BT has reached a deal to pay down the 4.1 billion-pound deficit on its staff pension fund more quickly than previously planned, resolving a long-running concern for investors and clearing the way for potentially higher dividends.
Shares in the former state telecoms monopoly leapt to a four-year high after it said on Friday it had agreed with the BT Pension Scheme's trustee that it would start clearing the deficit immediately with a top-up payment of 2 billion pounds ($3.16 billion) by the end of this month.
The group, which had previously relied on cost cuts and improved efficiency to drive cash generation, said it would then be able to make lower annual contributions for the next nine years of 325 million pounds, compared with its previous goal of clearing the deficit over 17 years.
Analysts said the new deficit estimate for the scheme - the country's largest private pension scheme - was also less than expected, in an announcement that was widely welcomed by investors, unions and credit ratings agencies.
The company now has a better balance sheet for dividend payments, and also crucially for more investment in the business, Bernstein analyst Robin Bienenstock said.
BT, which has been dogged in recent years by the pension deficit and the restrictions it placed on its dividend, said a new triennial valuation at the end of June put the deficit at less than half the size of the 9 billion pound shortfall when the scheme was evaluated in 2008.
This agreement under which the company makes an immediate contribution to the scheme of almost half of the deficit reflects BT's financial strength, Chief Executive Ian Livingston said.
Moody's and Fitch also welcomed the deal, even though it will lead to BT's net debt increasing.
The reduction in the size of BT's pension deficit is a clear positive, says Damien Chew, Senior Director in Fitch's European Telecoms, Media and Technology team.
One of the key issues for BT's credit profile is the level of cash contributions it makes to fund its pension deficit. This risk is now lower, with certainty for at least the next three years.
Even though the 2 billion pound lump sum payment will lead to an increase in leverage over the next two to three years, ongoing pension deficit payments will be reduced.
The new deficit settlement compared with a previous payment plan which ran over 17 years and started off with an annual payment of 525 million pounds which would then rise to 856 million pounds in 2025.
The Communication Workers Union said the announcement was good news for members of the scheme but also for all BT employees, as the firm would now be able to invest in other areas of the business, following its programme of building out a super-fast fibre network.
Union Prospect agreed.
The scheme is now safe for the pensioners of today and tomorrow, Assistant General Secretary Ben Marshall said. There are very few defined benefit schemes in the UK today that are as securely funded as this one.
Analysts noted a condition that BT would have to pay more money into the scheme if its shareholder returns between March 2012 and June 2015 exceeded the pension deficit payments.
With shareholder returns for that period forecast at around 2.5 billion pounds, and the deficit payments planned at 2.98 billion pounds, analysts noted that there was plenty of headroom for BT to raise the dividend.
BT shares were up 5.6 percent at 232 pence by 3.45 p.m British time, having earlier scaled to a four-year high of 235.3 pence, the day's biggest rise by a European blue-chip stock.
($1 = 0.6326 British pounds)
(Editing by Greg Mahlich and Erica Billingham)