City & Business: Fault lines disrupt BT's American dream

There was little hiding BT's surprise and disappointment at the shock announcement last week from putative US partner MCI that it was taking much longer and costing much more than expected to penetrate the lucrative US local telephone market. The news that MCI was anticipating losses of $800m (twice the level forecast) in its local telephone business this year, with more to come next, has forced BT back to the drawing board amid calls for the deal to be renegotiated or canned completely.

The biggest worry for BT is that it had no inkling that MCI's assault on the US local market was floundering. It has three representatives who sit in on MCI's monthly finance review meetings, but the first hint of trouble came only last Wednesday. That suggests a disturbing lack of control and a fundamental flaw rather than a little local difficulty. BT has therefore needed no urging to rethink the MCI deal.

This will be a complex affair. It is not just a question of attempting to reduce the price BT is prepared to pay to acquire MCI. The numbers are important, but in terms of what they say about MCI's strategy, not what they say about the deal itself. Cutting the MCI purchase price from pounds 12bn to pounds 6bn is irrelevant if the underlying strategy is inappropriate to secure access to the US local market.

BT believes, and its big shareholders agree, that a presence in the $100bn US local telephone market is critical to its ambitions to be a global telecommunications operator. The question is how to achieve such penetration while still getting an adequate return on its investment.

That is why BT's number crunchers are carefully analysing how MCI has contrived to lose twice the amount expected. In particular they are assessing what element of the loss is accounted for by items which represent capital rather than revenue expenditure. The aim here is to develop a clear profile of the cost and nature of the investment in local telephone markets.

Once the true level of the anticipated investment is established, BT can move to assess the likely returns. The most important element of this review is an analysis of MCI's strategy, which has so far failed miserably to deliver on its promises. It is apparent that the local monopolies are more difficult nuts to crack than MCI anticipated. BT will want to revisit that strategy in some detail.

So far BT has only been able to provide limited on-the-ground support to MCI. It may be there is an argument for a more substantial BT presence. Its own experience of domestic monopolies has not yet been fully brought to bear in the US.

Only when these important questions are answered can BT decide whether MCI is the best route into the US market. On balance it probably still is, given the difficulties in either going it alone or finding another partner. Don't forget that MCI offers more than just the US local markets. These attractions are not easily replicated elsewhere.

Investors can be reassured that BT will renegotiate the terms of the MCI deal. However, the more important changes will be strategic rather than financial.

Why are we waiting?

Bank of England Governor Eddie George has once again restated his credentials to be reappointed for another term. For the second Monetary Policy Committee meeting in a row he has overseen a rise in interest rates, confirming not only his commitment to bear down on inflation but also his ability to deliver the Government's 2.5 per cent target rate.

The move to push up rates by 0.25 per cent to 6.75 per cent may prove unpopular with home owners and exporters, but Mr George is not prepared to put personal popularity before what he sees as a personal responsibility to guard the country against inflation.

Contrast the Governor's approach with the altogether less robust stance taken by Chancellor Gordon Brown in his Budget earlier this month. He steered well clear of direct taxation on the consumers who pose the biggest inflationary threat. His reluctance to address consumer spending head- on left the MPC with no choice but to sanction an increase.

The Chancellor is perfectly entitled to put politics before economics. However, if he goes down this route then he most certainly needs a steady and respected hand on the tiller at the Bank of England. The Bank has such a hand in the shape of steady Eddie George. He will meet the Chancellor's inflation target, even though he has to do it on his own.

Gordon Brown must recognise this by now. Why is he taking so long to confirm the Governor's reappointment?

That's all, folks

Small earthquake at Hambros - not many dead. That is the best I can offer, I am afraid , to readers panting for more gory detail and shocking revelations about life at one of our smaller merchant banks.

Hambros has been attracting some rather active headlines in the past few days following the resignation of three of its directors last week. These came in the wake of a report from the law firm Norton Rose into Hambros' conduct of its relationship with Andrew Regan, the architect of the failed and controversial bid for the Co-operative Wholesale Society earlier this year.

Some observers have chosen to draw dramatic conclusions about the conduct of the City in general and the outlook for Hambros in particular from what we must call "The Co-op Affair".

Sadly, only a handful of people know what really went on. But I am not convinced that the public at large would learn a great deal to its advantage even if it were given a detailed blow-by-blow account of an unfortunate liaison.

It has been a difficult and traumatic time for all those involved either willingly or unwillingly in the bid for the Co-op. Lessons have been learned and prices have been paid.

In the final analysis, however, it was only a small earthquake.