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December/1/2001
Financial Management (by Cathy Hayward)
Cold calling
The telecommunications industry seems to have exhaled its last breath, but does it have the strength to revive itself? Cathy Hayward traces the demise of the telco business and asks whether there are signs of a pulse.
Telecommunication companies (telcos) and their shareholders have had a rocky ride over the past year. The industry, which peaked in spring 2000, when telecoms shares sold like expensive hot cakes and everyone dreamt of making millions, has been brought to its knees. Over the past 18 months the nine largest listed telecoms firms have lost 245 billion in value after average stock market falls of 60 per cent. Many have plummeted out of the FTSE 100 index; about 300,000 jobs have disappeared; and there have been high-profile management restructuring drives throughout the industry notably at Marconi and BT.
According to Michael Grenfell, telecommunication and competition partner at law firm Norton Rose, the general downturn in the economy contributed to the meltdown the cost of which has exceeded the combined annual value of the Swiss and Irish economies. “Every industry has been affected one way or another, and the situation was exacerbated by the terrorist attacks in the US on 11 September, which aided the onset of a recession,” he explains.
In addition, the telcos' strong relations with dotcoms helped to precipitate their collapse, Grenfell argues. “Telcos are part of the same pie as dotcoms. When dotcoms started to go under, they dragged telcos with them”.
Tony Kremer, principal consultant at telecoms consultancy Cartesian agrees. “It's a ripple effect. Dotcoms were the first to be affected, then their suppliers had problems and it rippled through the technology sector.” Almost 90 per cent ofthe dotcoms which were supposed to deliver increased traffic through the telecoms networks have gone bust.
But Kremer also claims that flaky business plans are to blame. “Firms were spending money as if it were going out of fashion, but they were earning far less than they had anticipated in their business plans,” he says. “When investors started asking questions, the answers weren't good. The industry said it would take longer to put the new generation systems in place, but claimed the revenues would be greater. It couldn't prove it, so investors, already burnt by the collapse of the dotcoms, pulled out.'
It didn't help that some firms deliberately inflated their expected revenues. Deutsche Telekom, for example, is being investigated for overstating its property assets by almost half.
In retrospect, the telecoms sector was like any other utilities business until the arrival of the technology boom. The growth of the internet, coupled with deregulation, seemed to offer unlimited, if ambiguous, possibilities. Firms created new business models and took on more debt, reasoning that increased revenues would fund the borrowing; but the revenues didn't materialise.
The opportunities were so appealing that hundreds of new firms entered the market and there was not enough business to go round. “Telcos failed to recognise that mobile phone sales will naturally tail off as the market reaches saturation point;' Kremer says.“Not everyone in the UK wants or needs a mobile phone and people won't upgrade every year”.
Just as revenues were below target, outgoings rose higher than expected. The cost of building essential high-speed internet networks proved to befrightening: cable operator NTL spent L11 billion constructing a network in the UK; Telewest spent 4 billion; and BT spent L5 billion.
An already difficult situation was made even more precarious when telcos were laden with further debt after buying third generation (3G) licences from the government. Orange, Vodafone, One2One, BT and TIW (Telecommunications and Wireless Company) paid L22.5 billion for the radio spectrum they needed to broadcast high-speed internet services over mobile phones.
“This is main reason behind the telcos collapse,” Grenfell argues. “The major telecoms firms spent billions on 3G, but had no way of knowing whether it would catch on. They over-- stretched themselves and then the market panicked about whether this was sustainable.
Kremer agrees. “The technology was developed with the confidence that it would be useful, but commercial questions were ignored”.
Research by telecoms consultancy Quotient Communications has predicted that it could take more than 10 years for telcos to get back their money from 3G licences - particularly if tight budgets force them to offer substandard services. The popularity of 3G has also been questioned: Nicolas Gaudois, an analyst at Morgan Stanley, predicts that handsets will be bigger and more expensive, with less battery, talk and standby time than current models, which might result in lower handset sales - the thing that telcos dread most. “3G might be the most brilliant thing, but it also might.flon.” Grenfell agrees.
Kremer believes that the telcos' struggles also stem from bad internal practices. At least 5 per cent of telcos' revenues never arrive because of poor operational practice and fraud, he points out. “It's got worse. New companies have set up and grown rapidly, and they've focused more on marketing and less on engineering their internal systems to ensure everything talks to everything else”.
But Steve Jenkins, former vice-president of sales for Europe, the Middle East and Africa at Nortel Networks, argues that the bottom has not fallen out of the telecoms market. “From a stock-market perspective, yes, it has, but from a business point of view it hasn't, he says. The failure of dotcoms unnerved investors about the whole technology sector, and this caused the collapse, he argues. But he believes that many telcos'business plans are still valid.
“Some telcos got caught up in the dotcom bubble, but many have a strong business platform,” Jenkins says. “Businesses spent huge sums of money before the millennium making sure their systems were all up to date, so now spending has fallen.” He is confident that 3G will encourage people to upgrade again.
The telecoms market also received an unlikely boost after the terrorist attacks on the World Trade Center in September. Teliris, a privately owned video-conferencing firm, has seen a fourfold increase in demand for its technology since the disaster. Demand has been bolstered by people's reluctance to travel in case of further hijackings following the bombing of Afghanistan.
In the long term, there are also some reasons to be positive. Telcos have recognised that they are in trouble and they are looking for solutions. Many are cutting costs and jobs to reduce debt, or are choosing to buy back debtto reduce interest payments.
For example, Versatel, the Dutch broadband network operator, is buying back all ofits 700 million of outstanding high-yield bonds and convertible notes. Deutsche Telekom plans to cut L610 million of its capital expenditure next year to meet its debt-reduction target. NTL is targeting savings of L115 million in 2002. Telecom New Zealand expects capital expenditure to shrink from L570 million this year to L222 million next year. And BT aims to cut L575 million of costs nextyear.
Firms are also looking at mergers to create cost synergies. NTL and Telewest are working towards an operational merger before they consolidate in the UK cable industry, in order to present a united front against fierce competition. Other companies are diversifying into new markets. Spanish telecoms group Telefonica and its Finnish partner Somera, for example, will start offering a voice service in Germany next month in an attempt to win clients before the arrival of 3G.
The French government recently slashed the upfront cost of 3G licences in a move that boosted share prices. Other European governments may follow suit - which would certainly help to bolster the telecoms sector.
All this news is extremely positive for the industry, and it has resulted in some small signs of recovery. In mid-October, Motorola reported an improvement in its mobile phone business, which returned to the black in the third quarter. The group said it expected industry-wide handset sales to be around L390 million this year, a decrease from 2000, followed by growth to L450 million in 2002.
But Pat Gallagher, strategy director at BT, argues that it is still early days. “We are still a number of years away from 3G technology and content being available to all consumers. We are still relying on WAP technology at present, which offers vastly inferior service. I see the take-up curve being similar to that for computer games. Early games such as Pacman and Gameboy were inferior and created only small interest but, with the arrival of Dreamcast and Playstation 2, we have seen incredible levels of take-up”.
Telcos struggling to survive in the saturated US and European markets are looking to Asia, believed to be the world's fastest growing telecoms market, for profits. Virgin recently launched a mobile phone operation in Asia and expects the region to account for half of the group's value by 2005. Alcatel, the French telecoms company, is looking to gain a controlling share in its flagship Chinese jointventure, Shanghai Bell, in coming months.
In Japan, the launch of DoCoMo's I-mode 2.5 generation service games, has spawned a generation of mobile phone e-mail users - and mobile phone experts hope that this craze will spread to the UK and the rest of Europe. Research firm Datamonitor estimates that the mobile phone market will be worth L4 billion a year by 2005.
But are investors likely to trust telcos after their recent rollercoaster ride? Shortly before delivering a dire profit warning, and two months before his firm's share price collapsed, Lord Simpson, Marconi's former chief executive, was happily assuring investors that Marconi was financially sound. Even with a change of management, will investors ever believe in the industry again? It would be like asking Railtrack's shareholders to invest in another public-private partnership project.
Grenfell is quietly positive. “The big players will survive the crisis,” he says. “I suspect that companies with the stamina and deep pockets to survive this dip in confidence will be okay. But a lot of those firms that rushed to imitate the bigger names will fall by the wayside”.
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Copyright (c) 2001 ProQuest Information and Learning. All rights reserved. Copyright Chartered Institute of Management
Accountants Nov 2001
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