Colt - 2005 New Year, New Highs.............

Remember F stumped up a large wad at 50p a share.... this price is now being approached again .... at what point do F decide to bail out ?

Between 1998 and 2001, its losses more than tripled and by the beginning of 2001, Colt faced a perceptible funding gap in the region of £600 million and a £1.4 billion debt that cost £60 million per annum to service (Colt Telecom, 2002). Table II shows the financial performance of Colt from 2000 to 2003. In 2000 and 2001, high capital expenditure and rising debt repayment, along with slow revenue generation, led to a sharp rise in negative net cash flow.

This underpinned the need for the new defensive strategy to generate the necessary financial resources to restore (or at the very least support) both investor and customer confidence. Consequently, Colt has scaled back both operational and capital expenditure, sought to buy back a share of its bonds (thereby reducing its debt), and disposed of non-core assets to focus more clearly on and defend its core business. This shift in strategy was motivated by the need to address three interlinked concerns:

meeting its current financial commitments and to demonstrate that it had sufficient financial resources to fully fund its revised plans and see the company through to profitability (Day, 1997; Rigby and Rogers, 2000);
sending a signal to customers to demonstrate its reliability, continuity and long-term survival; and
sending a signal to rivals to create barriers to consolidation and to put the focus on weaker competitors to be the more obvious targets for consolidation and/or bankruptcy.
Colt was seeking to preserve its current position by enhancing its core business through generating cash to keep users and investors happy but also to fend off rivals and win market share as others exited the market place.

The ability of Colt to achieve these stated objectives of its new defensive strategy was directly assisted by the position taken by its parent company, Fidelity. In underwriting an equity issue to raise over £400 million to support the operator to cover its revenue shortfall (Financial Times, 2001) and defending Colt from an attempt by a rogue bondholder, Highberry (a UK-based hedge fund), to push the enterprise into administration, Fidelity sent an important signal to both customers and investors about the long-term prospects of the company (Underhill and Cotton, 2003).

The actions by the parent company, Fidelity, were not necessarily a vote of confidence in Colt or its management. The financial support offered was more about Fidelity securing a return on existing investments by ensuring that Colt had sufficient cash to see it through to becoming cash-flow positive. For Fidelity, Colt was always more of a financial than a strategic investment. This parental support enabled Colt to close the funding gap between its strategic ambitions and the ability to achieve those objectives without endangering the future of the company. This support gave Colt access to funding that others were finding it difficult to obtain. Many European-based alternative operators without this support have tended to undertake even greater retrenchment through either refocusing on their core market (e.g. Energis; see below) or simply going bankrupt (e.g. KPNQWest, Atlantic Telecom).

Thus, over the short term, the financial support of its parent – while not necessarily born of parental care – has been a key competitive differential between Colt and many of its major alternative operator rivals. The consequence was that the degree of adjustment undertaken by Colt as it shifted to a more defensive strategy was less drastic than many of its rivals. The experience of a key rival, i.e. Energis, offers an interesting juxtaposition. Energis's rapid expansion into the pan-European market left it with both a high debt (around £1.2 billion) and operating revenues that were insufficient to cover the interest repayments on this debt. A key problem for Energis is that it acquired businesses for large amounts of cash that required substantial further investment to move them into profitability. When both existing investors and the parent company, National Grid, refused further finance to support these loss-making European businesses, Energis reverted to a more defensive strategy (see Figure 1), leaving the pan-European networking market to refocus on its core UK market. However, with no purchasers for its European assets to be found, Energis was forced to write off nearly £1 billion.

Many alternative operators simply could not increase sales fast enough with low operating costs and capital expenditures to justify the optimism of their business plans to rationalise further support. To cover these inadequacies, and the failure of traffic to emerge as fast as operators claimed within their business plans, many operators engaged in hollow swaps. Operators sold fibre capacity to each other as a means of artificially inflating revenue for income statements as a means of generating the customer and investor confidence that the business needed over the short term. These were clearly attempts to mislead both investors and customers over the state of the businesses, though they have only have ever proved a short-term measure and have not really distracted from the long-term prospects of the businesses nor hidden any core underlying weaknesses.

While alternative operators were shifting towards increasingly defensive strategies, incumbents were becoming increasingly offensive within their domestic marketplaces. The high level of debt that had been accumulated by the larger incumbents as they sought to internationalise and cement their position as “communications conglomerates” with the purchase of third-generation mobile licences meant that they could not be aggressive in their consolidation of the sector. Consequently, consolidation tended to be more about pragmatic opportunism than explicit aggression, only taking place at fire sale prices (see for example BT wholesale's acquisition of Redstone's UK network assets for £1). Thus, incumbents sought to use their pre-eminent position within the domestic market place to overcome their short-term financial concerns. While regulatory as well as financial constraints limited their ability to be as aggressive as they might in fully exploiting their dominance, incumbents became increasingly customer-focused. They sought to exploit investor and customer concerns regarding alterative operators to position themselves as financially secure operators who could offer secure, reliable and high-quality communication products.

Colt's desire to secure its position within the European market place by moving to a more defensive strategy was ultimately a move that was of limited success over the medium to longer term. Those operators who left the European networking environment had limited market share, and thus there was only little diminution of the intensity of competition. It is evident that changing market conditions and sentiment increased incumbent power, and this was something that these operators were able and willing to exploit. Thus, despite parental support giving Colt a short-term competitive advantage over its alternative operator rivals, it did little to improve its position vis-à-vis incumbent operators. Overall, the refocusing by incumbents on their domestic marketplaces represents a longer-term challenge to the position of Colt unless it can demonstrate continuity and sustain the improvement in its financial position. Thus, over the medium to longer tem, Colt has to examine exactly where it is going to position itself within the European networking environment.



The longer-term strategic options for Colt


The type of strategic behaviour reflected within the above framework and exhibited by Colt was very much derived from the nature of the interaction between the changes in the external environment and of the resources/capabilities available to the enterprise (Kay, 1995). If either were different, the strategies followed would probably also have differed. Consequently, for a change in strategic behaviour to occur, either the environment has to change or there is an alteration in the nature of the resources at the disposal of the business. In terms of the strategic framework outlined above, it is likely that over the medium term the glut of capacity within the telecommunications sector will keep market growth subdued. The result is that the generally defensive stance of Colt is likely to be sustained into the near future. Based on this not unrealistic assumption, it is evident that the survival of Colt (and any other alternative operator) depends on going for scale to compete more effectively alongside the considerably larger incumbents. Consequently, given the position that Colt is seeking to secure in the market place, a number of options emerge.

First, Colt could adopt a policy of “sit and wait” while maintaining its defensive strategy. This would enable it to achieve scale through its ability to attract customers and purchasing (at vastly reduced prices) the networks of failed operators. This “natural” strategy relies on changes in the industry cycle or an industry shakeout “naturally” enabling the firm to gain scale (see Harrigan, 1990). As others leave, the sector it gains market share; or, as activity starts to increase, its ability to survive the downturn makes it attractive to new and/or existing customers. Thus, a reduction in competition within a framework of low growth could see Colt go on the offensive, picking up market share at minimal cost. This strategy is based on Colt's short-term advantage of being relatively secure financially being translated into a longer term positioning based on demonstrating security and continuity. However, this is risky, and relies on sustained support from the parent to cover likely future losses. If market conditions improve and an aggressive acquisitor emerges, Fidelity might well decide to minimise its losses on its investment and sell Colt. It also relies on a gamble that others will leave and that Colt will pick up sufficient market share to increase its scale. While Colt has been picking up customers from failed rivals, the rate of defection has not been sufficient to radically change the fortunes of the company. In what remains a subdued market, this suggests that Colt's larger incumbent rivals – via sustained offensive strategies – are also seeking this method to generate traffic for their own networks.

Second, Colt could seek to attain scale through merging with a rival. It is already evident that consolidation needs to happen within the European telecommunications sector and that, due to its limited scale, Colt will be consolidated rather than being a consolidator. A key influence on this potential option will revolve around the patience of the parent and how long it will be prepared to support Colt. It has already been widely anticipated that Colt would be an attractive partner for either BT or C&W, who are both seeking to expand their presence in Europe. The longer Colt's losses are sustained, the more attractive the option of consolidating the business into a larger operator is likely to become. Sustained low growth would make a strategy of a dash for scale increasingly attractive for both customers and investors, especially in the low margin, increasingly commoditised business of wholesale capacity. Alternatively, it could attain scale through increased co-operation with partners to benefit from scale in areas such as sales and marketing (see below), or even enhance its position within chosen markets through the acquisition of a local rival.

Third, Colt could scale back its operations to focus on gaining the benefits of scale in microsegments within its key target group, and then go on the offensive in this more narrowly defined niche. With this strategy, Colt resigns itself to being a bit player on the European telecommunications market. To this end Colt, like many of the surviving operators, has sought to move up the industry value chain to offer higher-margin “communications solutions”. What many operators (Colt included) have moved towards is tailoring their product portfolios more precisely to the needs of the user. This reflects the fact that the strategic emphasis for Colt – with its network built – is on harvesting that infrastructure through aggressive sales and marketing. It was under this premise that Fidelity (in 2001) changed the head of company. While Colt is part of a consortium (with HP, Cisco, Nortel, Microsoft, Sun and Oracle) that offers higher-value “total solutions” (encompassing IT services as well as telecommunications), it is only a minor partner offering networking capabilities to the alliance. It has neither the scale nor the capabilities to be an effective competitor on its own in this market segment.

Experience suggests that those players who survive the long term in the European telecommunications market will be those (most notably incumbents) who have a sound financial backing. For Colt, while it may be relatively strong amongst alternative operators, its position among incumbents is relatively weak. Incumbents have a clear advantage, as they already enjoy economies of scale, can achieve reasonable revenues, and have a chance to establish brands and take advantage of market uncertainty by acquiring the assets of failing rivals. Thus, sustained offensive actions by incumbents in their domestic markets places, and increasingly in geographically adjacent states, will continue to put Colt under severe competitive pressure.

The ability of Colt to sustain its long-term position will depend on the attitude of the parent company, how long it is prepared to support this business and the rate of turnaround for both the market and the business. As the market improves and the finances of operators shift, likewise Colt will have to find a new longer-term source of competitive differential in the market place. In this case, the push for scale makes a lot of sense if Colt emerges as the only serious alternative to incumbents and large US-based global carriers. Alternatively, Colt may need to seek to occupy a more narrowly defined market niche, specialising in a few sectors and not seeking to compete head-on with larger rivals. Furthermore there are emerging situations where the rise of broadband and the provision of “voice over Internet” are forcing incumbents back on to the defensive in certain areas of their domestic business. Thus over the short term, generating the finance to challenge this vulnerable side of the incumbent could a key strategic objective for Colt.



Conclusion


The turbulent European telecommunications environment of the mid-late 1990s witnessed a shift in the strategic behaviour of both incumbent and alternative operators. As much as this shift was unintentional, the effect was essentially to switch power back to incumbents and away from alternative operators. Alternative operators faced twin challenges, not only of investors losing faith in their strategy and the underlying business model but also of customers doubting the long-term ability of these firms to deliver sustainable, quality services. Such challenges cemented the dominance of incumbents over their domestic market places. Colt's problems were symptomatic of the sector as a whole, where overly aggressive expansions were financed by debt. However, unlike its incumbent rivals, it could not retrench to a large, steady, core business to shelter it from the challenges that emerged. Thus Colt had to fundamentally reassess the nature of its strategy in the European telecommunications market place. The essence of its strategy went from aggressive expansion to one of survival. Strategy was essentially based on creating a competitive differential vis-à-vis its rivals through its ability to demonstrate financial security.

For all operators within this turbulent commercial environment, the preoccupation has been cash generation. This is as true for incumbents as it is for the alternative operators, and reflects how the firm has had to adjust internal resources to fit the needs of the external environment, as shown most markedly through the flight to profitability and quality by investors and customers respectively. Colt's experience demonstrates how important a supporting parent company can be to the survival of the business. It is difficult to believe that Colt could have survived in the form that it has without this support. Others who did not have such support have been among the most notable failures and the most vulnerable of Europe's alternative operators. It is evident that European telecommunications has not finished changing. A sustained period of slow growth will keep all operators focused on cash generation to avoid being consolidated.

The longer-term challenge for operators is in deciding how to reposition themselves in a market that looks like having a sustained glut of capacity and slow growth for the foreseeable future. For many operators, the immediate response has been to move further up the industry value chain, offering less standardised products and focusing on customer intimacy. For alternative operators, there is an apparent need to go for scale if they are going to compete effectively with the much larger incumbents. The options specified for Colt could well be applied to any alternative operator seeking to preserve its position within the European marketplace. Thus, if alternative operators are going to go on the offensive and effectively challenge incumbents, they need to be larger and there needs to be fewer of them.