Deutsche Telekom and France Télécom can only survive if they follow BT’s restructuring efforts by splitting into horizontal lines of business, according to a new report by Forrester Research B.V. (Nasdaq: FORR). But Forrester believes that BT should go further in 2006, and that a full breakup of BT could unleash £11 billion more value for BT’s shareholders. A break-up strategy, however, could carry significant risks.

Forrester believes that European incumbent telcos like Deutsche Telekom (DT) and France Télécom (FT) must restructure along three horizontal lines of business — networks, innovation, and retail — to overcome their fundamental innovation, revenue, and profitability challenges. Restructuring internally along these lines and a gradual opening up of a telco’s value chain, as BT has done, is the first step toward a new industry paradigm that Forrester calls “layered telecom.”

“BT is now structured as four main lines of business (LOBs) — Wholesale, Ignite, openworld, and Retail — which fits well with our vision of the path toward renewed growth,” said Forrester Senior Analyst Lars Godell. “However, other incumbents like DT and FT still focus on outdated vertical integration and try being all things to all people — and neither an industrywide meltdown, crumbling finances, speculation about massive recapitalization of their own companies, nor CEO departures can convince DT and FT executives to fundamentally change the way they do business. DT in particular still believes it can be world-class simultaneously in networks, innovation, and retail across its four vertical silos of fixed, mobile, Internet, and IT solutions. The concept is fundamentally wrong and shareholders have lost 85 percent of their DT investments in the last 30 months.

“In contrast, since completing its transition to a layered model in October 2001, BT has identified hard, quantifiable business benefits attributable to its new structure and business model. Forrester believes these already-manifested benefits will deliver £10 billion in value to BT in present value terms. In total, these and future benefits will create a company whose equity value in present value terms is worth 136 percent or £23 billion more than BT is valued today.”

However, while Forrester holds BT’s current strategy as a role model for other European telcos, by 2006 it will reach the limits of what internal layering can deliver. In 2006 a breakup — a separate listing of BT’s retail, innovation, and network businesses — will be seen as a natural evolution, not revolution inside BT. And while a breakup carries significant risks that could destroy more than £5 billion shareholder value in a worst-case scenario, Forrester thinks the arguments against it don’t stack up. Forrester believes that a breakup is the next logical step that could create an extra £11 billion in shareholder value for BT. Timing a breakup for 2006 and preparing carefully, BT could create 28 percent more value for shareholders than internal layering will alone. With the execution risks managed, BT’s newly fully independent business units would concentrate on innovation, deliver higher revenues and lower costs, and achieve lower salary costs. The breakup recommendation doesn’t stop with BT — other incumbents like DT and FT should prepare for breakups this decade as well.

“But European regulators could easily wipe out most of the expected breakup benefits if they were to mandate breakups of BT and other incumbent telcos. European regulators, including the UK’s Oftel, so far haven’t grasped how to change behavior through a mix of incentives. And regulators have a great track record for messing up the industry through its local loop unbundling and 3G auction policies,” Godell added. “The odds are that unwilling incumbents would fight any breakup mandate for years and play the necessary games to derail the initiative on principle alone. Instead, regulators must encourage voluntary structural separation by granting incumbents that break up on their own terms full relief from their industry-specific regulatory burden.”

Read more about BT’s restructuring efforts.