BT's third quarter results contained few surprises; the bad news was communicated in an earlier profit warning. While the group reported positive revenue growth across the business, the focus is on the poor performance in BT Global Services. It took one-off charges of Â£336 million (â‚¬374 million) as a result of the financial and contract reviews.
Underestimated upfront contract costs
BT Group earnings (EBITDA), down by 9% to Â£1,336 million before write-offs, suffered after one-off charges at BT Global Services, which has become the primary cause for concern.
We have suggested in our previous commentaries that the deterioration of the performance of BT Global Services is down to slower than expected delivery of cost savings. Today's presentation made it clear that BT Global Services is still grappling with cost demons in its network operating review.
In fact, operating costs at BT Global Services were 10% higher in the third quarter of the current year. Management said that while some of this cost was in people (where a divisional reduction of 2,500 jobs has been made already), most was in increased access lines and network costs - that is daily operational buying costs rather than structural or financial items.
This may seem surprising given price conditions for bandwidth in the global market, but it makes sense that with a fast-growing order book and contracts to fulfil, the global services division should be spending to build the networks its customers want.
The surprise is that it took so long for the business and group managers to figure out that the cost equation of building and funding five to seven-year network contracts would require more up-front spending.
End of surprises‾
CEO Ian Livingston said he was putting an end to surprises and insists that, "Global Services is an operational problem with operational solutions. Full stop." But the operations review, which BT Global Services chief executive Hanif Lalani said three months ago would take 90 days to reach step-change, is still going on.
The contracts review is expected to conclude in the fourth quarter. Of 17 major customer contracts selected for review, 15 have been concluded with mostly no changes in agreements, according to the CEO.
The two outstanding contracts are bigger and more problematic. Whether the savings or additional cash flow that could be realised are worth the trouble that may be caused for customer relationships is another matter. Clearly these contracts have outstanding issues which are under review and probably re-negotiable. We will watch with interest how severe the write-offs are against them.
However, BT has a good track record in managing major accounts and in our opinion has done contract reviews consistently well. While BT Global Services' performance has been disappointing, the financial rigour being applied now is clearly the best policy going forward.
Global Services not diminished in marketplace
Our observation about BT Global Services is that enterprises generally - and the customers we have engaged with - have by and large remained positive about the unit.
Our impression is that BT Global Services' market presence has not diminished - its pipeline is plump and it continues to bid for and win contracts at a similar rate against its peers. We have not seen BT Global Services execute on the re-focus on the large enterprise, but it is perhaps a little early to see the fruits of the strategy to pursue the fatter margin business here.
Today's presentation frankly was short on evidence that BT is making significant cost savings at Global Services, although the management was clear in November that it would take the rest of the current financial year to clean up accounts and get the business back on track.
Lack of replicable processes is expensive
According to group CFO Tony Chanmugam, BT hasn't made the progress it would have liked on access cost transformation, although it has identified opportunities and started to put some savings through. In particular, he was concerned that too much is being spent on solutions for individual customers that do not produce replicable products or processes - in the back office as much as in the front-end service.
The good news is that BT continues to offer multinational and enterprise customers winning propositions, and is maintaining its commitment in service levels and product delivery. The company confirmed it is on target for Ethernet node roll-outs and gave a heads up to a new enterprise cloud services portfolio.
We believe that BT is working on improving cash flow management as a priority, but that it will reduce capital intensity in its enterprise network projects and, as a global services player, be in better shape for it.