All-new Eircom set to make miraculous market return

John McManus examines why the majority owners of Eircom may consider it is time to sell.

The flotation of Eircom, possibly as early as March, is looking increasing likely. If it goes ahead, with a projected price tag of €4 billion, there will be none of the hoopla that surrounded the original stock market offering in 1999 and the shares will not be offered to the general public.

That, however, is unlikely to be enough to prevent a reopening of the barely healed wound inflicted on the national psyche by Eircom's previous incarnation as a stock market company.

Some 450,000 small shareholders were effectively forced to sell their shares at a loss in late 2001 after the larger shareholders - a combination of other telecoms companies, financial institutions and the Employee Share Ownership Trust (ESOT) - accepted a €1.365 per share offer to take the company private from Valentia Telecommunications, a consortium led by US private equity funds.

These same ex-shareholders will undoubtedly ask - no doubt with some helpful prodding by the media - how a business bought off them in a firesale for €3 billion can be worth €4 billion just two years later, despite having paid out almost €500 million in cash to its shareholders in the interim.

This turnaround cannot be explained by improved performance. Turnover in the year to March 2003 - the last set of full year results - was €1.68 billion, compared to €1.5 billion in 2001. Operating profit has grown in an equally respectable but far from stellar fashion from €167 million to €180 million, while the number of retail lines is up from 1.8 million to 1.9 million. Staff numbers fell from 13,000 to 9,000.

The explanation is of course market timing. Valentia bought Eircom at the bottom of the cycle. In many ways, the only really surprising thing about the re-flotation of Eircom is that Valentia has decided that now may be the time to get out.

Providence Equity Partners and Soros Private Equity, the venture capital funds that are the éminence grise behind Valentia, do not invest for the long term. Their investment horizon is typically between three and seven years. But, their decision to exit from Eircom after little more than two years does seem a bit hasty.

The timing and nature of the mooted flotation imply that Providence and Soros, who own 70 per cent of the company, have concluded that - from their perspective - the game is over at Eircom and there may never be a better time to sell.

Ideally, Eircom's owners would like to go to the market with a story offering a combined fixed-line and mobile strategy. Already dominant in the low-growth fixed-line business, Eircom desperately needs a mobile dimension to its business if it wants to pitch itself as a growth stock.

The obvious route - buying one of the two big mobile operations in Ireland - is not really an option, although Eircom has sounded out O2.

With a price tag of between €1.5 billion to €2 billion O2 is too rich for Eircom's blood, given that the flotation must provide an exit for the private equity investors and possibly refinance borrowings of €2 billion. Vodafone's Irish operation - the former Eircom subsidiary Eircell - is not for sale.

With the purchase of one of the two big players ruled out, mobile looks like only ever being an add-on to the Eircom business story, probably in the form of a virtual network deal with one of the smaller players.

This means that whether Eircom goes back to the market this year or in three years' time, the pitch will be much the same.

It will market itself to institutions as a straightforward utility play: dominant in its market, well run and with strong cashflow underpinning an attractive dividend policy.

Having been out of favour for many years, these type of businesses are popular once again after the past three years of carnage in the markets. Whether this will still be the case in three years is impossible to say, but Providence and Soros would appear to be betting that positive sentiment towards these types of stocks will wane.

There are a couple of other factors that might be pushing Eircom's owners towards the exit doors a little bit ahead of schedule.

They include the regulatory regime in the Republic and - to a certain extent - the industrial relations set up at Eircom.

When the Valentia consortium bought Eircom, its ambitions were modest enough. It planned to run the business pretty much as before, defend market share and cut costs. The potential for growth was limited, and lay in broadband.

Two years on the company is engaged in a war of attrition with the Commission for Communications Regulation (ComReg) over the opening up of its infrastructure to competitors.

Every inch of ground is being defended to the last, but ultimately it is not a war that Eircom can win.

The collateral damage is increasing Government impatience with the company because broadband has failed to take off in Ireland.

Eircom's reluctance to allow competitors access to its network and its long delay in introducing affordable broadband is a big factor in this.

The State is now committed to spending more than €170 million on publicly owned metropolitan fibre networks and the ESB has recently switched on a national broadband network.

Both of these developments will eat into Eircom's future revenue streams.

Cutting costs has not been all that easy either. Their experience of the Irish industrial model has been something of an eye-opener for the US investors.

The positive side is that the ESOT has shown itself to be a zealous convert to big-time capitalism.

It has immersed itself in the venture funds world of preference shares, quasi-equity and billion-dollar bond issues, reaping the rewards as a result.

The ESOT has dispersed €199 million to its members since 2001. These include the bulk of the Vodafone shares it got as a result of the sale of Eircell. In addition, it has passed on preference shares that were part of the Valentia deal.

It has still to hand out another €6 million worth of Vodafone shares and some €70 million in cash.

But its main asset is the 29.9 per cent stake in Eircom, which could fall to around 25 per cent if the flotation goes to ahead, but still worth something in the region of €1 billion .

The flotation of Eircom would be attractive to the ESOT as it would provide a liquid market in Eircom shares, which must be passed on to the ESOT's 13,000 members - just over half of whom still work in the company - by 2014 under the terms of the trust.

Eircom's employees may be willing partners with Providence and Soros when it comes to the ESOT, but wearing their other hat - as members of the union coalition - they have been as enthusiastic about restructuring as any other group of Irish workers.

And as far as American venture capitalists are concerned, that is pretty unenthusiastic. Not least because - in a throwback to the company's origins as a state body - a significant proportion are effectively guaranteed jobs.

As a result, Eircom's unions may have somewhat curtailed the cost-cutting ambitions of Eircom's owners, but operating costs are still down over €100 million in three years.

The question of how much further operating costs can be pushed down, together with the state of the investment markets, the regulatory environment and what opportunities lie elsewhere for Providence and Soros, will ultimately - and shortly - dictate whether Eircom returns to the market.