Increasing competition in its domestic market together with investment for future growth will depress profits at Eircom next year. But shareholders need not expect a corresponding slide in the share price.
Some of the profit slippage for the year to March 2001 will come from increasing competition and from a market-led shift from higher to lower-margin business. But most of the fall will arise from the decisions to accelerate its restructuring and to invest in its mobile and Internet services. Eircom now appears to be making the strategic moves required to reposition itself, against a background of increasing competition in its domestic market and changes in telecoms services markets worldwide.
Investment in building up Internet and mobile services has a dilutory effect on profits initially. This is because a company has to pay upfront for new subscribers and technology while there will be little or no revenue from these investments in the first year. Revenue and profits from the new customers and services build up over time.
But such investment helps the valuation of a telecoms company. In valuing telecoms companies, the market is increasingly concentrating on their volumes of mobile and Internet subscribers rather than their fixed-line customers.
There is evidence in the Irish market and internationally of a shift from fixed line to mobile telephone calls and from fixed line voice to data services such as e-mails and Internet-focused activities. The huge growth in mobile phone usage - 43 per cent of the Irish population now has mobile phones compared with 3 per cent in 1995 - is a double-edged sword for the incumbent fixed-line company in the market.
Eircom has reported both an instrument substitution effect, with the emergence of "a significant minority" of subscribers who have only mobile phones, and a call substitution effect with increasing levels of mobile-to-mobile calls. The total number of mobile lines is expected to exceed fixed lines before the end of the year. And even though the booming economy means that the volume of fixed-line call traffic is increasing, the mix of that traffic is changing negatively for Eircom. Lower-margin Internet access and interconnector or wholesale calls are growing faster than the higher-margin local and national calls. In addition, competition in the market has increased.
The result is that Eircom's prices and volumes are under pressure in the fixed line business while its cost base remains high. Eircom is moving on two fronts to improve its fixed line operations - cost cutting and refocusing operations. The company is accelerating its job reduction programmes - it aims to reduce its payroll from 11,000 to 7,500 within two to three years at a cost of €406 million to get annual savings of €76 million.
Fixed line operations are being refocused towards the fastergrowing areas - data, multimedia and Internet - and the service is moving to broadband in the local area network to provide high-speed Internet access, interactive services and new content capabilities. With its domestic market under increasing threat from competitors, Eircom needs to look for new markets. Although it could have moved earlier, it is now moving aggressively into Northern Ireland and is bidding for a mobile licence in the UK. The decision to spin off some of its Internet/multimedia operations is welcome in that it will release some of the value in that area for the group and provide access to share-based funding for future growth through acquisitions or mergers.
Since it floated in July 1999 at €3.90 (£3.07) the Eircom share price has behaved erratically. It touched a high of €5.00 and a low of €3.67 in 1999. In the current year it has traded in a highlow range of €4.80 to €3.98.
Uncertainty over the sale of the 35 per cent stake held by KPN (24 per cent) and Telia (11 per cent) is one negative factor. A sale of the shares en bloc would trigger a bid for the group unless waivers were granted. Alternatively, 29.9 per cent could be sold to a strategic partner. But aware of its need for a strategic partner/partners and with its own project team working with the sellers, Eircom is trying to achieve the outcome which will be best for its own future. With many international partnerships already formed and British Telecom now out of the running since its takeover of Esat, it may be that Eircom is coming late to the altar. Market speculation has centred on some of the US telecoms groups, Deutsche Telekom and France Telecom as possible buyers.
