BT worth £7bn less after Italy fraud shock

BT said three months ago it had taken a big charge on "inappropriate management behaviour" at its Italian operation. But a "best estimate" of £145 million has proved significantly wide of the mark. In fact, the damage is more than three times that. This is a massive shock ahead of Friday's third-quarter results, and we also hear of problems in the UK public sector, which will batter profits, too.

After calling in accountants KPMG, the damage done is now put at £530 million, with the mismanagement of BT Italia, part of the Global Services division, far more serious than the company imagined. A mass exodus of shareholders plunged the shares to a low of 309p on Tuesday, their lowest since June 2013.

"These investigations have revealed that the extent and complexity of inappropriate behaviour in the Italian business were far greater than previously identified and have revealed improper accounting practices and a complex set of improper sales, purchase, factoring and leasing transactions," BT told the City.

"These activities have resulted in the overstatement of earnings in our Italian business over a number of years."

Given the scale of "inappropriate working capital transactions" BT and its advisors still cannot decide how much of the shortfall should be treated as prior year errors, or reassessment of current-year estimates, and how they should be reflected in the accounts.

What we do know is that third-quarter adjusted cash profit will fall by £120 million, and by £175 million for both the full year to March 2017 and 2018.

For the large part business elsewhere was good during the quarter. However, there are problems at the international corporate and public sector division where underlying cash profit is now tipped to slump by double-digit percentages in the first three months of 2017. That's blamed on large central government contracts not being replaced when they end and on tighter public sector budgets.

All this means underlying revenue will be "broadly flat" for the next two years and adjusted cash profit in the year to March will be just £7.6 billion, down from City estimates of £7.9 billion. It will probably be the same in 2018 when analysts had been looking for over £8 billion.

Haitong Securities analyst John Karidis called the news "a bitter disappointment" and criticised BT for not bringing forward quarterly results from Friday.

However, it is significant that BT chose to repeat expectations it will still grow the dividend by "at least 10% in both 2016/17 and 2017/18". That, says Karidis, implies BT Consumer, EE and Openreach are doing well, although his fair value and recommendation are "under review" till Friday when we'll get more detail.

Based on UBS forecasts for an annual dividend of 15.4p in 2017, BT offers a prospective yield of almost 5% at the current share price. It's not quite as simple as that, however.

BT chief executive Gavin Patterson may have cleared out senior management in Italy, and is parachuting a new man to run the business there from 1 February, but this happened on his watch, and it does not reflect well.

It seems the business there was rotten for years, with inadequate governance, compliance and financial safeguards. Yes, BT is a company of over 100,000 staff, but investors will ask how could this have gone unnoticed for so long?

In hindsight, the October heads-up about issues at BT Italia should have caused more of a stink than it did at the time. Finance director Simon Lowth gets some slack seeing as he's only been in the role less than a year; the former BG Group FD taking over from Tony Chanmugam last July.

Remarkably, Alistair Strang, technical analyst and regular Interactive Investor contributor, predicted this crash with alarming accuracy.

Last July, with the share price at around 400p, Alistair said: "To cut a long story short, the price of BT shares was - in common with many others - given an absolute stuffing on Brexit Day.

"The share price was moved below the uptrend since 2013 and now resides in an area with drop potential to 309p, but, realistically, we'd expect a real bounce from 212p, as weakness toward 309p would also shatter the uptrend since 2009."

BT's low price at lunchtime Tuesday was 308.55p. Spooky.

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