Deutsche Telekom's Toughest Job Is at Money-Burning Tech Fossil

(Bloomberg) -- The effort to strike a deal for T-Mobile US Inc. has drawn attention away from another Deutsche Telekom AG unit that needs fixing more urgently: its money-draining computer-services business.

With a T-Mobile US deal now on hold, the German giant can focus on reviving the T-Systems tech division that’s struggling to compete with more agile cloud startups and multinational giants. That job will fall to Adel Al-Saleh, an American software veteran with a track record of turning around troubled businesses, who starts Monday as the unit’s chief executive.

The effort is crucial because the division gives Deutsche Telekom access to large multinational clients it can sell other services to, yet it has for years been the company’s problem child. Some of the unit’s contracts have proven loss-making, and it has come under pressure as IT services are increasingly moving into the clouds of Amazon.com Inc. and Google, where they’re available at a lower cost.

“These IT services units -- from T-Systems to that of BT Group and Orange SA -- all have the same problem: Where they operate in a country where they don’t have a network, the margins are poor,” said Jonathan Dann, an analyst at RBC Capital Markets. “The new T-Systems CEO must focus on more profitable contracts and avoid those in countries where they have no network. And find a way to add value beyond just re-selling cloud offers from the likes of Amazon.”

Deutsche Telekom's Toughest Job Is at Money-Burning Tech Fossil

The stiff competition has hurt margins and stifled growth at T-Systems, which has accumulated operating losses of more than 1.8 billion euros ($2.1 billion) since 2012. Deutsche Telekom Chief Executive Officer Tim Hoettges wants to see the start of a turnaround next year after having to write down 1.2 billion euros of goodwill at the unit last quarter on declining orders.

More Cuts?

Hoettges has said internally that he doesn’t want to rule out anything for T-Systems, including more personnel cuts or the sale of problematic businesses, according to a person familiar with his thinking. Small acquisitions to strengthen promising ventures, such as cybersecurity, are also possible, the person said, declining to be named because the discussions are internal. Al-Saleh, who spent the first two decades of his career at International Business Machines Corp., wants to push more cost cuts at T-Systems, partly by increasing the offshore share of the business, the person said.

Deutsche Telekom declined to comment on potential cost cuts or acquisitions. T-Systems is “undergoing a comprehensive transformation into a leading digital service provider” and can improve in many areas, the company said in an email.

Al-Saleh’s past successes include reviving NIS, a U.K.-based company specializing in human resources software. He was brought in as CEO in 2011 by owner KKR and went on to streamline the company’s portfolio, update its strategy and cut costs. He also restructured the business’s debt and brought in Goldman Sachs Group Inc. as an investor in 2016.

“Adel has a proven record of turning businesses around,” Hoettges said in October, when the new unit chief was named. Hoettges has previously voiced his impatience with T-Systems, saying at Deutsche Telekom’s shareholder meeting in May he’s annoyed the unit “ruined” the company’s 2016 result.

Growth Areas

Selling unprofitable parts of T-Systems is one way to cut costs, yet finding a buyer won’t be easy as many of the division’s employees can’t be easily fired because they retained the civil-servant status of the former state-owned monopoly. Deutsche Telekom considered selling the outsourcing business of T-Systems’ IT division, which services computer systems for corporate clients, people familiar with the situation said this year. So far, no sale has materialized.

There is room for some optimism. T-Systems is creating new growth in areas such as cybersecurity, its cloud business and Internet of Things-related services, Chief Financial Officer Thomas Dannenfeldt said. Deutsche Telekom cooperates with Huawei Technologies Co. for its IoT offerings and has won clients including shipping company Deutsche Afrika-Linien, which tracks its containers to ensure they arrive undamaged.

T-Systems also built a cyberdefense center that helps corporate clients such as gas company Linde AG fend off attacks and developed products including an app that alerts users if someone is trying to hack their mobile phone.

A healthy performance at T-Systems is key for a carrier the size of Deutsche Telekom, which seeks to benefit from industries digitizing their factories in Germany and abroad, said Erhan Gurses, an analyst at Bloomberg Intelligence.

“The new CEO’s main challenge is to put the unit back to a sustained growth trajectory with improvement in profitability,” Gurses said. “This may mean further pain ahead before things start to improve as the segment needs to reduce its reliance on traditional IT projects and invest to gain better traction in high growth areas including IoT, cloud and security.”

©2017 Bloomberg L.P.