BT Group plc (BTA) Earnings Call Transcript & Summary

Great. We will get started. It's my pleasure to welcome back to Communacopia BT's CFO, Simon Lowth. Welcome back, Simon.

Hi Michael. Hi, everybody.

Great. Before we get started, just one admin point, which I'm sure people are already aware of. But if you would like to submit a question, you can do that by the online functionality on the Communacopia website.

Simon, I'd love to kick-off, just thinking about the impact of COVID. BT's clearly highlighted some pretty material impacts, particularly in the second quarter. So could you update us here on how some of those impacts are progressing? And also whether some of the more temporary impacts, such as sport, roaming, et cetera, are they coming back at all in the second half?

Okay. Well, in summary, for the first quarter, Michael, you'll remember that we were impacted year-on-year significantly by COVID, although slightly less, I think, than the market had expected. The big impacts for us were, as you said, no sport being played. So we were given Consumer rebates. We would get -- we were out of pubs and clubs, and therefore, that revenue was not available. And then that was one big driver. We had reduced trading activity in the SME and wholesale space. And that was a second big sort of driver for us. And then we also obviously have some lower volumes in areas like roaming, pay-as-you-go volumes were down. And those are probably the 3 main sort of headwinds. We had a little bit of a tailwind from sort of conferencing volumes, messaging volumes and some work with our large customers, kind of get them connected through lockdown. So those are the big trading issues, I think, COVID in the first quarter. As we look forward, sport, obviously, we're great to see back, particularly soccer, which is our big rights. We completed seasons. We're now starting again in the premier league. And so that's obviously given us support on the consumer side, although the pubs and clubs business, as you'll know, we're wondering around most parts of the country remains very subdued. So that will remain a headwind for us. In terms of trading on the Consumer side, actually, with the retail stores back, which is an important channel for us, particularly in mobile for sort of acquisition and upgrade, stores are back. And we're seeing trading stop to revert to back to sort of normal. Although I would say that that's -- it's still -- we're probably still not quite sort of where we were and I would say it's also quite -- it's pretty price competitive in terms of acquisition market. The -- in the Enterprise side, and we said at Q1, and that will remain, we believe, the primary impact of COVID, particularly in the SME segment into the remainder of the year. The macroeconomic -- very challenging macroeconomic conditions impacting both business activity and volumes of both and in addition to that, obviously, there is a growing insolvency risk. We haven't -- we've provided for that at a level of that at year-end. We haven't -- in Q1, we said we haven't changed those provisions, but we're watching that very closely. So there's probably the main headwind. So sport volumes, pubs and clubs, trading in SME and in solvency in SME, I should probably set also because roaming is also nowhere near back to normal. So those are probably the main ones offsetting that, we continue to drive costs hard and we found ways of taking some mitigation to that. And actually, we found, despite the remote working, we and BT have been able to drive our transformation program, pretty much at the pace we expected. It's very -- we're concerned that working in an agile way doing the IT-LED transformation with more difficult remotely. Actually, the team's done a great job sustaining that. And then -- so that's probably for this year, Michael, a high-level sort of summary of COVID for the year. I mean I think as you go forward beyond this year, as we work through, particularly the SME sort of insolvency issues, the more general message is that this pandemic has really reinforced people's understanding of [ Audio Gap ] And we think that, that must and will be a positive for us, both in terms of the performance that consumers will demand and actually the needs for business is going to be working on a much more interconnected way. So that's got to be positive for us in the midterm.

Yes. Got you. You sort of rolled into my second question there, which was pretty much now, which is how do you think about the longer-term impacts of COVID on a business like BT? And in particular, one thing about as to summarize in the last couple of days I communicated with you already that some telcos are highlighting the ability to go faster on projects like digitalization and also the work from home actually has benefits for the telco as well.

Yes. I mean I think, look, if we just start within BT quickly, I mean I think BT has done actually a terrific job through the pandemic. I mean I think for our customers, I mean, the feedback we get has been very strong. We were very proactive in bringing changes to the connectivity customers needed to keep working through lockdown. We reached out to a lot of vulnerable customer groups, NHS customer groups. I mean I felt it was good to be part of BT during that. I think the company responded extraordinarily well. And in addition to that, we've got pretty much our entire workforce either safely working in their sites because they have to be there or working from home. We've learned a great deal, Michael, and I'm sure all of the organizations and people on this in those meetings have done so. At how effectively we could actually remotely. And as I said, with our transformations efforts have continued unabated, therefore, we are actively looking at how we will work as a company and what the role of offices will be in the future. And that was timely because as you probably know, we were going through a massive office consolidation program to bring our people into a small number of regional hubs. And I think this is going to help us do that because we'll be able to -- and in fact, we're already planning, it will shrink the amount of capacity we need, and I think allow us to use that for more collaboration centers and combine with more smart working. So I think that's going to be beneficial to our effectiveness, but also, frankly, our cost base. For our customers, we're seeing exactly the same thing, which is that I really made the point. They're just looking for much more resilient, high-performance connectivity. And they're looking for consumption of applications across that. In networks with security, despite the fact we're now in a fragmented way of working. And that's -- for our business, that's -- we've got really distinctive propositions in that space because we can really bring secure connectivity in a highly distributed network. And that's exactly what enterprise customers have been looking for. So there's going to be yes, definite positive there. Yes. I think the flip side also, even in the SME case, it's going to be a very tough time, and we get -- we are going to see a rise of insolvencies. We're also going to see a hell of a lot of new business startups and formations as the economy recovers. And that, I think, is a big opportunity for us to support businesses from the outset to get their businesses up and running.

That's really, really clear and really interesting points. So I'm just going to do now pivot to Openreach. I know it's been, I guess, the hot debate really on BT, partly because of everything you're doing and the cycle rim with the regulation. And my observation is what you've got here is clearly a long duration asset, but with probably limited free cash flow generation in the near-term due to the high levels of fiber to the home CapEx that you've committed to. So in a sense, this is almost penalized in the group valuation, but would be rewarded by a different type of investor base potentially. So as a broad question, how do you think about that as a management team?

Okay. Well, firstly, we have a -- we have a deep belief in the value that investment in a nationwide FTTP footprint will bring to Openreach and to BT retail and to the BT Group. We are -- we talked about this generating returns, confident returns of sort of 10% to 12% return. And that is relative to -- on the investment relative to not doing it, and we think that is a strong return. And it will -- that the return comes from retention and growth of the Openreach customer base, an uplift in pricing through high-performance product. And secondly, it paves the way for a very fundamental reduction in the Openreach cost base because we remove the copper network. We remove all of the manual interventions associated with an analog copper network, we can remove the large sways of our exchange network and we reduced the cost of folks on our aging network. So this will be transformative to the Openreach cost base. So we have a deep conviction in this being a high-quality long term asset. But to your point, Michael, it's a -- it is a long payback and that we have to put significant investment in. We build the network, the CapEx then drops out, and this is going to be -- this is massively strong in cash generating, long-term predictable asset. So we recognize that, and we also believe that, that is not -- clearly isn't reflected in our share price today. There are -- public equity markets are quite capable of funding those sorts of investments, much of the infrastructure in other parts of the U.K. infrastructure has been funded through the public equity markets confidently. I think that there are some steps we need to take that will take place that will help investors better understand that investment. I think publication of the regulatory, the final regulatory settlement, we have the benefit of intensive engagement with Ofcom. Our investors will see that when it's published. We need to ensure the fair bet is within that. So clarity on the regulatory framework. I think demonstrating continued scaled up build by Openreach at ever-lower cost points. And in addition, its CPs driving take-up of that and into retail share and at good retail prices. And the early signs this year of that are very good. We're very encouraged. And then thirdly, seeing CPSs, all the CPs actively promoting and partnering with Openreach to drive it. And again, over the next 12 to 18 months, we think we'll be able to demonstrate real progress in that regard. And I think as we see that very strong competitive proposition. And people get a better sense of whether and how what level out nets will build. I think all of that will help our investors, and there's probably more, Michael, we can do to explain how to arrive at and how to -- what the moving parts are in the 10% to 12% return. So those are things that we think will help our investors over the next 12, 18 months. Now the question you pose is whether we could further enhance the understanding of the value of Openreach by opening up an investment in Openreach to third party investors, not through the direct public equity markets. Could it access low-cost source of capital? Could it demonstrate -- could 1 or 2 investors demonstrate the value to others. We've got a very open mind to those 2 sources of potential value. We've got an equally challenging mind to ensuring that our investors today don't essentially cease part of their high-quality asset, not realizing proper value. So we have to be -- we have it open but very disciplined mind. As you know, accessing a minority investment, whatever scale, there are 2 very significant complications to that and we've been very clear about those. One is that there's a significant cost, financial management focus in the separation of assets and systems to do that. Openreach Limited today doesn't own any assets. It's a service company. So there's a huge piece of work will be needed to essentially underpin the assets into Openreach. And that would divert management from rolling out FTTP at pace and at signing up and working with retailers to drive take-up. Secondly, we're in the middle, as you know, of our transaction evaluation, [Audio Gap] the separation sit well, the structuring of Openreach to attract investment would subordinate the pension fund, that's no secret. The pension funds, we're very clear about that at the time of the DCR, the digital communications review, back in 2016. And in subordinating it, they also made clear that they would need to be made whole, and that would require a significant cash contribution. And if they -- if we -- if they demanded that and used it to derisk the pension fund, that would not be in our equity holders' interest. So open mind, 2 issues to solve. Now it's not -- right now, it's not the right time, but could we see a circumstance when it might be, we're always open to that.

Great. And that's super comprehensive there. I mean the one thing I would pick up on, which I think came up at 2Q is, and you mentioned is on the volume side. It sounded a little bit at 2Q, like the message on volume deals was perhaps a little bit more complicated than the market was assuming. And certainly, versus the volume deals, you managed to strike for your FTTC network, but could you just give us an update there? And are there any issues? And how is the progress? Or what are you thinking about? And what's potential timeline?

Yes. I mean I think -- I mean the -- first of all, the immediate focus for our work with retailers, CPs, has been to ensure that they have got the systems proceed processes in place that they can start to consume and sell and provision FTTP. We have worked with them on a number of commercial propositions to promote FTTP in sort of local and regional markets. And we're also implementing. And in fact, we announced this back in June, a stock sell contractual arrangement in certain -- in a number of exchange areas. So where they've got availability to FTTP, they can stop selling the legacy, and that was an incentive to do that to drive FTTP. So our immediate focus has been on what I would term shorter-term commercial arrangements in order to drive rapid take-up of FTTP as we're building. Now once we've -- as we get that regulatory enablers put in place, and both we and our CPs are really clear about it, now all the finer points of the regulatory framework, we will, of course, be looking at working with CPs on longer-term arrangements. I think the -- there's a key issue for us where we are still deemed to have SMT and Ofcom's mines and we can enter into long-term arrangements, but they need to be ones that are consistent with competition law, and therefore, are not deemed in those areas to foreclose competition. And so -- and that's clearly important. And therefore, some forms of volume commitments can be more difficult and more difficult perhaps than in the FTTC deal, although you may recall, we actually structured the FTTC deals very carefully to meet -- to ensure that it was absolutely consistent with competition door and there were various carve-outs, roadmaps and so forth. So focus today, short-term drive take-up. We will work with our CPs on longer-term arrangements. We need to do so in a way that is consistent with competition lower, and therefore, we needed to be very careful about sort of volume commits. We've solved it once for FTTC, there will be a different sort of solution for FTTP, but that's work to do.

Yes. No, great. I mean perhaps the very last question on Openreach is a lot of people are talking about overbuild. We're seeing this across Europe and in particular, in the U.K., I think it's quite a long list of overbuilders now. What's your sort of holistic view of the overbuilders? I mean, clearly, they're all different -- all got different plans, different investors. But from an Openreach perspective, what do you see as the risk from overbuilds?