Corporate Reporting Analysis: Cable & Wireless / UK Fixed line
Accounting & Corporate Reporting Analysis Group Coursework:
UK FIXED-LINE TELECOMMUNICATIONS INDUSTRY
April ’10 - March ‘11
UK Fixed Line
Cable & Wireless
Figure 1: Cable & Wireless Share Price (Apr’10-Oct’11) Source: www.cw.com/investors
Cable & Wireless Worldwide is a global telecommunications company based in the UK.
From its 2010/11 Annual Report it appears confident in its business strategy, and its
headline data (EBITDA/trading cash flow) suggests it is in a healthy position. Yet six months
after the report’s closing date, its share price is in steep decline (Figure 1), it has issued
three profit warnings and the CEO has resigned (Appendix 1).
Aims & Objectives
Using Cable & Wireless as a benchmark our primary aims are to:
1. Explore the extent to which it is possible to read between the lines and numbers of a
company’s annual report to locate the causes of poor performance.
2. Compare the reports of five entities operating within the same industry to observe
which factors most impact their performance.
UK Fixed-line Telecoms Industry
Our reporting entities were selected on the basis that they represent a broad sample of
Telco’s (Telecommunications Service Providers) in the UK fixed-line sector: (See Appendix 2
for profiles on each company)
Cable & Wireless Worldwide1
Telecommunications is an incredibly capital-intensive business. Network infrastructure and
operational systems must be constantly refreshed in order to be at the forefront of new, more
efficient network technologies and business processes. Management is charged with the
dual responsibility to grow capacity and at the same time drive down the price paid by the
consumer as directed by the regulator.
Cable & Wireless Worldwide demerged in March 2010, hence there is limited historical data on the
stand-alone business, despite the former group having traded for over 100 years.
TalkTalk also demerged from the Carphone Warehouse Group in March 2010.
The fundamental criterion for a Telco’s success is its ability to generate sufficient free cash
flow from operations and raise additional external capital to reinvest back into the business.
Hence why EBITDA and free cash flow so often feature as key metrics in the headline data
of our annual reports.
In this study we will explore the free cash flows of five entities, considering (1) their ability to
generate cash from operations, (2) the extent of gearing and the returns from leveraging
external capital, and (3) how they reinvest capital back into their business. In doing so, we
hope to understand the contrasting business models and growth strategies in the UK fixedline sector and determine the areas where Cable & Wireless might be going wrong.
From the narrative in our annual reports, we can observe the strategic aims of each entity as
well as some broader market trends affecting the industry as a whole.
Key points are summarised in the table below:34567
BT Group plc, Annual Report & Form 20-F 2011 (Chairman’s message) p.3
Cable&Wireless Worlwide, 2010/11 Annual Report (Our Strategy) p.2
Colt Group S.A., 2010 Annual Report (Vision, Mission, Strategy) p.1
KCOM Group PLC, Annual Report and Accounts 2010/11 (Our Vision) p.5
TalkTalk Telecom Group PLC, Annual Report (Chief Executive’s Review) p.6-9
From the above there is a consensus view on the need for continuous investment in network
technology and efficiency or ‘business process’ improvements i.e. drive down costs and
exploit new opportunities in better differentiated product-services in order to offset the
declining revenues from regulated (voice network) services.
1) Top-Level Performance Analysis
By contrasting and comparing various ratios we can begin to compare the overall
performance of the five companies. Starting with earnings before interest, tax, depreciation
and amortisation (EBITDA) as a percentage of revenue, we observe that each company has
seen a slight improvement from the previous year.
This graph tells us very little in isolation, except that BT is leading the industry in its ability to
generate gross margin and that Cable & Wireless is in a similar position compared to its peer
competitors. This is the start of the investigation process. We will now consider the
distribution of earnings i.e. where the cash generated by the business is employed by
working down the cash flow statements and hence, calculate the ‘free’ cash that remains.
Each entity defines ‘free cash flow’ differently, thus in order to make a comparison it is not
possible to use the stand-alone figure from the reports. The following charts represent our
own definition which we call ‘discretionary cash flow’ i.e. EBITDA less interest and tax,
dividends, working capital, CAPEX, pensions and exceptional items; to observe the extent to
which the company is able to finance its various activities by cash generated internally.
Distribution of EBITDA in 2011 (See Appendix 4 for notes and figures)
A full breakdown of where cash is being spent allows us to visualise the companies’ cash
flow and work out the percentage of what is left to be distributed at the management’s
discretion: to keep money in the bank, reduce debt or reinvest back into the business. In
C&WW’s case, it is negative hence they have increased their liabilities to pay dividends. This
is not immediately obvious from the balance sheet as it shows a decrease in liabilities overall
(following a heavy pension pay-out in 2010), but an increase in the amount of loans and
obligations under finance leases in both current and long-term liabilities (Appendix 5).
2) Gearing and Return on Capital Employed
It is not only the ability to generate cash internally that is important for financing growth, but
also the Telco’s ability to raise new capital through its shareholders and the banking
stakeholders. Management must balance dividend payments and internally-funded CAPEX
spending, whereby paying competitive and sustainable dividends to shareholders
encourages further investment in the company by maintaining a steady, growing share price.
This then provides an environment to leverage this equity to raise capital from the banks and
keep the company expanding, thus taking the pressure off the shareholders for new capital.
Gearing shows the extent to which a firm’s capital structure relies on borrowed funds in
comparison to shareholder’s funds.8 It is not necessarily a quality mark against the company
but more an indication of the management’s investment strategy.
KCOM, TalkTalk and most especially BT are highly geared, suggesting that a large
proportion of their capital is derived from borrowed funds. This could be seen as negative in
the sense that they have high debt and potentially high interest rates to pay. However, in the
case of BT and KCOM, each with a proportionately large asset base and a guaranteed
(regulated) market in their respective business operations (see history in Appendix 3), there
is little risk to the banks of a default hence interest rates would be comparatively low.
Mclaney & Atrill – ‘Accounting: An Introduction’ (Pearson 3 Edition, 2005) p.230
Gearing = long-term liabilities / share capital + reserves + long term liabilities x100
If we now consider the return on the capital employed (ROCE),9 BT and KCOM show a more
efficient use of capital, due to advantages within the core business model (discussed below).
But in 2010 C&WW were less efficient than their peers. Following restructuring they have
made a substantial improvement, but still they lag behind their competitors.
* Cable&Wireless: no values for the previous financial year due to demerger in March 2010.
** BT has negative equity in 2009/10 due to ‘recognition of actuarial losses on retirement benefit obligations’.
*** TalkTalk provides no values for previous year due to its demerger from the Carphone Warehouse Group.
ROSF (above) illustrates the net benefits to the shareholders as a result of the decisions
taken by management and their ability to gear the company effectively. As a brief aside, it is
very clear from the ROSF comparison that BT and KCOM, both former incumbent Telcos
provide the best return for shareholders, whilst newer entrants are struggling to maintain
their position in the industry. Such concentration of investment capital in the former
incumbents is reminiscent of the old monopoly situation in the 1980s, which must be a
concern for OFCOM as it is their goal to maintain competition in the sector.
A possible cause for operational inefficiencies within Cable&Wireless can be seen in note 17
of their annual report which sets out the costs of assets and the depreciation applied
historically (Appendix 5). The largest asset is Plant & Equipment (£855m out of a total of
£983m). The original purchase price of these assets was £5376m. The historical
depreciation of £4525m would indicate that these assets are over 15 years old,10 suggesting
C&WW is managing a rapidly aging asset base, hence its high and increasing operating
costs and low gross margin in the ‘legacy’ voice network.
3) Capital Expenditure
If we now consider the CAPEX breakdown (see below), management may need to revisit
their decision to only invest 2% in network improvements if they are to reduce the sensitivity
of the company to reductions in voice revenue. The charts below indicate that the bulk of
Cable & Wireless’ CAPEX is either in new business activities (31%) or growing its ‘managed
services’ (customer contracts: 57%) i.e. activities where it is essentially using its CAPEX to
serve its customers’ own capital requirements. Profit margins for these activities look good at
(61%) and (73%) respectively, but the EBITDA to CAPEX ratio is disproportionate,
considering revenues from their core business i.e. its voice, indicating that C&WW is out of
its depth in these new areas of activity thus failing to deliver shareholders’ expectations.
IP and Data
Applications and Hosting
Voice and Legacy
ROCE = net profit before interest and taxation / share capital + reserves + long-term liabilities x100
Calculated as the depreciation to date divided by the yearly write-off and depreciation rate, less
new CAPEX: £4525m / (£266m + £266m - £232m), Cable & Wireless Annual Report 2010/11 p.80
The above figures for C&WW,11 and those produced from its competitors’ reports in
Appendix 10 suggest revenues and gross margin from traditional voice services are
decreasing. The 2011 Ofcom report (Appendix 8) also supports this. C&WW as a
consequence of this trend states in their annual report that it is exiting its historical ‘core’
business and moving ‘towards the cloud’, thus no longer investing in lower costs structures
as a means of enhancing its EBITDA. The strategy seems sensible, yet recent turmoil
suggests the transition has been made prematurely and at the expense of essential
investment in their core network which delivers these higher-value ‘cloud’ services.
CAPEX Breakdown 201112
- Cable & Wireless invests just 10% in maintaining its
network infrastructure, and 2% in cost-reduction
(efficiency) measures. 31% goes to new capability
assets in ‘cloud’ (Applications & Hosting)
- BT spreads its activities across a variety of services.
However it continues to invest heavily in its ‘platforms
and networks’. Access (23%) representing the new UK
high-speed broadband (fibre) network.
- Colt’s core network activity is in providing ‘data
services’ to businesses in which it invests 60%
Cable & Wireless Annual Report 2010/11 p.31
See Appendix 11 for corresponding data.
- KCOM and TalkTalk comprise a single voice and
broadband network in which they clearly invest heavily.
Despite limitations in the amount of comparable data provided in the annual reports, the
above comparison still shows how out of step Cable & Wireless is with its peers, all of which
are staying true to their core area of competence by investing in network infrastructure,
hence the loss of confidence by shareholders and the subsequent collapse in share price.
Cable & Wireless is a well-established and asset-rich company, which when compared to its
peers is clearly underperforming. Analysts have been slow in recognising structural
problems in C&WW as it took three profit warnings to alert the market, yet there is a case to
be made that these issues were present in its first report as a newly formed entity. This
recent restructuring of two of our five entities (CW&W/TalkTalk) made a comprehensive
analysis difficult due to a lack of historical data. However, we can conclude that close
comparison reveals that the sector is generally in good health, with former incumbent telcos:
BT and KCOM clearly dominating (an issue for the regulator and a topic for further study).
Therefore, the problems of C&WW can be attributed to structural weaknesses in the
management’s strategy, namely their plans to offset the decline in traditional voice revenues
by investing in next generation services without sufficient investment in their core network.
With hindsight, a better strategy may have been for C&WW to reinvest in its core business to
reduce its overheads and improve margins on its voice network before migrating to new
In carrying out the report we reached the following conclusions about effective corporate
1. To get an accurate picture of a company’s state of health it is necessary to read the
notes in the pages at the back of the annual report first.
2. A broad understanding of the industry is required to analyse and compare company
reports operating in the sector.
3. Despite recognised accounting standards there are still inconsistencies in the way
reports are presented and therefore the numbers behind the ratios need to be
understood and sometimes redefined.
APPENDIX 1: Cable & Wireless in the press
The Financial Times reporting on Cable & Wireless’ performance following the annual report.
Source FT.com: (Interactive timeline) http://www.ft.com/cms/s/0/9fffeb4a-a188-11e0baa8-00144feabdc0.html#axzz1cuxUOaeM
June 28th 2011
“Jim Marsh, Chief Executive of Cable & Wireless Worldwide, resigns after poor sales force it
to issue its third profit warning in 15 months and halve its dividend for 2011-12. He is
replaced by John Pluthero, chairman”.
June 21st 2011
“Cable & Wireless Worldwide's annual report reveals that the company has decided to curb
executive pay in 2011-12. It will scrap plans for a new scheme providing potentially large
share awards to top managers, and will reduce stock issuance to them under another plan”.
May 20th 2011
“Bosses at Cable & Wireless Worldwide are set to miss out on final payments from their
controversial long-term incentive plan, the FT reports. The fifth and final year of the plan is
not expected to provide any cash payments due to poor share price performance”.
March 31st 2011
“After the news that Tim Weller, Cable & Wireless' Finance Director is to leave the company,
The Times claims this follows the board's rejection of his advice to lower its profit guidance
before a positive trading statement in February. This statement was followed by a profit
warning two weeks later”.
March 24th 2011
“Shares in Cable & Wireless Worldwide fall by more than 14 per cent after it issues its
second profit warning in less than a year. Jim Marsh, chief executive, insists he will not
July 20th 2010
“Cable & Wireless Worldwide warns of a "very significant slowdown" in UK public sector
contracts, triggering a 17 per cent drop in its shares. It blames a drying up of one-off
telecoms projects, such as extra bandwidth and site moves”.
Demerger of Cable & Wireless Worldwide from Cable & Wireless Plc
APPENDIX 2: Company Profiles
& A global telecommunications company, based in the UK which specializes in
providing communication networks and services to large corporations,
Worldwide governments, carrier customers and resellers. Its services include managed
Voice, Data and IP-based services and applications in UK and internationally.
BT is one of the world’s leading communications services companies,
operating in the UK and 170 countries worldwide. Its core activities are the
provision of fixed telephony lines and calls (retail and wholesale), broadband,
mobile and TV products/services to consumers and SMEs as well as
managed networked IT services for multinational corporations, domestic
businesses and government organisations.
TalkTalk is the ‘value for money’ provider of fixed line broadband and voice
telephony services to consumers and business users. Serving over 4.8 million
customers in the UK they have grown their business to compete with BT. It is
split into TalkTalk, AOL Broadband and TalkTalk Business. The company
demerged from Carphone Warehouse Group in March 2010.
KCOM could be described as a BT in miniature, providing almost identical
services through its four ‘brands’ KC, Kcom, Eclipse and Smart 421, it has a
virtual monopoly of the Hull and East Yorkshire region, also providing voice
and broadband services to consumers and SMEs in other parts of the UK. It is
comparatively small, therefore more agile and has been quick to invest in
high-speed broadband and next generation services.
COLT, ‘City of London Telecom’ (est. 1996) is based in the UK but operates
mainly in Europe. It specialises in voice, data, and integrated IT-managed
services for businesses of various sizes. It operates with pan-European
assets, and aims to become the leading information delivery platform.
* Colt’s annual report is for the calendar year 2010 and states its currency in Euros.
**Virgin Media and Sky are both big players in the UK telecoms industry. They were not
considered in this report on the basis that fixed- line is not the core of their business.
APPENDIX 3: A Brief History of the Telecoms Industry13
BT was formed in 1982 when HMG privatised the former Post Office telecommunications
activity. The Conservative administration recognised that there was a need for increased
competition in the telecommunications sector and the cost to ‘digitise’ the UK network would
be beyond the UK Treasury’s ability to finance.
In parallel to the privatisation of BT, OFTEL (the precursor to OFCOM) was established and
granted an operators license to Cable & Wireless who established Mercury Communications
as a competitor to BT’s retail business. This arrangement became known as the “duopoly”
and continued until 1994 when the Telecommunications Act caused HMG to open the UK
market to more competition, where OFTEL set the rules for fairness.
KCOM, (formerly Kingston Telecommunications) was under the ownership of the City of Hull.
Being the only part of the UK Telecoms network not directly owned by the state and under
the jurisdiction of the Post-Office prior to 1982, it was part-privatised and became KCOM plc.
Summary of articles found here: http://www.btplc.com/thegroup/btshistory/1984onwards/1984.htm
APPENDIX 4: Reference for EBITDA breakdown charts
Interest and taxation
*Exceptional items, Movement in exceptional provisions, LTIP Payment
Source: Cable&Wireless Worldwide, ‘2010/11 Annual Report’ p.34
Interest and taxation*
*Interest paid - Interest received + Income taxes paid
Source: BT Group plc, ‘Annual Report & Form 20-F 2011’ p.50, p.103
Interest and taxation
Source: Colt Group S.A., ‘2010 Annual Report’ p.19, p.61
Interest and taxation
*Exceptional items-One company, demerger
Source: TalkTalk Telecom Group PLC, ‘Annual Report’ p.17
NOTE: KCOM did not provide sufficient data in their annual report to show a useful
breakdown of EBITDA.