Telecoms Under Pressure After Cutbacks

Cable & Wireless Worldwide (CWW) saw their share price lose almost 20% this week, after warning that their full-year profits were likely to come in at the lower end of expectations.

The telecoms giant attributed the dip to a sharp decline in UK public sector spending following the emergency budget on 22 June.

Housing company Connaught was the first to blame government cutbacks for disappointing results. Their share price tumbled after warning that spending cuts were likely to negatively affect their results. Investors are treading with caution, but is there really reason for alarm given the percentage of business at stake?

Tremors in the market

The share price’s dramatic drop does appear premature, bearing in mind that CWW’s revenue is still expected to fall within the forecasted range. Non-contracted work accounts for just 20% of CWW’s annual UK public sector revenue. But Deutsche Bank reports that of the 12.5% of revenue CWW earned from public sector clients last year, 20% of that business was not contracted, thus achieving the highest profit margin. This work has quickly tapered off since the government announced £6.2bn of spending cuts.

The key issue for CWW and other companies supplying the public sector, and indeed the main concern for investors, is what will be the next move. The government may now seek to renegotiate existing contracts into cheaper ones. Before a meeting with the government’s 20 largest private-sector suppliers, Cabinet Officer Francis Maude made it clear that 'We will expect you to tell us how we can pay you less, some of which will be for doing less'. [1]

What next for company shares?

CWW will cut operating expenditure to curb some of their losses. But all eyes are now focused on who will be next to feel the effects of the government’s tightened belt. BT is certainly a likely contender, as their Global Service division draws 11% of group revenue from the public sector – roughly the same percentage as CWW. IT services company Logica is also in a similar boat, as 15% of profits are drawn from UK government contracts.

Capita, however - a key supplier to the government and named by David Cameron last year as a contractor which received too much work - hit the top of the FTSE 100 table on July 22 after reporting a 15% rise in interim profits. They credited strong demand across the public and private sectors, with chief executive Paul Pindar saying ‘Whilst the current pressures on public spending may potentially affect growth in the short term in a small number of our trading activities, the need for our public sector clients to achieve substantial cost efficiencies offers significant opportunities for the Group going forwards.’ [2]

As evidenced by CWW’s tumble this week, investors are not sure about the true size and scope of the coalition government’s cost-cutting measures. Uncertain about the medium-term outlook of public sector shares, investors are wary, and sentiment is heavily influenced by the initial fluctuations in company earnings.

Take a position

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Sources: [1] Bloomberg News 7 July 2010, [2] Capita website 22 July 2010

Updated: 22/07/10

The above comments do not constitute investment advice and IG Markets accepts no responsibility for any use that may be made of them.