BT announced its annual results today.
Press comment focused on BT’s profit growth and the reduction in their pension deficit. However, both of those stories are not quite such good news for BT as might be supposed. Profit growth came from BT cutting costs faster than the fall in BT’s revenues – trends which are not exactly going to set the analysts’ models humming when plugged into DCF valuation models. BT’s pension deficit reduction was to a large extent driven by timing – not surprisingly it looks much better now than shortly after the 2008 market crash – and some commentators have suggested that BT has used some rather optimistic inflation assumptions in its deficit valuations modelling.
For me a bigger story was BT’s narrative that revenue growth would come from its (very capital-intensive) roll-out of fibre-optic access and associated services (such as BT Vision). With established competition from Virgin Media, the strong triple-play offering from Sky, potential new entrants such as Fujitsu and continued regulatory scrutiny there would seem to be significant implementation risk around this plan.
However, I always find that the most interesting sections of annual results are buried in the notes to the accounts. In note 11 (risks) BT says this about regulation:
“Communications industry regulation
Some of our activities continue to be subjected to significant price and other regulatory controls which may affect our market share, competitive position, future profitability and cash resources. Many of our wholesale fixed network activities in the UK are subject to significant regulatory controls. The controls regulate, among other things, the prices we can charge for many of our services and the extent to which we have to provide services to other CPs. In recent years the effect of these controls has required us to reduce our prices, although in some recent cases, prices have been allowed to increase in real terms.
Regulatory authorities may increase the severity of the price controls, extend the services to which controls apply or extend the services which we provide to other CPs. These controls may adversely affect our market share, our ability to compete and our future profitability and cash resources. Wholesale customers may also raise disputes with Ofcom, seeking lower prices on wholesale services which are not subject to direct price control.
Impact
In recent years, changes in price controls have required us to reduce our prices and in some instances to make payments in respect of retrospective price adjustments. Additional or more substantial regulatory price reductions could constrain our revenue growth. Regulatory actions may also indirectly affect us. For example, Ofcom has reduced the mobile termination rates that mobile network operators can charge to terminate calls on their network. There will be a stepped reduction in prices over four years starting from April 2011. This regulatory action will have a significant impact on future transit revenues in the UK and Europe.
We may be required to provide new services to wholesale customers on a non-discriminatory basis, increasing our costs and increasing retail competition. Disputes may result either in reduced revenue or increased costs going forward. We may also be required to make retrospective payments to CPs if it is ruled that past charging mechanisms we have applied have overcharged CPs. Appeals may change Ofcom’s decisions, which had originally been concluded in our favour.
Risk mitigation
We continuously monitor and review potential regulatory changes and disputes, and maintain a strategic dialogue with regulators and other key influencers on critical issues.” [underlining added].
This is a very interesting statement in the light of BT’s recent loss in the PPC case in the CAT.