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2009 to be decisive for small-cap telcos

This year could well be make or break for small-cap telecommunications companies, many of which are vulnerable as larger rivals step into their traditional areas of trade in an attempt to increase market share in uncertain economic times, analysts say.

Amid the gloom, however, some companies have shown a resilience to the downturn by growing market share through regional business and providing a series of niche services.

These companies have managed to create partnership arrangements with "tier one" blue-chip peers - big companies which typically own a physical infrastructure or network - carving out areas of resistance where other smaller companies may be struggling.

Tier one companies are now starting to move back into servicing the small and medium enterprise (SME) market through a process called "aggregated outsourcing." This involves going to smaller telco companies and asking them to badge themselves as either BT Group PLC or Cable & Wireless, for example, to undertake SME work, with the tier one company taking a cut of the profits while outsourcing the work.

"BT won't be the only blue chip eyeing the SME market, Cable & Wireless is also another contender after it cut its customer base from 30,000 to about 3,000 SMEs back in 2006," said Andrew Darley, a telecommunications analyst at institutional broker and corporate adviser FinnCap.

One company which has shown resilience in the current market is AT Communications Group PLC. The company specializes in maintenance, and designing and installing Internet protocol technology which allows for communication of data across a packet-switched internetworks alongside standard telco operations.

"We're seeing a reverse in the current trend, with more business from tier one companies," said Chief Operating Officer Scott Kean."If you look at Cable & Wireless, for instance, they're clearly moving out of that [SME] space, and passing it on to suppliers like us."

"C&W handed SME contracts over to us on condition that we don't shift them onto another carrier. They still keep the revenue, albeit they reduce their margin," he said.

"By doing this, tier one companies can shave off staff costs through structured redundancy," Kean said.

"AT Comms has done well in a credit crunch, as people defer spending on hardware," said Philip Carse, a telecommunications analyst at Teleq Consulting.

"By being lower down on the scale in terms of the sort of customer they are catering for, much of their business comes from the maintenance type, support contracts, areas which will show resilience as customers defer spending on new technology," Carse said.

Kean said, however, smaller telco dealers and resellers will start to lose more ground to the tier one companies if they don't secure partnership deals.

"Dealers and resellers are, and will continue to suffer for the moment. We'll probably see more small companies looking to sell their business on or consolidate, getting out before their revenues are further reduced."

Analysts also cautioned that, while AT Comms will benefit from aggregated outsourcing, it is still likely to suffer from recent cuts by blue chips in contractors and staff."BT cut its contractor costs by 30% this year and you'd expect AT Comms to have a rather hard time because BT is their major client," Darley said.

Analysts also said mid-size telecommunications firms could stand to benefit in the current market after a series of profit warnings in recent months from the likes of Alternative Networks PLC, Maintel Holdings PLC, and KCOM Group PLC, a Hull based telecommunications and internet provider, pushed such companies into significant restructuring.

"With these companies cutting so many costs, plotting how their positioning will look when the market recovers becomes difficult. But, if you look at KCOM, it's a highly cash-generative business with a flexibility you may not get from a tier one," said FinnCap's Darley.

KCOM's Chief Financial Officer Paul Simpson said that a company like KCOM will always have the advantage of bespoke products and services, something that larger peers can't always offer.

"The larger you are, the more difficult it is to bespoke a product every time somebody rings you, but our size gives us a flexibility that you may not find with the larger players," Simpson said.

It would be futile for a company like KCOM to buy up smaller networks to try and compete with tier one companies, he said."We are a long way behind BT and C&W in terms of the size of our network; in this respect we're much better off utilizing other people's networks in combination with our own to drive our offering."

The restructuring of the company's operations has revolved around getting its Integration and Managed Services unit back to profitability. The company always had a very cash-generative business on one side of the fence and that "there would be no point in buying a smaller network unless it gave extra reach, and was underpinned by cost savings," Simpson said.

Redstone PLC, a smaller communications services provider, is a unique investment case. The company operates very closely within the limit of its banking covenants and could stand to benefit from consolidation more than other smaller players.

The company migrated up the value chain to focus on much larger contracts to facilitate growth. While it has a strong sales pipeline, it faces cash flow problems as clients delay on contracts, according to FinnCap's Darley.

Of the smaller telcos, Redstone is trapped in a financial straightjacket where it can't generate sufficient cash to consider making significant acquisitions, Carse said.

This, therefore, pushes it toward one of two possible outcomes: either forge further partnerships with tier one players or look at the benefits of consolidation.

Carse said a merger or acquisition was still conceivable with Redstone, the shares of which have lost 85% of their value in the past 12 months, although it was more likely to be initiated by a tier one player who possessed "greater financial fire power."

"The risks in the interim are significant, as are the rewards in the long run. However, there is no incentive to own the stock until those rewards are closer," Darley said.

When asked Redstone didn't wish to provide comment.

Analysts also cautioned about the dangers of "catching a falling knife.""If we've hit the bottom of the macro trend, then consolidation holds fewer perception risks," said Darley, referring to the benefits of consolidation in an environment which would typically limit organic growth.

While the current market is still very uncertain, analysts are confident that there are benefits awaiting some smaller companies."Apocalypse phase one, is passing," said Darley.

"Direct company action on the balance sheets through initial and far-reaching cost-saving measures has resulted in more partnership deals and bespoke services, which has allowed them to reinforce their areas of business," he said.

"There's a proliferation of smaller telco companies which serve the SME market better than a tier one company can offer...investors should still be braced for volatility but understand that there are some highly cash-generative businesses on in this market trading at very much knocked-down prices," Carse said.

Источник: Total Telecom

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