Carphone Warehouse - A tale of two days

The phenomenal success story of Charles Dunstone’s Carphone Warehouse goes on, but there are signs that they may be posing a little more threat to the Network Operators than they feel comfortable with. Are they starting to show too much influence on the High Street? Are the Network Operators going to reign them in? Its looks as though the cosy relationship may be showing signs of strain, but Carphone Warehouse are fighting back.

The recent news flow started well, with Carphone Warehouse announcing the much rumoured, and much expected acquisition of AOL’s Internet access business in the UK, for a staggering £370 million. The Company will pay £250 million on completion (after the various regulatory approvals have been received), with 3 further instalments over the following 18 months. Carphone Warehouse beat competitors such as Sky TV to the acquisition of the AOL business, but many in the industry believe that the price is a little too high for comfort. However, in the hands of Carphone Warehouse, and with their past track record, there is every chance that they will again prove the critics wrong.

There is no doubt that the acquisition of AOL UK’s 2.1 million new customers (consisting of 1.5 million broadband and 0.6 million dial-up subscribers), offers the potential for massive cross selling of additional Carphone Warehouse services, and also give the much heralded Broadband subsidiary the critical mass they have been craving. The former AOL UK business generated revenues of £442.1 million and operating profits of £14.1 million in the year to December 2005, although gross assets were only £77.9 million.

The AOL UK business appears to be worth more to Carphone Warehouse because it can be integrated with the Groups existing Broadband business which currently has 625,000 customers. The Broadband business was originally launched in a blaze of publicity as the UK’s first free Broadband Service. The increase in size will take Carphone Warehouse to number three in the league of UK Broadband providers, and take the existing Broadband business from loss making to profitability in an instant, even before operational cost savings.

The company are confidently forecasting the acquisition will increase Group profits by £10 million in 2006, and £30 - £40 million in 2006. It seems that Carphone Warehouse may yet again surprise the market, and squeeze every last drop of cost savings and profitability from the expanded business. The company is certainly becoming a force in the Broadband market, but what is happening with the traditional Mobile Phone business? All was steady until……….

While analysts and company directors were taking in the massive impact of the AOL UK deal, a small but very significant announcement was released by the world leading Network Operator, Vodafone. They have decided to withdraw from their contract sales agreement with Carphone Warehouse (which is due to end later this year) and move back to the original telecoms starlet Phones 4U. So what has gone wrong?

While all of the major UK Network operators have a strong presence on the high street, many customers have preferred to visit places such as Carphone Warehouse for a more balanced view of the products on the market. This resulted in a significant shift of business from the Network’s own brand shops to the more general “Mobile Superstores”, but this came at a price - commissions to the likes of Carphone Warehouse.

As we all know, the UK regulator has been particularly tough on UK Mobile Phone Operators, with severe price pressure on UK based income. This has resulted in a number of Network Operators reviewing their positions, looking to reduce costs, and increase net income from UK operations. So why has Vodafone “jumped ship”?

It appears that Vodafone have had reservations about the levels of commission being paid to Carphone Warehouse for sometime, although the announcement to move was a bolt from the blue. It may be that Carphone Warehouse have become too powerful, and Vodafone have not been able to agree a new sales agreement on lower commission rates. They have decided to move to Phones 4U, who have been over shadowed by Carphone Warehouse for some time, and were willing to take a lesser commission for the exclusive rights to sell Vodafone contracts.

This has prompted the likes of Orange and O2 to announce a review of their cost base, with many in the industry forecasting a reduction in profit margins for the likes of Carphone Warehouse. While they may try to reduce the commissions paid to Carphone Warehouse, there is every likelihood that the remaining sale partners of the Group will see an increase in sales, by filling the void left by Vodafone. This should offset much of the expected reduction in commission for Carphone Warehouse, but it now appears that they are able to fight their own corner, and the big Network Operators dont like it!!!