Thursday, 30 July 2009

Panic! No wait...don't panic

Robert Peston writes an entertaining, slightly scary, story about BT's pension liabilities.

But is this anything to worry about? Not really. He makes a few points that sound striking, but under closer examination are utterly unsurprising.

...in an economic sense, BT's current and future pensioners own this totemic business.
True, but any business is "owned" both by its creditors and its shareholders. The creditors always have to be paid off first before the shareholders have clear title to the company's assets. And in most large, old companies, pensioners are among the biggest creditors. Look at General Motors, which has just handed over a majority stake in itself to its pensioners (via their union, the UAW).

To put this £8bn chasm in its pension-scheme into an appropriate context, the entire market value of the company is less than £10bn.
Also true, but meaningless. The pension deficit - like any other debt that BT has - is already factored into its market value.

If you take out a £300,000 mortgage on a £400,000 house, then the "market value" of your asset is £100,000. You could try to scare yourself by comparing your £300,000 debt to the £100,000 equity, but it wouldn't be very effective unless you're really subject to panic attacks.

The meaningful comparison is to enterprise value, which is much higher than the £10 billion market capitalisation. This is clearly indicated by the fact that the company, in the middle of a recession, generates over £1 billion of cash each year. This money-generating enterprise would be worth at least £20 billion on any sensible valuation.

...if BT were forced to value its pension liabilities on the basis of the yield on gilts...well then the deficit would be well over £20bn
...and if my aunt had balls, she'd be my uncle. There's no reason whatsoever that BT should use gilt yields to discount its pension, as it can earn a much higher return on investment in its trading assets than it could get on gilts.

Having said all that, the story is informative and sheds interesting light on the internal structure of BT's business. It just isn't as big a deal as Robert would like to make us think. But then, news that plays up to the audience's fears and prejudices always gets more eyeballs.

5 comments:

Thomas said...

The real problem with all of this is that the "£400,000" house is, in any sane assessment of things, worth ~ £150,000. So yes, I would be having a panic attack in that situation. Or rather I would be handing back the keys!

Leigh Caldwell said...

Of course in any given case, that might be true. I'd be the last one to argue that markets always find the right price.

But this is why I referred to the free cashflow of the company: I think it's pretty reasonable to assume an enterprise value in the region of £20 billion, and therefore that the market price already factors in the pension liabilities.

I have no objection to Robert bringing the liability to people's attention in case they haven't considered it. But I think the price of BT stock is one of the more liquid, well-informed numbers out there at present so I'm really not that worried.

If your objection is to my use of property prices as an example, it's a fair criticism. It's a dangerous comparison to use at present!

Rodimus Prime said...

I read this from Peston and my immediate thought was also one of 'scary story' - Robert runs a bit of a 'The Sun' blog if you know what I mean, but it's quite entertaining. Of course I agree that this is all currently priced into the market, but we don't escape the fact that BT has an enormous pension liablity which it needs to service over the coming years. If it wasn't the cash-generating machine that it is, it would be in serious trouble. I'm sure you'll agree that the current climate has shown us that no-one can predict or know with any certaintly whatsover 'what the future holds...' - but if you think it's worth a punt (and clearly a lot of people do) then go ahead and purchase a piece of BT, you could do worse of course perhaps and buy RBS, Lloyds, Barclays et al...? :-)

Leigh Caldwell said...

Well I'm not about to make any stock picking recommendations...I suspect the FSA do not look too kindly on unregulated blogs that do such things!

I will point out that lots of people did very well out of Barclays in the last six months...you could have bought between 60p and £1 for most of January and February, and it's now at £3.

Even with RBS you'd have doubled your money in the last six months.

Shares can go up as well as down, etc. etc.

Rodimus Prime said...

nobody looks too kindly on unregulated blogs with stockpicking comments...but it doesn't stop teenage key-jockeys sitting at home on their laptops making recommendations on yahoo or google finance. always bizarre. a lot of people certainly did well on bank stocks recently, particularly in the UK - of course I noted that Barclays went up over 500% since March this year...but conversely it dropped over 95% leading up to March and wiped out millions of dollars of investments, pensions etc. with it (including my own company sponsored pension), sigh