Corporate Profile: The call of the wired

Two years ago BT's primacy in telecoms was under threat as aggressive newcomers outmanoeuvred the company. Now it is in a position to take on (or take over) allcomers. But it's not just talking a good game...

BRITISH TELECOM was in the news again earlier this week. Telecom Italia, the former state-owned operator, was reportedly looking for a white knight to rescue it from a hostile takeover by Olivetti, the typewriter- maker that has reinvented itself as a telecom group. As a former state- owned company itself, BT was named as an ideal candidate to step into the breach.

As it happens, the odds are that BT will not bid for Telecom Italia. But the mere fact that the company is named as a leading candidate - and the fact that its shareholders do not panic at the prospect of it mounting a 55bn Euro (pounds 37bn) acquisition - is a sign of how far BT has come in a relatively short space of time.

It may seem hard to believe now, but it's less than two years since BT was seen as the company that needed rescuing. The former monopoly appeared to be under attack from all sides. Aggressive new operators were luring away its most lucrative business customers by offering better services at cheaper rates. Its residential customer base, under pressure from the cable operators, seemed condemned to a fate of managed decline.

The group had taken its eye off Cellnet, allowing rival Vodafone to establish a clear lead in the emerging mobile phone market. Two failed mergers - first with Cable & Wireless, then with MCI of the United States - had left its international strategy in tatters. Critics were beginning to question the management skills of Sir Peter Bonfield, the newly appointed chief executive.

Today, the situation could hardly be more different. BT's share price is riding high, prompted by an explosion of data and Internet traffic that has helped give its residential business a new lease of life. A pounds 10bn international joint venture with AT&T, the US giant, has restored BT's credibility with its largest international clients.

Still, stock markets are prone to exaggeration. If investors were prematurely writing off BT two years ago, they are probably being a shade over-enthusiastic about its prospects at the moment. In the fast-forward world of technological innovation, the next major challenge is only just around the corner.

"What we are facing is that every four years we need to completely transform ourselves," says Andy Green, BT's director of strategy and development. "After first downsizing and then making ourselves more marketing-driven, we need now to turn ourselves into a data telecommunications company."

He is referring to the projected explosion in data traffic, helped by the growth of the Internet and the arrival of Internet-based technologies, which allow large amounts of information to be squeezed down existing telephone lines. At the moment, most telecom firms make the lion's share of their revenues from traditional voice calls. Over the next decade, however, voice is likely to be overtaken by data.

This realisation underlies just about everything BT does at the moment. The company is pouring cash into building new Internet-based networks, both in the UK and in continental Europe, while capping the amount it spends on its traditional circuit-switched network. The same Internet- based architecture will form the basis of BT's joint venture with AT&T.

At the same time, ADSL (a technology that gives customers high-speed Internet access over copper telephone wires) should be available later this year. "We see the future as a world that is 'always on' with significantly higher bandwidth available in the home," says Mr Green.

Meanwhile, BT has linked up with Microsoft to explore the possibility of piping Internet-based services to mobile phone terminals. Cellnet, which even though it is not wholly-owned has now been fully integrated into BT's management structure, is also attempting to regain some of the ground it has lost on its rivals by offering simple messaging and e-mail services. And BT is carefully planning its bid for one of the five third- generation UK mobile phone licences, which will make mobile phones capable of high-speed data communications.

Yet some wonder whether this will be enough. After all, BT's success so far has come partly from being in the right place at the right time. The sudden acceleration in local call revenues - a main feature of its last set of quarterly results - was largely attributable to the free Internet services that were pioneered by the likes of Dixons' Freeserve.

The picture is complicated by BT's continued dominance of the UK residential market - 15 years after privatisation, it still has more than 80 per cent of all residential customers.

"On the one hand, BT wants to be a market innovator, but on the other hand it's a market defender," says Chris Godsmark, telecoms analyst at Investec Henderson Crosthwaite. This translates into a reluctance to introduce any innovations that might undermine the existing revenue base.

An example is ADSL, which is likely to have an expensive price tag when it is first introduced. A more radical option would be to roll out the service aggressively, reaping the benefits in terms of the extra traffic that the availability of high-speed Internet and data services would almost certainly generate. But the feeling is that the "bean-counting" mentality still prevalent in parts of BT will probably prevent such a move.

Another concern is that BT will find itself missing the most valuable aspects of the "datawave". While supplying the pipes for telecom traffic has been lucrative for BT so far, the worry is that this will become a commodity product with rapidly falling prices.

"Where BT has been less successful is in becoming a dominant retail Internet company," says Investec's Mr Godsmark. "It could have already become a portal operator along with the likes of Freeserve."

While Mr Green insists that BT is determined to remain what he calls a "communications company" - it does not plan to expand into television or other media - the company is clearly not averse to supplying services. It is an equal shareholder in Open, the interactive shopping service available on the Sky Digital satellite television platform. It also has a shareholding in LineOne, the Internet service. Eschewing the term "content", Mr Green opts for a different buzzword - "context" - as a definition of what BT plans to offer.

At the international level, BT has been carefully picking strategic investments in fixed and mobile telecom operators from Italy to Indonesia. The continental European investments are already beginning to generate a profit, although most of the Asian investments are still losing money. An exception is last week's pounds 240m venture in a 20 per cent stake in SmarTone, the highly profitable Hong Kong mobile phone operator.

The value of these investments is beginning to shine through in BT's share price. "People realise that BT is not just a domestic business," says Jim McCafferty, head of European telecoms research at SG Securities. "They are wondering: 'if Orange is worth pounds 10bn then how many stakes in operators like Orange does BT own?' "

Going forward, however, the challenge is to make the most of these investments. When taking a stake, BT normally insists on retaining the right to help choose the operator's technology, even though it may not have overall control. This allows it to build up experience in one country, which can be transferred to another.

"BT is transforming itself into more of a normal multinational with a series of global product lines," says Mr Green.

One hole in BT's portfolio is Japan, which is a key market in its quest to build a truly global alliance with AT&T. The two companies are rumoured to be close to investing in Japan Telecom, a smaller operator. But analysts reckon its sights should be set higher. "They need to pick up a big player which would give them access to large Japanese multinationals," says John Matthews, principal consultant at industry analysts Ovum. "A deal with NTT or KDD would be a big prize."

A deal in Japan, combined with the long-awaited buy-out of Securicor's 40 per cent shareholding in Cellnet, would help one of BT shareholders' other gripes: its unnecessarily strong balance sheet. The company would like to bring gearing up to the 50 per cent level from about 3 per cent at the moment. But shareholders have also made it clear that they do not want the cash returned to them.

So BT is looking for investments. But having watched his reputation grow with the help of some clever moves and a following wind, Sir Peter will be reluctant to risk it now.

If BT does resist the temptation of bidding for Telecom Italia, nothing could better demonstrate how far the company has come in the past few years.

Talking Telecom Numbers

Based in St Paul's, City of London

Chief Executive: Sir Peter Bonfield

Chairman: Sir Iain Vallance (right)

Market Capitalisation: pounds 70bn

Pre-tax profit 1997/98: pounds 3.2bn

Turnover 1997/98: pounds 15.6bn

Number of residential lines:

20.1 million

Number of business lines: 7.8 million

Number of cellular customers: 4 million

Internet access customers: 500,000

Employees: 125,000