ANALYSIS:Losing 1,300 customers a week, the debt-laden telco desperately needs to reduce costs, writes CIARÁN HANCOCK

EARLIER THIS week staff in Eircom were briefed about the current state of the company and the Irish telecoms market. The picture painted was not pretty. They were told that the Irish market is expected to shrink by more than 10 per cent over the next four years.

The underlying message was that Eircom would have to be transformed if it is to protect its position as the country’s biggest telco.

This won’t be easy. The average age of Eircom’s workforce is 51 and just 6 per cent of staff are under 40. About 80 per cent of employees are on Civil Service contracts, dating back to its time under State ownership. And 700 of its staff are based in Donegal.

More importantly, its costs per phone line are about €200, roughly double those of cable TV operator UPC, which is eating its lunch with a cheap triple play offering of television, phone and broadband.

Staffers saw the briefings as a softening-up process as the company and unions begin talks on taking out another €90 million in labour costs over the next three years.

The revolving door of redundancies shows no sign of stopping.

Chief executive Paul Donovan has declined to put a figure on how many jobs this will involve but one informed source this week put it at 1,500. This would be on top of the 1,531 who were removed from the payroll in the latest headcount reduction up to the end of June.

On Tuesday, the company warned that it could default on its €3.8 billion debt within the next 12 to 18 months unless remedial action is taken. “That really is a signal around our commitment to attack our cost base,” Donovan told The Irish Times this week.

“You can’t have a situation where you are losing 1,300 fixed lines a week and maintain labour costs which are constant. So it’s really important that we can achieve the efficiencies that are necessary to have costs on a par with our competitors.”

Aggressive cost-cutting helped Eircom to bring its fourth-quarter – April to June – Ebitda (earnings before interest, tax, depreciation and amortisation) in at €172 million, just 0.6 per cent below the figure for the same period of 2009. Eircom will trigger its debt covenants if its net debt-to-Ebitda ratio falls below a certain level. So keeping the Ebitda level up is hugely important.

Donovan wouldn’t reveal what the crucial ratio figure is, citing confidentiality with its lenders. “The business is generating cash flows to support its debt but we will have to have some remedy in the future in relation to the covenants,” he said.

Concerns about its debts resulted in Moody’s downgrading Eircom yesterday.

For now, at least, the unions seem to be on the same page as Donovan. Talks are under way and the Communications Workers Union appears pragmatic in its approach to slimming down the company. It has been down this road before and if the terms are acceptable a deal can be done. But cutting labour costs is only one part of the equation.

Donovan also has to find a remedy for its massive debt mountain, a legacy left by its previous owners. Sources close to the company say the focus is likely to be on the €606 million worth of payment-in-kind (PIK) notes, which are currently trading at a discount.

“They’re likely to buy at least some of these,” one source said. “They’re trading at a discount and there’s a saving to be made.”

The PIKs are due to be repaid in 2016. In the meantime, the interest continues to roll up.

Eircom has about €3.1 billion in other debts. Of this, €431 million is due to be paid by the middle of 2014. This is probably manageable. After all, the company has €400 million in cash at hand. But after that there is a sharp spike in repayments. They rise to €1.2 billion in the next year and €1.6 billion in 2015/16.

“I think you can expect they will be talking to their bankers as well,” said one well-placed source.

On Tuesday, Donovan said Eircom could seek “relief” around its covenants from its lenders. This would come at a cost. Eircom’s debt was priced before the global financial crash.

It is fair to expect its lenders to push for higher interest rates in return for relaxing their covenants.

The other option is for the shareholders – Singapore-based STT and the employee Esot – to inject equity into the business. New equity would count as Ebitda, Donovan said.

STT took control of Eircom in January without placing any equity into the business. The Esot, which comprises thousands of current and former workers, is believed to have more than €100 million in reserve. No payments have been made to members for about nine months. In a recent circular, the Esot’s board said it would await the formulation of Eircom’s new business plan before deciding on how to spend its cash pile.

That plan has been tabled by Donovan. It is now up to the shareholders to decide their next move.

Sources suggest that up to €300 million might be needed. That could be a bit rich for the Esot, which owns 35 per cent of Eircom.

Many former employees would probably prefer to get a tax-free dividend rather than see their funds pumped into Eircom.

A lively debate is likely and the Esot must also be mindful of the need to wind up the trust by 2014 as per its arrangement with the Revenue Commissioners.

Nobody is sure about the intentions of the Singaporeans, but STT has long stated its intention to be a long-term investor.

Donovan also needs to tackle the company’s performance. It is losing more than 1,300 fixed-line customers a week.

Revenues are in almost terminal decline – they fell 8.5 per cent last year to €1.8 billion – and even the Meteor mobile business, once the jewel in the crown, is feeling the chill wind of recession. Average customer spend on mobile products fell by 15 per cent in the fourth quarter.

Added to that, UPC is making significant market share gains and Vodafone has launched an assault on the fixed-line market.

Donovan is credited with having stabilised Eircom since taking the reins last year, notably cutting a deal with unions to eliminate its pension deficit.

But others worry that there is no plan to aggressively win market share – to take the fight to the competition.

Donovan might point to the success of its next-generation broadband. He expects to have 280,000 customers by the end of December.

And a fast-fibre network trial, slated for the first half of next year, is on track.

But there is no money in the company coffers to build a national fibre network, which is badly needed to replace the crumbling copper wire.

In the search for new revenue, Eircom Mobile, targeting an older customer base than Meteor, will be launched later this month. But there are no green shoots of recovery, Donovan said. The outlook is for “more of the same”. “We’re very keen to continue to drive our penetration of NGN [next generation network] services . . . and we want to get our mobile business back on track while tackling the cost base.”