That episode ended in financial disaster for most of the company’s small investors and also seems to have set back hopes of creating a shareholder culture in Ireland.
The company’s privatisation and subsequent return to the market last March was a low-key affair directed at institutional investors, but with an attractive dividend yield of over 7% also found favour with well-heeled private investors.
However, with the company facing pressure on several fronts a number of analysts believe the investment case is very weak.
The two experts below have been selected for their skills in several investment areas. They, or the funds they manage, may hold shares in the companies or sectors discussed.
Pramit Ghose, head of investment strategy, Bloxham Stockbrokers
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IN this column in March we highlighted our cautious outlook on Eircom. Since then the stock has underperformed the Iseq index by about 13% and has failed to trade above its €1.55 flotation price.
Although Eircom retains a dominant domestic position in the fixed-line rental market, it is our view that growth prospects over the medium term are limited, so we reiterate our negative outlook on the stock.
Eircom reported broadly in-line full-year results in June, benefiting from tight cost control and improved gross margins. Earnings growth over the medium term is expected to be driven by a combination of cost rationalisation and improved operating efficiencies, with growth in access and broadband revenue compensating for reduced voice-traffic revenue.
However, the roll-out of broadband and upgrade of the network will require significant capital expenditure, expected to average between €180m and €220m annually over the next three years. The group is also expected to spend €140m over the next four years reducing its head count. Combined with high indebtedness (Eircom had net debt of €1.96 billion at the end of March), we are concerned that this may lead to stress on the high dividend payout, commonly cited as the primary attraction of the stock.
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Although the group has indicated that it will re-enter the mobile business when a viable option emerges, the absence of a mobile presence since the sale of Eircell in 2001 further underlines the lack of significant growth potential.
With a shrinking fixed-line business, increasing competition from mobile substitution and a lack of attractive growth opportunities, we are yet to be convinced of Eircom’s long-term prospects. Our Contrarian Fund has positions in France Telecom and Vodafone, two stocks that we believe currently offer good upside potential.
Judgment: sell
Brid White, equity analyst, Merrion Stockbrokers
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EIRCOM returned to the stock market last March with a high dividend and a high level of debt. Since flotation, its shares are down about 8% and the dividend yield has risen to 7.7%. The decline in share price reflects the high level of financial risk associated with the firm’s debt level and the absence of large growth initiatives from the company.
In the near term, profit growth at Eircom is coming from cutting costs. As a consequence of its former state ownership, the company is still overstaffed; reducing numbers will add to profits this year and next. This supports the current share price over the short to medium term, while allowing the company to reduce its debt load.
Paying some of the debt will result in a healthier balance sheet over time. This should, in turn, enable a reduction in interest costs. By mid-2007, Eircom could see its debt rating improve, which could raise its share price.
The company’s core market for fixed-line telecom services in Ireland is shrinking as more people use mobile phones. In addition, in the internet market broadband is replacing dial-up internet access. To increase profits over the longer term, Eircom needs to find new growth opportunities.
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So far the company has concentrated on broadband as its growth driver, but we estimate that because of the high start-up costs and reduction in dial-up revenues, Eircom is currently losing money in this area. Another proposed growth initiative is re-entry into the mobile market; however, Eircom needs to be innovative in its strategy.
It remains the largest player in a regulated market and there would have to be a radical transformation of the industry to threaten its dividend, but Eircom has little room to grow over the medium term. Until its debts are reduced, or the potential for growth becomes clearer, its shares have limited upside.
Judgment: hold
THE FIRM AT A GLANCE
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Share price: 1.45c
Market value: €1.07 billion
Year end: March 2005
Forecast ’05 EPS: 7.8c
Leading shareholders: Eircom ESOP Trustee 29.1%, Goldman Sachs 13.5%, Bank of Ireland Nominees 6.9%, Morstan Nominees 6.5%, Chase Nominees 5.8%