BT warns on profit over Italian scandal and UK slowdown

By Kate Holton

LONDON (Reuters) - BT lost almost a fifth of its market value on Tuesday after an Italian accounting scandal compounded a slowdown in its British government business to force the firm to cut revenue, earnings and cash flow forecasts for the next two years.

Shares in the 171-year-old British firm were on track for their worst ever one day fall after BT said it would now not be able to grow revenues for the next two years, bringing an abrupt end to years of painful and steady recovery following the 2008 economic downturn.

The telecoms company, which had revealed an initial investigation into historical accounting practices in Italy in October, said a review had found a complex set of improper sales, purchase and leasing transactions.

A writedown to the business of 145 million pounds ($181 million), announced in October, has been increased by more than three times to around 530 million pounds.

According to a person familiar with the situation, staff had colluded with suppliers to inflate their accounts over a number of years, before a whistleblower contacted senior executives at BT headquarters last summer to make them aware of the practices.

Although the update on the Italian business grabbed the headlines, the division only contributed around 1 percent of the group's core earnings for the year to the end of last March.

More serious for the long term was the comment in the unscheduled statement that BT had also seen a deterioration in its core corporate and public sector businesses.

"We expect the market to react negatively to the deterioration in trading in public sector and international corporate," analysts at Citi said.

"In addition BT risks a credibility hit that this protracted and significant distortion to its accounts in Italy has happened at all." Citi has a "Buy" recommendation on the stock.

NEW ITALY BOSS

BT shares lost more than a fifth of their value last year, while the benchmark FTSE index rose 14 percent. The shares traded 17.5 percent lower at 315.8 pence by 1000 GMT.

BT is facing challenges on a number of fronts -- a regulatory battle over its core network, a growing pensions deficit and the cost of expanding its TV business.

BT said group revenue will now not grow for the next two years while the guidance for core earnings, or earnings before interest, tax, depreciation and amortisation, has been cut to 7.6 billion pounds from a previous guidance of 7.9 billion pounds.

Normalised free cash flow for 2016/17 is expected to come in at 2.5 billion pounds, compared with a previous forecast of between 3.1 to 3.2 billion pounds. And free cash flow is also forecast to be lower than the guidance given for 2017/18.

However, it said it expected to increase its dividend per share by at least 10 percent in both 2016/17 and 2017/18.

The group said it had taken immediate steps to strengthen its processes and controls in Italy. It suspended a number of BT Italy's senior management team, who have now left the business, and appointed a new BT Italy CEO who will take charge on Feb. 1.

"Further, we are conducting a broader review of financial processes, systems and controls across the group," it said. "The BT Group Remuneration Committee will consider the wider implications of the BT Italy investigation."

($1 = 0.8019 pounds)

(Reporting by Kate Holton; editing by Guy Faulconbridge/Keith Weir)