage electricity and gas mains is a favourite amongst retail investors. The company’s eight-year regulatory agreement means it can weather the storms of elections, Grexit, Brexit, Frexit, the softening Chinese economy and the hardening US dollar, possibly even a Martian invasion, whilst still expecting to increase dividends on a current yield, at 5%, that trounces cash. The need to replace creaking infrastructure adds growth to the mix.
Efficient market
The rump of BT — the remaining 2/3rds plus mobile operator EE which BT is acquiring — would look more like its competitors in the telecoms sector. That’s not just good for competition, it should help investors to compare players, and choose between management teams and business models. The more efficient the market, the better for investors.
Ofcom will report preliminary findings at the end of this year, and there will be many twists and turns in the story. But BT shareholders should have nothing to fear from talk of a break-up; quite the contrary.