Despite its inroads into broadband, the absence of a mobile subsidiary means Eircom is not regarded as a growth story by investors. Another factor weighing down the company is its heavy debt load. Eircom’s main attribute is its dividend, which is one of the highest on the market. Any indication that the current dividend level is threatened would be a serious negative for the share price.
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.
Tricia McEvoy, equity analyst, NCB Stockbrokers
EIRCOM’S share price has retreated about 20% in recent months from a €2.20 high in February amid concerns over its failure to execute on broadband and the extent of any potential equity fundraising to secure a purchase of Meteor. As demonstrated in its financial year 2005 results, it continues to mount a good defence of its traditional business in the face of increasing competition (with win-back campaigns and new products), while its headcount reduction and property disposal plans have exceeded expectations.
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In response to disappointing broadband take-up, Eircom launched Broadband Time last week to attract lighter internet users, reduced the price of its always-on standard broadband product by €10 per month, and reduced wholesale rates. Given its lead in the broadband market (84% market share) we believe this new approach will deliver strong broadband growth over the summer.
We expect Eircom to re-enter the mobile market in the next six to 12 months. The acquisition of Meteor, the third-placed Irish mobile operator, is one of several options open to the group, and shareholder value will, in our view, dictate the group’s choice of strategy. The Meteor auction is expected to conclude next month. If Eircom does not buy Meteor, we expect it to revert to either the mobile virtual network operator route or purchase the last remaining 3G licence and build its own mobile network. It could realise its mobile and fixed-to-mobile convergence aspirations with either of these options at a lower cost than a purchase of Meteor.
While local loop unbundling (LLU) is a threat, it remains in its infancy with further delays likely due to a pending High Court case. In any event, Eircom’s full LLU price is one of the highest in Europe and there are significant growth opportunities for it and other operators as the Irish broadband market is so underdeveloped.
Eircom paid an interim dividend of 5c last December and is paying a final dividend per share of 6c after its annual meeting at the end of July. It has one of the highest dividend yields in the sector, with a yield of 6.5% for the 2006 financial year. We have a buy recommendation on Eircom with a €2.25 target price based on 11.6 times our 2006 adjusted earnings per share estimate (a 10% discount to the sector average P/E to reflect Eircom’s lack of mobile).
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Judgment: buy
Pramit Ghose, head of investment strategy, Bloxham Stockbrokers
THE greatest threat facing Eircom is cannibalisation, and we don’t mean Hannibal Lecter. The “cannibalisation effect” in this case occurs when new technologies eat away at a company’s older businesses. The biggest strategic issue facing incumbent telecom companies is that broadband, wireless and voice over internet protocol are starting to encroach on traditional voice services. Unfortunately for Eircom its competitive position is hamstrung by the heavy debt load that is a legacy of 2001’s leveraged buyout.
Total group debt of €2.2 billion compares with a market capitalisation of €1.3 billion, which leaves Eircom as one of the most indebted telecoms groups in Europe. Using a total debt to market capitalisation ratio, Eircom’s debt is equal to 171% of its market capitalisation, compared with BT’s ratio of 68% and Telecom Italia’s 94%. When that is combined with the company’s commitment to a pay-hefty dividend (its shares are currently yielding 6.3%), Eircom does not have much headroom when it comes to investing in its infrastructure.
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Investment is needed to compete with the new technologies. BT recently announced that it was spending £10 billion over five years to upgrade its network from voice telephony to a broadband service using internet protocol. Eircom’s size in Ireland has meant for the most part it has been able to fend off local competitors, but the 25,000 fixed-line customers it lost in the first three months of 2005 are evidence that competitive headwinds are building.
By aggressively pushing its broadband rollout and trying to re-enter the mobile market, Eircom is hoping to counteract its shrinking traditional business. Since a high of €2.20 in February, Eircom’s share price has dropped 24% to €1.74.
Eircom is in transition. While it might fend off smaller competitors, its 84% market share of narrowband fixed-line telephony in Ireland puts it firmly in the cross hairs of regulators. EU regulation stipulates that local loop unbundling (which will allow other companies to go directly to customers’ homes) must occur and it is that threat of a further erosion of market share that is behind our negative view of Eircom as an investment. There are much more attractive value investments with excellent mobile operations such as France Telecom and Deutsche Telekom.
Judgment: sell
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THE FIRM AT A GLANCE
Share price: €1.76
Market cap: €1.3 billion
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Year end: Mar 06
Forecast EPS: 19.7c
Forecast dividend: 11.2c
Leading shareholder: Eircom ESOP Trustees Ltd 20.2%, BOI Nominees 6.9%, Morstan Nominees Ltd 6.5%, Capital Group 6.1%