C&W in a game of catch-up

With the Vodafone deal done and dusted, Cable & Wireless could be the next hot tip in telecommunications, writes Peter Koenig

AS CABLE & WIRELESS senior management retreated to a conference centre west of London 10 days ago to discuss strategy, they had a wall of bad news to confront.

Since the company broke off talks with Telecom Italia in November, analysts have brickbatted C&W for not knowing what it is doing in continental Europe. C&W's Hong Kong Telecom subsidiary, once a monopoly and cash cow, faces an uncertain future now that Peking runs the former colony and the telecoms business there is being opened up to competition. On 10 December, C&W was sent reeling when Dick Brown, its deal-making Texan chief executive, peremptorily announced he was quitting to return to Texas to run Electronic Data Systems Corp. And almost literally as C&W's bosses, led by chairman Sir Ralph Robins and acting chief executive Rodney Olsen, drew up in their cars, a rumour hit the City that Deutsche Telekom, the privatised German telecommunications group, was going to mount a takeover bid.

"We didn't talk about any of that," says Stephen Pettit, C&W's executive director for global business, "although we did touch on the management issue."

So what did they talk about?

"Making sure our internet business was on track. Making sure the development of our global network was on track. Making sure that we were delivering on the promises we've made to our customers."

A Terry-Thomas look-alike, Pettit is blessed by an instinct for understatement, which is refreshing in the context of the roaring telecoms industry. Pettit, indeed, sounds convincing when quietly arguing that C&W is undervalued by investors. So convincing, indeed, that investors appear to be waking up to the possibility that C&W is an overlooked value play in the heavily worked-over telecoms sector.

Lagging behind the UK telecoms index by some 40 per cent over the last year, C&W shares have stopped slipping since the management meeting and performed on a par with the index last week.

An analyst from Henderson & Crosthwaite, Paul Sharma, says: "C&W has a market capitalisation of about pounds 20bn. Orange has a market cap of pounds 10bn. Comparing the share prices and assets of the two companies, I think you have to say C&W is undervalued."

In a mini-outburst, Pettit rails against the stock market's love affair with newcomer telecoms companies ranging from giant MCI WorldCom to smaller fry like Colt and the recently merged Esprit and Global Telesystems Group.

"Why do these companies get the hype?" he explodes. "Because they show lots of revenue growth. But they don't show earnings growth. In some cases they don't show any earnings at all."

Pettit acknowledges that, because of intense competition, C&W's own earnings may be flat in 1999. A fortnight ago, for example, Hong Kong Telecom slashed prices on its mobile phone services by as much as 70 per cent to protect its position in the liberalising local market. At the same time, however, Pettit stands by the strategy C&W has pursued for the past three years to secure its footing in the pounds 300bn-a-year global telecoms industry.

C&W is an "old-world" telecoms company - just as BT and AT&T are - as opposed to "new-world" telecoms companies like MCI WorldCom and Equant. They have built totally new businesses in recent years on the back of deregulation, privatisation, and new technology.

Howard Ford, head of European operations for Equant Network Services, says: "We can sign high-level service agreements with customers because we have one seamless global network based on the internet."

As an old-world telecoms firm, C&W has the advantage of an existing client base (17 million customers in 70 countries), being the third-largest supplier of international phone services behind AT&T and Deutsche Telekom, and control of a twelfth of the world's undersea phone lines.

But it also has an old-world management which grew up when telecoms was a monopoly business focused on selling voice communication, not internet services or cable television. C&W also has a higher cost base than a company like MCI WorldCom. Many of its switches - the devices routing phone traffic - are outdated and inefficient. New-world switches are cheaper to operate because they package voice as well as data traffic into compressed digital signals, then send them in packets down lines making more efficient use of line capacity.

"The internet is not a business," says Pettit. "It is a facilitating technology. When I talk to customers, I don't talk to them about the internet. I talk to them about hooking up computers in the home to the office, and eventually televisions in the home to the office."

But, he concedes, the strategy of C&W is to make the transition from old world to new. The challenge is to do this faster and more efficiently than other old-world telecoms firms making the same journey. C&W must also fight off new-world telecoms firms such as MCI WorldCom seeking to steal its customers by offering them cheaper services based on a lower cost of doing business. Competition in the industry is ferocious.

"Deutsche Telekom is making [this] transition successfully," says a spokesman for Deutsche Telekom. "We are doing this because Germany is the most deregulated national telecoms industry in the world."

James Richardson, head of European operations for Cisco - the California- based manufacturer of internet routers, the devices gradually replacing traditional phone switches - says: "The battle is all about timing."

C&W must time its investments to move from old switches to internet- protocol ones, while also laying increased-capacity fibre optic cable, and "migrating" its many national networks into one global network. Judging how well Pettit and his colleagues are performing this task in comparison with the efforts of its competitors goes to the heart of valuing C&W. The stock market is looking at the easy numbers in contrast with the harder business of getting to grips with this analysis, Pettit believes.

However, Pettit cites various numbers when arguing that C&W is making the transition from old world to new. Reconfiguring its Atlantic and Pacific cable networks, he says, will allow C&W to save between pounds 50m and pounds 100m over the next few years. Reconfiguring the company from a federal network of many companies into one company with one global brand being sold by one sales unit to top-of-the-line corporate customers, Pettit says, C&W lined up pounds 500m in new business between January 1998 and this month. One new customer is Chase Manhattan. Another is a major US information technology company. "We increased our [top-line sales] hit rate from one- out-of-10 to four-out-of-10," he says.

Pettit also cites corporate moves - chiefly the pounds 1.1bn purchase of MCI's internet business in the US last year after WorldCom acquired MCI and had to sell MCI's US internet business - with its 3,000 corporate customers - to satisfy US anti-trust regulators.

"This puts us top of the [pecking] order in the US," says David Wickham, chief executive of C&W's global network. Wickham explains, this means that C&W pays few interconnection fees for internet traffic to other US telecoms companies, while many of those US companies pay fees to it. Pettit also points out that two weeks ago C&W bought the German internet provider ECRC Network Services for pounds 27.5m.

"We not only bought a business," he says, "we also bought 60 people who've been involved in the internet in Germany since the start."

Assessing Pettit's claims is very difficult. But no less an authority than Cisco's Richardson backs them up. "C&W has massive international prospects," he says. "They're very, very well positioned."

Responding to the argument that C&W is exposed in Hong Kong, where it generates nearly 40 per cent of its sales, Pettit says that C&W is gradually cementing good relations with China's leaders in Peking.

Cisco's Richardson again endorses C&W's step-by-step strategy.

Henderson Crosthwaite's Sharma, meanwhile, argues that there are a variety of steps C&W could take to increase its appeal to shareholders. "In One2One it has an excellent mobile phone business. It could float that."

If C&W is so under-valued, isn't Deutsche Telekom or someone else going to make a bid for it? Pettit has an understated chuckle. "There have been bid rumours ever since I got here," he says.