Kate Bulkley, Media Analyst.

The man who would be king. From undersea to over all: The C&W story

By Kate Bulkley

The Independent

May 23, 2001

Graham Wallace, the reigning CEO of Cable & Wireless can sell, and he can make money on the deals.

In the two years this former engineer and accountant has held the top job at one of Britain's oldest telecoms companies, he has intoned a mantra of sell, sell, sell. Gone are the mobile phones, cable TV and undersea cabling as C&W repositions itself away from traditional telecoms towards the cutting edge of internet protocol technology.

The result is that once his last big sale of Australian carrier Optus closes in July, Mr Wallace will be sitting on a cash pile of more than 6bn, at a time when most telecoms companies are licking their wounds and counting their pennies.

It would seem an enviable position. But the heat is on. Despite focusing on the new networks and technologies, such as internet protocol (IP), that Mr Wallace believes hold the keys to growth for Cable & Wireless, the early financial results of this strategy are looking piqued and the market is punishing the stock.

In his office at C&W headquarters, Mr Wallace, 53, absorbs the criticism and in talks about the way things are. He believes the excess supply of telecoms network infrastructure has pushed prices down, impacting the bottom lines of all companies in the network business. And the newer, value-added services C&W sees as the company's future growth drivers, are still small in revenue terms, relative to C&W's overall business.

Taken together, this means C&W expects revenue growth of just 5 per cent this year, and it has announced a delay over when it expects strong cash flow growth, or EBITDA (earnings before interest, taxes, depreciation and amortisation), to come through. C&W sees positive EBITDA growth rates of 20 to 25 per cent only in 2004 or 2005. "That's a long time away," says one frustrated analyst.

In its latest results, C&W showed a 35 per cent drop in cash profits before interest and depreciation for C&W Global, the unit that serves multinational customers and is the bedrock of the company's future strategy. Profit before tax for the whole company, which includes a number of overseas local telephone operations, was down 16 per cent to 3.4bn and revenues were down 12 per cent from a year earlier to 8bn.

Although the underlying revenues from providing (IP) services were up 41 per cent, showing strong demand, price competition held down profit margins and will continue to do so for the foreseeable future, say analysts. Mr Wallace says the company is working aggressively on fixing the margin shortfall, particularly in the hardest-hit US business. In April, 10 sales offices were closed and a ban was put on selling telecoms services to customers unless they are within 30 miles of a C&W-owned network. Mr Wallace admits that it is a "short-term" answer to the problem, but the goal is to search out customers who will create bigger margins.

"When we are a long way away we've got to pay others for use of their networks and you can get the sale going into a loss," he says. "So, you just have to cut the tail off and that is the specific action we've done in the US."

Mr Wallace says he is willing to accept lower revenue growth on the back of improving margins in a business that he is sure has long-term potential. "I'm a fundamental believer in the power of IP, and that all communications will go over IP, and that demand from businesses in particular is insatiable. It's only just starting in terms of e-enabling businesses. [But] it won't be a very smooth ride. We think it's very important to be financially strong so we can take a few ups and downs without it being fatal. PSINet couldn't. A few ups and downs and they're on their back."

PSINet is a sort of mini-C&W that recently suffered the ravages of the market and is now all but out of business. The American-based company is a classic acquisition target and Mr Wallace, the ultimate seller until recently, has begun showing how smart he is by picking up fire sale bargains. The most recent and potentially most important strategic buy is last week's purchase of California-based Digital Island (DI). The purchase catapults C&W into the value-added services business, and does so without breaking the bank, a fact Mr Wallace clearly relishes.

Along with rival Akamai, Digital Island is considered one of the pre-eminent US companies scoring big successes in the relatively arcane world of digital content delivery and managed web-hosting. Adding Digital Island's technology, its client list with names such as Sony and Microsoft and its experienced senior management team, is a real coup and paves the way for C&W to leverage its global IP networks business and move into higher margin services for corporate customers.

Mr Wallace obviously likes people knowing the price he paid for Digital Island was a shadow of the company's worth nine months ago. At its high, DI was trading at $148 (102) a share, but C&W paid only $3.40, or a total of $340m in cash. Given the difficulty DI had finding new finance to grow its business, the company was happy to accept C&W's offer.

C&W is not done buying yet, although Mr Wallace is careful not to name names. But he seems less interested in buying networks, even at distressed prices from players such as PSINet, than in adding companies with strong management teams which can help speed his networks or add services for his customers, such as managed web-hosting or application service provider (ASP) services. They also have to fit geographically into Europe, Japan or the USA.

But even this kind of focus doesn't guarantee clear sailing. There are concerns in some quarters that the new, value-added services are being commoditised quickly as new technologies help start-ups leapfrog over their competitors. As one analyst says: "Mr Wallace has done the easy part of selling the assets, now comes the hard bit [of delivering the goods]." Insiders say he also knows that making the transition from re-focusing C&W to operating it will be a sort of corporate litmus test.

"Graham is very much of the frame of mind that his whole reputation and career rests on getting the next 12 months right," says one insider. "Digital Island ... is part of the strategic objective of moving C&W into the higher-value services area and of getting more traffic across its networks. How well he implements this acquisition is really important because it is a big part of how he will deliver operationally on his strategic plan."

Certainly, Mr Wallace's early steps show he can grasp the big picture. He saw early in his tenure at C&W that its so-called "string of pearls" strategy was flawed, especially as telecommunications was becoming increasingly competitive.

After building up C&W's UK cable TV assets under former CEO Dick Brown, one of Mr Wallace's first moves when he took over in February 1999, was to figure a way to get out of the local cable business. He saw the potential of building up C&W's global networks business, which included the internet backbone network Mr Brown had recently purchased from MCI in the USA. The same reasoning was behind the sale of C&W's UK mobile phone business One 2 One to Deutsche Telekom.

Mr Wallace also decided much earlier than many in the industry that the integrated model of telecommunications, where one company tries to provide every type of service for everybody, doesn't stand up in today's highly competitive environment. This was true for C&W's assets in Optus in Australia and in its stake in Hongkong Telecom (HKT).

"He could see earnings in HKT were falling off the cliff," says an insider. "There are 11 mobile licences there. The competition is gruesome and he didn't believe the integrated model would work. So his basic stance was 'I must get out of HKT at all costs, provided I can get a decent amount of cash'."

A quality Mr Wallace has honed is a level of conviction about C&W's direction. When asked why he doesn't spin off C&W's collection of regional telephone businesses mainly in the Caribbean and Panama he doesn't deny the possibility. But he quickly defends the regional business, saying although it is slow-growing, it posted 10 per cent top-line growth and an enviable 40 per cent EBITA margin last year.

Analysts say the regional business would be worth a bit more than 2bn if it were spun out, which could go some way towards placating shareholders who see C&W sitting on a big cash pile and them getting none of it. If history is any guide, Mr Wallace will sell this asset only when he can get the best price.

On the matter of a share buy-back, Mr Wallace says he will formally ask for the ability to buy back 15 per cent of C&W's shares but that he sees it clearly as giving him greater flexibility than a hard commitment.

"Who would have known 12 months ago that we could buy Digital Island for $3.40 a share?" he says. "So in six or 12 months time we could look back and say 'Good job we kept that (cash) flexibility because there are opportunities that we couldn't foresee at the time'. If you ask me, 'What are they?' I don't know, but that is the nature of unexpected opportunities."

Some in the City have gone so far as to say that Mr Wallace has pared the company down so that it looks ripe for take-over, a possibility that Mr Wallace would be likely to view, as he does all potential ways to increase shareholder value, with a good deal of interest and a lot of dispassion.

The impatience of some professional C&W watchers may also have something to do with how the business is being re-shaped, away from the familiar-looking integrated telecoms carrier it was, into a company that is nearer the cutting edge of IP network technology and fast-moving services such as managed web-hosting.

Even the name Cable & Wireless looks a bit out of synch. But then there is also the more mundane issue of falling revenue and falling profits. The jam expected from the re-shaped C&W could well be worth waiting for, but if that wait goes on for too long, it could ruin a few appetites.

1872: Merger of three undersea telegraph companies to form The Eastern Telegraph Company, which took over a number of other British international telegraph companies.

1929: Merger of Eastern and Associated Telegraph Companies with Marconi's Wireless Telegraph Company to form Imperial and International Communications.

1934: Imperial and International becomes Cable & Wireless.

1947: Nationalisation of C&W.

1976: First C&W operations in USA.

1981: Privatisation of C&W 49 per cent sold at 168p per share. Three share splits (one for two in 1983; one for one in 1986 and one for one in 1993) mean that one share in 1981 is six shares today. Remaining government shares sold in two tranches: 1984 and 1986. Eric (later Lord) Sharp becomes executive chairman.

1982: Mercury Communications launches a competitive service to BT.

1984: C&W takes control of Hong Kong Telephone Companyto form Hongkong Telecom in 1988.

1989: First "private" transatlantic telecoms cable completed built jointly by C&W and Sprint.

1990: Lord Young becomes executive chairman when Lord Sharp retires.

1992: Optus begins operation in Australia (24 per cent owned by C&W, 24 per cent by Bell South and 51 per cent by an Australian consortium.

1994: One 2 One mobile begins operation in the UK.

1995: Lord Young resigns.

1996: Dick Brown appointed chief executive (with Sir Brian Smith as non-executive chairman).

1997: Merger of Mercury, Videotron, Bell Cablemedia and Nynex to form Cable & Wireless Communications. Graham Wallace joins from Granada as chief executive of CWC. Cable & Wireless gains control of Optus.

1998: Acquisition of MCI's internet business. Dick Brown leaves to run EDS in Texas.

February 1999: Graham Wallace appointed chief executive of C&W.

April 1999: Cable & Wireless Marine sold to Global Crossing.

Summer 1999: Sale of One 2 One to Deutsche Telekom announced. Restructuring of CWC announced, including the sale of CWC's residential operations to NTL and the merger of its business operations into C&W. Acquisition of 80 per cent of IDC in Japan gives C&W control.

May 2000: Restructuring of CWC transaction completes. Formation of Cable & Wireless Global.

August 2000: Sale of Hongkong Telecom to PCCW completed.

March 2001: Sale of Optus to SingTel.

May 2001: Acquisition of Digital Island for $340m (235m) cash.

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