From 5/18/98 Barron's:
>>Foreign Affair
Will Britain's Cable & Wireless join forces with one of the Baby
Bells?
By RICHARD EVANS
Don't expect America's giant phone companies to stop trying to merge with one another any time
soon, and don't be surprised to hear the name Cable & Wireless thrown into the mix. Already
this London-based telecommunications giant has had informal merger discussions with the likes
of AT&T and Bell Atlantic. In part, the attraction is Dick Brown, age 51, the guy who now runs
Cable & Wireless and earlier served as chief executive of H&R Block and chairman of its
CompuServe unit. He also worked as vice chairman of Ameritech and an executive vice
president at Sprint.
Another powerful draw at Cable & Wireless is the
company's valuable assets, including stakes in phone
companies in Britain, France, the Caribbean, Australia,
Singapore and Hong Kong. These operations make Cable &
Wireless the world's third-largest carrier of international
phone calls, behind AT&T and Deutsche Telekom.
Under Brown's expert guidance, the profit picture is
improving rapidly. Last week, Cable & Wireless announced
that earnings for the fiscal year ended March 31 roughly
doubled, to $2.1 billion, or $2.80 per American depositary
share. Revenues, meanwhile, increased 19% to $11.6
billion. Even after excluding onetime gains, the company's
earnings rose by about 13%, to about $1.50 per ADS --
pretty heady growth for a telephone concern.
"We are a growth company focused on growth markets,"
crowed Brown. As if to underscore that point, he recently
unveiled a new venture to provide telecommunications services to businesses in 20 European
cities.
Cable & Wireless was not always so
dynamic. It's true that the company,
founded back in the 1860s to string
telegraph wires and lay undersea cables,
as such boasts an illustrious history. But
by the early 1990s, it had drifted into a
torpor, still serving the distant corners of
the old British Empire yet failing to make
much headway in high-growth markets in
Europe and the U.S. In Britain, for
example, Cable & Wireless couldn't win
more than 5% of the market even though
the phone business had become
deregulated, giving newcomers the
opportunity to compete against British
Telecom, the longtime monopoly.
Matters came to a head in November 1995
when Cable & Wireless's then-chairman,
Lord Young, and Chief Executive James
Ross both left the company after a heated public dispute over who actually should hold the
company. Later, there were negotiations to merge Cable & Wireless into British Telecom, but
those broke down in May 1996. Rumors suggested that Cable & Wireless was likely to be taken
over in a hostile raid.
In July 1996, Brown came aboard, having been recruited by corporate headhunters. He quickly
moved to reshape what was essentially a cluttered and unfocused holding company. Today, less
than two years later, a new spirit of optimism pervades the company's headquarters in central
London.
One of Brown's key victories was joining forces with Bell Canada International and Nynex to
form Cable & Wireless Communications, a British-based venture that has quickly become the
No. 2 provider of cable TV service in the U.K. and the No. 1 provider of bundled telecom
services such as telephone connections, Internet links, cable TV and interactive entertainment.
Brown also bought a 49% stake in Optus, the successful Australian cable TV and telephone firm,
and he is now negotiating a strategic alliance with Italy's dominant telecom outfit, the privatized
Telecom Italia.
But Brown isn't just off on a buying spree. In all, he has disposed of some $3.7 billion in
underperforming assets, including minority stakes in struggling ventures in Germany, Sweden,
Eastern Europe and South America. His overarching strategy is to pour more resources into
markets where Cable & Wireless feels it can be an important player, and exit ones where it
cannot.
"In 22 months we have done 18 deals worth $17 billion," he explained in a recent interview with
Barron's. "We now have 17 million customers around the world and are fast changing into a
highly effective operating company."
In a recent example of Brown's hunger for dealmaking, he met some months ago with
Palestinian President Yasser Arafat at 1 a.m. in a London hotel to secure a franchise to provide
telephone service to the newly autonomous Palestinian-administered regions in Israel's occupied
territories. This drive for growth has been accompanied by a ruthless quest for cost-cutting. As a
result, Cable & Wireless American depositary shares, which trade on the New York Stock
Exchange and each represent three shares of Cable & Wireless, have risen from $19 in July 1996
to $34 recently. Some investors and analysts see the ADSs popping to $40 or higher by the end
of this year.
"Given Dick Brown's ability to drive top-line growth by 10% a year and the additional value
being unlocked in his drive for efficiency, earnings should continue to grow by 15% a year for
the foreseeable future," says Paul Norris, senior Lehman Brothers telecom analyst in London.
"The company is thriving in the new high-growth markets for cellular telephony and business
services, and it will probably become a leader in the new areas of video-on-demand and
interactive media."
Norris upgraded Cable & Wireless shares from "neutral" to "outperform" in March, mainly
because of the company's expansion in high-growth businesses. He expects the shares to rise by
as much as 20% by the end of 1998.
Other analysts agree. Morgan Stanley's top European telecom analyst, Paul Marsch, upgraded
Cable & Wireless stock from "outperform" to "strong buy" a few weeks ago, citing improved
financial performance and the new strategic alliance that the company plans to form with Telecom
Italia. "This is a solid step toward addressing a strategic weakness of not having a strong
position in Continental Europe," says Marsch, who is also projecting 15% annual earnings
growth in each of the next three years and a 20% rise in the company's stock price.
Under the terms of the Italian deal, Telecom Italia will work with Cable & Wireless as a partner
in southern Europe and buy Cable & Wireless's stake in the troubled French cellular-phone outfit
Bouygues Telecom. The Italians were also to buy a 5% stake of Cable & Wireless's U.S.
operation and 20% of its Caribbean venture, providing the London-based firm with $2 billion in
cash.
News surfaced last week, however, that the alliance with Telecom Italia may already be
unraveling, with Italian government officials complaining that Cable & Wireless was getting too
good a deal. Telecom Italia shareholders are asking why their management has apparently junked
a previously proposed alliance with AT&T. A final showdown is expected next month when
Telecom Italia shareholders will decide whether to keep the same executive board or demand a
new one.
While the proposed alliance could provide Cable & Wireless with an entry into the European
market, some investors feel it is just a halfway measure. They want more decisive action.
"Alliances make me a little nervous," says William Newbury, analyst and fund manager with the
New York-based College Retirement Equities Fund (CREF), a pension fund with some $200
billion under management. "Cable & Wireless is taking baby steps, but it needs the confidence to
take giant steps. Otherwise, it will be overwhelmed by giants."
Another analyst has a bolder take on the struggling alliance: "The Italians are disorganized and
political. It's far from the end of the world if it falls through, and Cable & Wireless will have the
opportunity to link up with someone better."
Despite concerns over the Telecom Italia deal, CREF's Newbury remains a solid fan of Cable &
Wireless stock: "They have a tremendous portfolio of international assets and they are leaders in
the new areas of multimedia, Internet capability and video applications. Earnings growth will
accelerate."
Cable & Wireless's stated goal is to sell a range of telecommunications services to consumers as
well as to businesses. Already the company has begun conducting interactive-video trials in the
U.K. Such service is already offered by Cable & Wireless in Hong Kong, one of the company's
most important markets.
Indeed, Cable & Wireless long enjoyed a monopoly position in Hong Kong through its 54%
stake in Hong Kong Telecom, to which the British granted an exclusive license to provide
telephone service for the colony and its outlying territories. Hong Kong Telecom has been the
brightest jewel in Cable & Wireless's crown of international subsidiaries. Analysts estimate it
may account for more than 40% of the group's assets and profits.
The advent of Chinese rule, however, and the departure of the British from their former colony
last July have brought new pressures. Beijing made clear its plans to allow international
competition among telecommunications providers in Hong Kong. But instead of just soaking as
much profit as possible from Hong Kong Telecom's exclusive license until it terminates in the
year 2006, Brown chose a bolder and potentially riskier course of action: He willingly terminated
the license eight years early, in January of this year, in exchange for $800 million in cash, plus
some concessions and a joint venture agreement with Beijing.
Under the January 20 agreement, China Telecom, which is the People's Republic of China's
state-owned phone company, bought 5.5% of Hong Kong Telecom, boosting its total stake to
13%. Beijing also agreed to let Hong Kong Telecom raise its rates on local calls, which had not
been allowed before. Hong Kong Telecom was also allowed to buy Pacific Link, a Hong
Kong-based cellular phone operator. This gave Hong Kong Telecom undisputed dominance of
the market.
Beyond these concessions, Brown's not-so-hidden agenda is to get his company invited into
China's potentially huge telecommunications market. "China is our most important market, and
Chinese officials are on our board," Brown points out. "We are partners."
One source close to Cable & Wireless goes farther: "The fact is that China blessed the deal and
will favor Cable & Wireless in the future. After all, why would they run down a business they
own 15% of?"
With competition heating up in Hong Kong's telecommunications market, however, Cable &
Wireless may have to get itself into China's mainland soon to offset shrinking
international-calling revenues from the former island colony. Hong Kong Telecom's annual
results for the year ended March 31 showed a 2.3% drop in revenues for international calls.
Local calling revenues grew 19% and Internet-related services jumped fivefold. But those gains
could be threatened as big international competitors move in.
"Hong Kong Telecom has a year or two before it becomes a depreciating asset," opines Bill
Newbury of the College Retirement Equities Fund. "They need to forge an operational link to
mainland China in the next year or so."
Last week's announcement of expanded telecom services in Europe is aimed at combating the
view that Cable & Wireless has yet to make a really significant impact in either Continental
Europe or the U.S. Its current 5% market share is just not enough to persuade big U.S.
corporations to sign multimillion-dollar contracts for the data, voice and video communications
services that have become the lifeblood of multinational business.
The big question for Dick Brown is whether Cable & Wireless will grow into a truly global
company on its own, or will need to merge with one of the globe's huge players to succeed.
Some observers are convinced that Cable & Wireless can go it alone. "Under Dick Brown, this
company has shown a real talent for making its own deals," says James Ross, a
telecommunications analyst with ABN-AMRO. "The company may be able to strike further deals
with local operators in the U.S. and Europe and achieve their goals that way."
A hostile takeover of Cable & Wireless would probably turn out to be tricky. China's 13% stake
in its Hong Kong Telecom subsidiary means that an unwanted suitor could probably be
repulsed. And because of Cable & Wireless's strong position in the U.K. market, any takeover
would probably also require approval by the British government. But a friendly merger with a
big U.S. telco might be a different matter.
"Of course, Cable & Wireless is talking to other people," says one analyst. "Any merger would
most likely be with a U.S. partner because there is so little overlap in their markets."
And remember, Dick Brown is no stranger to American turf.<< |
