Cable & Wireless imitates the Phoenix?

Citation

Curwen, P. (2003), "Cable & Wireless imitates the Phoenix?", info, Vol. 5 No. 5. https://doi.org/10.1108/info.2003.27205eab.001

Cable & Wireless imitates the Phoenix?

Peter Curwen

Cable & Wireless (hereafter C&W) is one of the world's longest-lived telecoms brands, having been in existence for roughly 130 years. At their peak in the Spring of 2000, its shares traded at £15 and it was valued at over £40 billion. However, there subsequently began a decline that saw the share price fall to a mere £0.37 in December 2002. Just another TMT company going belly up, much like Marconi? Probably not, since the share price has now risen back above £1. So how did C&W get itself into such a mess and is it rising, like the Phoenix, from the ashes of its discredited strategy?

In the mid-1990s, C&W's major holding was a 54.2 percent stake in Hong Kong Telecom (HKT). In the UK, it operated as Mercury Communications and was the main rival to BT. Between 1996 and 1999, CEO Dick Brown acquired new holdings - 21 in total at a cost of $20 billion including a 49 percent stake in C&W Panama - while also disposing of minority holdings including stakes in Bouygues Télécom in France and most of its East European interests. However, while this shuffling of assets gave C&W a better geographical focus, it failed to address the perception of the company as little more than a collection of widely distributed assets. To remedy this, statements made in mid-1998 gave the impression that C&W did not intend to compete directly with incumbents in the EU, but rather to target business customers and niche markets in the main cities. Further, it would use its international connections to become a global transport company. The main missing link in its global aspirations related to the need for a service provision facility in the USA, and C&W surprised the markets in May 1998 by putting in a successful bid to acquire the Internet backbone business of MCI for $625 million. When the European Commission subsequently insisted on the sale of MCI's entire Internet operation as a condition for authorising the WorldCom merger with MCI, C&W secured the retail businesses as well, paying $1.75 billion in all.

Dick Brown commented at the time that "we have bought the future''. Certainly, C&W had now gained, at a stroke, an established position in the USA; its brand image had received an enormous boost on a global scale; and it had opportunities to expand in the fast-growing data transmission business -- but at what cost? The abrupt departure of Dick Brown in January 1999 left the company in better shape but still without a fully-fledged strategy. Hence, C&W's new boss, Graham Wallace, announced in April 1999 that C&W would be getting out of businesses where it had neither influence nor control, for example selling its Global Marine business to Global Crossing for $900 million, mostly in cash. He claimed that the ultimate objective was to turn C&W into a specialist business-to-business service provider with a truly global reach. To this end, C&W would be increasing its annual investment to over $5 billion a year.

In an attempt to bolster its Far Eastern influence, C&W launched a hostile, but successful, takeover bid in March 1999, worth $560 million in cash, for IDC of Japan. However, it remained the case that many of C&W's overseas assets did not fit in with its new strategy, even including C&W HKT, and the subsidiary was accordingly sold off to PCCW at the beginning of 2000. In March 1999, UK mobile operator One-2-One was put up for sale by joint owners C&W and MediaOne. Deutsche Telekom made a successful offer in early August which included roughly $11 billion in cash, and the gross profit on C&W's stake worked out at $5.6 billion. Having sold off its UK cable TV operation, CWC Consumer Co. to NTL, for half as much again, C&W agreed with Compaq Computer to invest $500 million over five years in a global joint venture designed to provide an end-to-end e-commerce service for small and medium sized businesses. This would be the first to offer a full range of services - Internet access, Web site hosting and renting application software, electronic procurement, unified messaging, remotely managed network computing services for PCs and servers and Internet telephony. C&W thereby hoped to become a leading application(s) service provider (ASP).

For the time being, C&W could claim to own one-twelfth of the world's fibre-optic capacity and status as the third largest carrier of international traffic, and with lots of cash in the bank as a result of disposals, the future seemed rosy. The decision was made to reorganise the company as of 1 June 2000 into C&W Global, C&W Optus and C&W Regional (mainly the Caribbean holdings). However, rumbling discontent in the Caribbean, where C&W was coming under increasing pressure to give up its lucrative fixed-wire, mobile and international monopolies, became a public feud in August and led to a collapse in the C&W share price.

Publication of the half-year results to September 2000 revealed that the net cash position had been turned around dramatically to show a balance of £4.2 billion with more to come from agreed disposals. On the face of it, C&W's cash-positive position was a rarity in the telecommunications sector at that time, and although heavy investment of roughly £3 billion on the international IP network was pencilled in for 2001, it was expected to generate rising revenues and profits in the future. Nevertheless, C&W's share price suffered its third severe collapse at the beginning of 2001 since, in particular, the situation in the Caribbean continued to cause problems because an increasing number of island governments were determined to introduce liberalisation combined with early termination of C&W's monopoly licences. C&W could do little bar negotiate to have liberalisation introduced in stages, and this was expected to lead to a big reduction in C&W's profits in the area. Shareholders were also alarmed that the two main strategic options - pouring more money into C&W Global even though it appeared to be years away from profitability, and simply sitting back for now while minimising short-term losses - both looked likely to burn through the cash mountain. The sale of the US and Japanese operations was favoured by analysts, but senior management much preferred to spend a good deal on acquisitions, the first of which was Californian Web hosting Digital Island for $340 million.

Graham Wallace admitted that the company had mistakenly been chasing revenues instead of margins. Nevertheless, publication of the results for the year ending 31 March 2001 were well received, despite the operating loss, if only because the cash pile still existed. Bowing to external pressure, C&W finally agreed in mid-November to hand back £1.7 billion to shareholders via a special dividend of 11.5p per share plus a buy-back of up to 15 percent of the outstanding shares, which would still leave £3 billion in the bank. The purchase of its best data centres from Exodus Communications - a loss-making business in Chapter 11 bankruptcy in the USA - for $850 million in cash in late November was expected to double traffic on C&W's underutilised Internet backbone, but was seen by analysts as risky and long term. Hence, the situation at the beginning of 2002 was that C&W appeared to be suffering from a dose of schizophrenia. The C&W Regional networks used old-fashioned technology in unsophisticated markets to generate very large amounts of cash. C&W Global, on the other hand, used sophisticated technology in sophisticated markets to move ever further away from reaching free cash-flow break-even. The consequent renewal of the decline in the share price was not helped by the revelation that C&W was caught up in the "hollow swaps'' scandal whereby spare capacity was exchanged with other carriers and the "sales'' side of the ledger recorded as generating revenue even though no cash actually changed hands.

The year 2002 was characterised by a stream of negative stories - as was generally true for the entire TMT sector. Under severe pressure to do something to stem the tide, a much anticipated restructuring was duly announced in November which involved cutting a further 3,500 jobs in the USA and Europe and the number of global data centres from 42 to 23. That all was not well was confirmed when an internal strategic review discovered that, far from being in possession of £897 million of leases to house its operations, the true figure was actually £2.2 billion - the remaining £2.2 billion net cash could thus disappear within a short space of time to cover the costs of downsizing. This was promptly followed by further revelations of non-disclosure. In this case it was triggered by a credit ratings downgrade by Moody's which awarded C&W's debt the status of "junk''. What had not previously been disclosed was that, at the time when One-2-One was sold to Deutsche Telekom, C&W had agreed that should such a downgrade occur, it would provide £1.5 billion of collateral against potential tax liabilities arising from the sale. The downgrade accordingly meant that C&W would either have to obtain a bank guarantee for £1.5 billion or ring-fence that sum in cash. Since this amounted to nearly three-quarters of its cash pile, C&W's capitalisation fell below that required to retain its status as a FTSE 100 constituent.

Graham Wallace duly resigned as part of a general management reshuffle, but the news was overshadowed by the revelation in early February 2003 that C&W had been unofficially approached by PCCW with a view to a takeover bid worth £1 a share in cash. PCCW later withdrew its offer when it was not taken seriously.

It was noted that major shareholders were bailing out, but they had cause to regret this as the share price shot up on 24 March 2003 when it was revealed that C&W had agreed to pay £380 million to the tax authorities to settle outstanding company tax liabilities for the ten years to the end of March 2001. In return, the ring-fenced cash would once again become available. The share price also rose sharply on 1 April when C&W announced the appointments of Francesco Caio as its CEO and Kevin Loosemore as its COO. C&W also stated that it would withdraw from domestic-only operations and focus upon providing a service to multinational companies across Europe. On 29 May, the share price rose back through £1 - nearly three times the 37p low seen on 9 December. However, the results for the year to 31 March 2003 proved to be far from uplifting, involving as they did a record £6.5 billion loss, suspension of the dividend and the announcement of withdrawal from the USA as well as 1,500 redundancies in the UK. On the other hand, cash reserves stood at £1.6 billion, and, despite a refusal by Mr Caio to spell out his intentions in detail, the share price remained resilient since the withdrawal from the USA appeared to inject a dose of realism in comparison to the Wallace years. Nevertheless, although C&W Regional remained extremely profitable, unravelling the previously opaque accounts had revealed that the UK operation, far from being profitable as was widely assumed, had sustained an annual loss of £303 million on declining sales -- hence the need for job losses there. Mr Caio's remedy broadly appeared to encompass supporting companies such as Tesco that were launching own-brand telephony services and becoming more service-oriented. He also made business units accountable for targets based on pre-tax profit rather than ebitda.

In the 2003 Annual Review and Summary Financial Statement, Richard Lapthorne summarised the revised strategy as incorporating a:

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  new, simpler organisation that does away with the C&W Global and C&W Regional distinctions;

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  devolution of responsibility to country-based chief executives;

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  clarification of the lines of accountability;

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  restructuring of the UK business;

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  complete withdrawal from the USA by the least-cost route; and

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  shift of focus from building infrastructure to serving customers.

So where does all this leave C&W? Like Marconi, C&W spent the three years 1999-2002 unerringly transforming itself from a diversified and rather dull conglomerate into a company focused on a part of the telecommunications sector that was particularly prone to overcapacity and over-optimistic forecasts - with one difference: Marconi spent everything it had and ended up virtually bankrupt whereas C&W never quite got around to spending its entire pile of cash. Altogether, by the end of 2001, C&W had acquired £16 billion in cash plus various shareholdings in SingTel, NTL and PCCW. In turn, £9 billion had been spent on investment and acquisitions and a further £2.4 billion had been swallowed up in tax, interest payments and dividends. This left cash in the bank but the core business, C&W Global was shrinking instead of growing.

Between the end of 2000 and the end of 2002, the cost per megabyte of IP traffic fell from £400 to £170. There was nothing C&W, acting alone, could have done about that, but the indictment of its management is that they saw it coming yet refused to take avoiding action. Having committed themselves to a major change in strategy, the board were unwilling to tarnish their reputations by acknowledging that they had got their timing wrong, dumping most of the loss-making IP businesses and falling back on the profitable C&W Regional operations. Indeed, top management appeared to be fixated by the fact that the cash cushion would see them through, come what may.

Undoubtedly, the Achilles Heel in recent times has been C&W's somewhat cavalier approach to corporate governance. Not only did it engage in the technically legal but highly dubious practice of "hollow swaps'', but it took what can only be described as a very conservative approach to rules on non-disclosure - that is, it disclosed nothing it could get away without disclosing.

As noted, the old-style C&W was treated by the investment community as something of a joke - analagous to an investment trust. Certainly, few among them questioned the sense in selling off many of the company's subsidiaries at peak prices, but almost everyone questioned how the proceeds were being used. At the end of the day, what the above suggests is that it is ultimately better to run a not-much-admired company as well as possible than to be carried away with grandiose ideas that destroy the reputations of all concerned, not to mention quite staggering amounts of wealth. Having acknowledged that it was making most of its money from voice telephony, and that since only a few large multinationals needed a global telecoms provider it would be better off pulling in its horns to serve mainly UK businesses and those supplied by the former C&W Regional, C&W seems to be recovering gradually and avoiding the fate of Marconi. It will not go bankrupt although the costs associated with shutting down the US operation will eat heavily into the cash pile. Overall, C&W is not fully out of the woods yet - the losses in the UK must also be addressed as a priority and may never show a profit - and undisclosed liabilities may yet come back to haunt it, but for now at least it is doing its best to imitate the Phoenix.