Business Watch: Carphone demerger

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Carphone Warehouse shares have staged a pretty remarkable comeback in 2009 – and last week they got another big fillip.

That was partly thanks to long awaited confirmation the company is ready to push the button on the biggest demerger in UK telecoms since BT Group spun out O2 in 2001.

Carphone’s stock market value remains less than half what it was in 2007 when the shares reached the giddy heights of 350p each.

But now valued at £1.33 billion, based on a share price of about 145p this week, Carphone thinks the market would value its two main businesses more highly if they were split.

The Best Buy Europe division, which operates Europe’s largest mobile phone retailer in a venture with Best Buy of the US, will be hived off from the TalkTalk business that offers broadband and fixed-line telephone services.

Finance director Roger Taylor says the two different companies will appeal to different kinds of investors, each with “distinct investment profiles and improved comparability with sector peers.”

He’s not alone. Investors, unhappy with the company’s disappointing performance since 2007, have been pushing for a demerger for some time.

Part of Carphone’s problem in terms of its dealings with the City has been the lack of clarity about just what kind of company it is. Is it a retailer that can be compared with the likes of Tesco and Marks & Spencer, or is it a telecoms company that should be compared to the likes of BT?

Such questions are critical when deciding what kind of earnings multiple the shares should trade at because retailers and telcos are valued very differently.

The problem is highlighted by the fact that the company is followed by two distinct sets of analysts – those who follow retailers and those who follow telecoms. As smart as some of these City scribblers are, they don’t necessarily always grasp the finer nuances of the industries they don’t follow.

Chief executive Charles Dunstone says it might be possible to execute the break-up either late this year or early in 2010 –  with him becoming chairman of both businesses.

As founder he clearly wants to retain control of both his babies but he’ll need to be sure he can manage any conflicts of interest that might arise.

He’ll be consulting Carphone’s other major shareholder on the demerger plans and that will be something it may well ask him about when he’s touring the Square Mile to sell the idea.

Dunstone reckons much of the hard work is already done, with the two business operating almost as separate units already.

He wants to come up with a more precise timetable in July at the annual meeting but before he can do so Carphone has to sort out what to do about its debts.

The company has to renegotiate the terms of its £925 million of overdrafts ahead of the demerger – and a split now would almost certainly result in more expensive terms with its banks.

The banks include Royal Bank of Scotland, which is now controlled by the government and extremely cautious on lending in the wake of the mess it has got itself into. So there is much haggling to be done yet, I reckon.

Meanwhile, reports continue that TalkTalk wants to buy Tiscali’s UK assets, which would cost it a fair chunk of change and cause borrowings to rise.

Still, Taylor is confident of finding a solution within four months on how much debt to put into each business, saying “the situation of banks and the finance industry seems to be improving and getting more stable.”

Well, it’s certainly more stable than November last year when the entire capitalist system was on the edge of meltdown.

At that time Dunstone was busy warning the company was operating in the most challenging economic environment he had seen since he founded it.

But in the fourth-quarter trading update last week, Dunstone was more upbeat, saying the company would meet the City’s forecasts for its performance in the year to March 31.

While revenues at TalkTalk are expected to be pretty flat this year, it still expects to add 125,000-175,000 new punters, cementing its position as the UK’s third largest internet service provider.

Meanwhile the retail business managed three million connections in the first three months of 2009, up 12 per cent year on year. It was helped by its position as the only independent seller of the iPhone but also by rising demand for prepay phones among cash-strapped punters and, no doubt, unfortunate people that have lost their jobs.

Jonathan Groocock at stockbroker Investec said they were resilient results given the tough trading environment. Indeed, after the weak first quarter numbers from Nokia and Sony Eriscsson, Carhpone’s handset sales looked, he said, “excellent”.

Full article in Mobile News issue 438 (May 4, 2009).

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