BT can stem share rout with a 8216 hard reset 8217

BT shares claw back a few pennies on Wednesday following a 20% collapse the day before, though further slides look likely in the near term as its accounting scandal deepens. 

Continuing fallout saw Italian prosecutors belatedly open their own investigation late on Tuesday—some three months after BT disclosed “certain historical accounting errors” at BT Italia, and a £145m writedown. Those “errors” have now been upgraded to “inappropriate behaviour” and the estimated cost raised to £530m, almost 9% of group revenue forecast for 2016.

There’s no evidence that Chief Executive Gavin Patterson had any inkling before last autumn of the malfeasance abroad. Although he has been in charge since 2013, and before that was BT’s retail boss for five years, apparently stringent scrutiny turned up nothing for years. But there lies the rub. Culpability is lacking, but failure to spot the issue still puts Patterson in the frame in the eyes of many shareholders—see £7bn worth of market value destroyed on Tuesday.

The risk of opportunistic litigation risk is also rising. ‘Investor alerts’ by U.S. law firms calling for investors with info to come forward now number at least 10.

And whilst BT’s current assessment suggests just a fraction of the Italian businesses’ 1% contribution to core operating profits is involved, reputational damage is far greater. Particularly in light of news that UK government contracts have deteriorated. A £300m erosion of core earnings this year and a cash flow hit that could amount to £1.3bn over two years are far smaller than the punishment meted out to the stock on Tuesday.

The sell-off suggests that even the least ‘activist’ institutions have lost confidence in governance and competence.

We therefore think that whilst suspensions and subsequent departures in Italy, plus the broad review announced on Tuesday will go some way to limit further stock downside, an equally broad review of management strength would be even more effective. Unfortunately, BT might need to start at the top of the non-executive tree, and work down. Chairman Michael Rake has supposedly been in charge of acting in the best interests of shareholders since 2007.

Thankfully, there is no lack of heavyweight management experience available in-house to prevent a vacuum. The group could even settle on its new CFO, or the hired-in CEO of EE.

It’s worth noting that BT’s signal of remuneration committee action suggests there will be no closing of ranks. That makes sense. Making no changes ‘upstairs’ would compound a conduct issue with a strategic misstep in BT’s game of brinkmanship with Ofcom over Openreach.

With dividend guidance now affirming at least 20% growth by end-2017/18—well above more expensively rated SKY—BT’s valuation even starts to look attractive after Tuesday’s rout. However the pension deficit as a proportion of market cap has risen too.

That makes a ‘reset’ in the C-Suite even more urgent.