Eircom must tackle core issues to kick-start share price

Uncertainty about the KPN and Telia stakes has depressed the Eircom share price in recent months. But even if this 35 per cent overhang can be removed in coming weeks, there are a number of strategic issues the group needs to come to grips with before shareholders can expect any significant improvement in its share price.

These include expanding beyond the domestic market, cutting costs and developing its Irish operations, including its broadband capabilities, to meet increasing competition. It also needs to look at forming a strategic partnership or agreement to underpin future growth and expansion.

Other important issues for the group, and the telecoms sector generally, include the spiralling cost of new generation mobile phone licences and the burden of rising interest costs when companies need to undertake significant capital expenditure.

What is most worrying about Eircom now is that, even at the current low share price, there is no sign of any strategic investor rushing in to buy the group.

At a share price of €2.70, the group's market capitalisation or value stands at €5.96 billion and that should make it good value.

It has a good set of assets. It is still the dominant player in the domestic market with a particularly strong mobile operation. Unusually for a telecoms company, it has no debt but has a cash surplus. It offers an acquirer entry into the UK market. And there is potential for further cost cutting and rationalisation.

ABN Amro analyst, Ms Jemma Houlihan, has valued the shares at €4.80 on the basis of the value of each component of the business and calculated that Eircell - the mobile subsidiary - is worth more on its own than the market capitalisation of the whole company.

It would be 25 per cent less expensive to buy Eircom at €5.96 billion than to buy one UTMS licence in the UK where the business case in still untried and untested, she pointed out.

While the sector is weak on concerns about new licence costs and rising interest rates, Eircom is weak within its sector. The company is now trading at about eight times enterprise value to earnings before interest, tax, depreciation and amortisation (EV/ EBITDA) compared to the sector average of 14 times. When it was floated at €3.90, it was at a premium to the sector - 11.7 times EV/EBITDA compared with a sector average at the time of 9.7 times.

The absence of a suitor may be explained in part by the relative unimportance strategically of the small Irish market and the current preoccupation internationally with acquiring third generation mobile licences. But it must be a concern to the Eircom board. In the domestic market, Eircom has the advantage of being the dominant player. But where it was once the monopoly provider, a number of rivals are now targeting different areas of the business and putting it under pressure.

In the mobile telephone market Eircom subsidiary, Eircell, has about a 62 per cent share and has produced strong growth. It has operated in a competitive environment since 1997 and has one of the highest average revenues per user in Europe.

While Eircell is expected to continue to perform, competition will increase with the awarding of the third mobile phone licence yesterday to Meteor.

In addition, internationally there are concerns that overall mobile market growth may slow because of the impact the overspending by operators on new generation licences is expected to have on the prices they will charge customers.

While the process of awarding new generation mobile licence is not expected to start in the Irish market until the end of the year, the issues for Eircom revolve around the cost of the licences, the cost of rolling out a service and the implications if demand fails to reach targeted levels. In a rising interest rate environment it will be important for Eircell to get its strategy right if it is to develop this new business profitably.

In the fixed-line business, the opening up of the market has brought in new and aggressive players. With customers now able to switch service providers, Eircom's dominant position in some areas has been dented, particularly on international calls. Competition in the more lucrative areas will only intensify with BT/Esat and Worldcom now the main competitors in service provision and other companies such as Swiftcall, Sprint and Switchcom competing as resellers.

In this area the main strategic issues facing Eircom are the repositioning of the business from basic voice telephony to a full multimedia offering through the development of its broadband capabilities, the planned "unbundling of the local loop" - or giving other operators access to its local connection infrastructure - and cost cutting.

The ADSL, or broadband technology, involves getting information down a phone line more quickly and, for example, would allow customer to use their Internet and telephone at the same time.

With rivals NTL and Princes Holdings already limbering up to be strong competitors, Eircom needs to put itself in a position to roll out its broadband offering as quickly as possible.

With the unbundling of the socalled "last mile" of loop - the connection between the nearest exchange and the customers home - Eircom will have to make strategic decisions on rental charges. While the telecoms regulator will set the charging formula, Eircom's competitors will have to be offered the same or a lower rental charge to that applying to its own customers, which may have implications for current customer rental charges.

Cost-cutting plans announced in March include the reduction of the group's 11,000 workforce by 3,500 at a cost of €406 million to achieve annual cost savings of €76 million.

Expansion outside the domestic market involves investment in Northern Ireland and Britain. The group has a strategic target to generate 20 per cent of its revenue outside the domestic market going forward.

A £25 million sterling (€39 million) investment in broadband infrastructure in Northern Ireland is under way aimed at getting a slice of a market currently worth about £500 million sterling per annum. Offering a mobile service in that market is planned.

In Britain, Eircom is targeting niche markets - selling fixed voice and data services to small and medium-sized business customers.

Having dropped out of the UK third generation mobile licence bidding process at £2.1 billion sterling, Eircom's strategy is to seek partners in that market to get "seamless roaming" - or a national service capacity.

On the issue of a strategic partner it is difficult to see much progress being made until the KPN/Telia holdings are successfully sold.

Other issues weighing on the share price include difficulties in negotiations on a share option plan for senior executives with the Irish Association of Investment Managers and the small overhang of about five million shares from the tranche held by the Government to meet the 4 per cent bonus issue to shareholders on July 8th.

The removal of the KPN/Telia share overhang or a significant corporate development could breathe some life into Eircom shares. But, because of the many competitive issues facing the group, shareholders may have to wait some time before they can expect to see the share back at flotation levels.