MmO2 backers won't go for jam tomorrow

IF VODAFONE catches a cold, mmO2 gets the flu. The mobile giant's share price has collapsed 38% this year. But its smaller rival, spun out of BT last year, has fallen by a half.

The reason? MmO2's biggest business, BT Cellnet in the UK, is second-rate. And its second-biggest business, Viag in Germany, is draining cash.

The group is not expected to break even on a free cashflow basis for a further five years. After that, cashflows may shoot up smartly. But, in their current mood, investors are not prepared to give much value to jam the other side of the rainbow.

Another way of looking at things is via ebitda (earnings before interest, tax, depreciation and amortisation) multiples. Investors used to think mmO2 deserved a higher multiple than Vodafone because its ebitda was growing faster. Sounds sensible? Only if ebitda was a good proxy for free cashflow.

But, despite attempts by silver-tongued brokers during the bull market to convince otherwise, ebitda is not anything like free cashflow. To get a remotely good proxy, you first need to subtract capital expenditure.

And here is the rub. Second-tier mobile businesses like mmO2 do not enjoy nearly as good ebitda margins as first-tier groups such as Vodafone. But they still need to spend almost as much on investment. So every £1m of ebitda mmO2 produces is worth less than a million earned by Vodafone.

That said, the notion that mmO2 is worthless, as argued last week by broker Collins Stewart, is extreme. BT Cellnet may not be great but it still has value. So does Esat in Ireland. As for Viag, if it can't be sold, it could at least be axed. MmO2 may begin with an M, but it is not another Marconi.

Size worries waste energy

DOES size matter after all? National Grid's bid for Lattice was, in large part, driven by a belief that a larger group would be able to grab more opportunities in the US.

The notion that mid-sized players cannot cut it was also behind Enterprise Oil's willingness to be snapped up by Shell, as was Innogy's eagerness to be bought by Germany's RWE. At present, this renewed size-ism is largely confined to the energy and utility sectors. With luck, that is how things will continue. Too much value has been destroyed in the past decade by the belief that big is better.

Executives who were infected during the mania have been immunised for life. If only those who were not infected could be too.

Banks' charm may fade

BRITAIN'S banks are suddenly the toast of investors. There has been a rush to buy shares in the likes of Barclays and Royal Bank of Scotland and, having risen by 8% since the start of the year, the FTSE Banks index is within a whisker of its all-time peak. Meanwhile, the FTSE 100 has gone nowhere.

There are reasons to celebrate. The banks have not been swamped with bad debts. Despite the recent troubles of big borrowers such as Marconi and NTL, their loan books have remained relatively sound. And interest rates will probably stay low for a while.

But bank stocks are mainly strong by default. Investors see them as a safe way of dabbling in equities. It helps that the shares are regarded as relatively cheap. The sector trades on a multiple of some 14 times earnings against about 20 for the market as a whole.

Is this discount justified? Historically, it existed to reflect the risk of a bad-debt explosion now and then. Some believe this is outmoded because the banks are so much cleverer at managing risk. And if the bad-debt cycle is flatter in future, the discount should narrow.

This seems premature. The banks' skills have yet to be tested by a real recession. In the meantime, the low inflation economy presents them with problems aplenty. Having cut costs to the bone, expenses are creeping up.

Revenue growth targets of 5%-plus will be hard to meet. Banks may look attractive when the rest of the market is so moth-eaten. But these charms may be transient.

Hugo Dixon is Editor of www.breakingviews.com