*FT. IRIDIUM: Born on a beach but lost in space
Friday August 20 1999
IRIDIUM: Born on a beach but lost in space
After a disastrous launch, the satellite phone service
faces financial meltdown. Christopher Price looks at its
demise, and what lessons can be learned
If we launch now, Ed Staiano will
lose his job," John Richardson,
then head of Africa operations for
Iridium, told a fellow board
member the week before the
group initiated its "use-anywhere"
satellite phone service last
November.
It was a prophetic warning. Six months later, Mr Staiano,
vice-chairman and chief executive, had been forced out.
He followed Roy Grant, the chief financial officer, and
Mauro Sentinelli, vice-president of marketing.
The boardroom clear-out underlined the scale of the
disaster that was Iridium. Today, the $5bn project faces
financial meltdown. It has debts of more than $3bn,
annual interest payments of $250m and satellite
maintenance costs of $550m a year dwarfing the income
trickling in from its relatively few subscribers. The
shares, floated on Nasdaq at about $22, were suspended
last week at just over $3.
A financial restructuring, under US Chapter 11
bankruptcy proceedings, is now Iridium's only chance of
survival. If the company - today led by Mr Richardson -
does not reach agreement with investors and
bondholders, it will become one of the biggest financial
collapses since Continental Airlines in 1990.
Even if a deal is reached, significant doubts remain as to
whether the business can ever prosper.
How Iridium came to be in such a sorry state is a story
of managerial and financial misjudgment, over-ambition,
and boardroom disagreements.
But it is also a tale of missed opportunities - how an
impressive technical feat was achieved but then
under-used; how the group's "first-to-market" advantage
was all but squandered; and how more than one million
sales leads were wasted.
The Iridium dream started in very different
circumstances.
In 1985, Karen Bertiger, the wife of Motorola executive
Bary Bertiger, was sitting frustrated on a Caribbean
beach. She wanted to call home and she asked her
husband why, in this era of technological achievement,
they could not invent a mobile phone that could be used
anywhere in the world.
The idea was suggested by Mr Bertiger to Motorola, and
the US electronics group set up a research team, which
he joined.
Seventy-seven low-earth orbit satellites were envisaged
for the system - hence the name Iridium, the 77th
element. This number was eventually brought down to 66
satellites, but the name stuck. Each satellite had a
lifespan of between five and seven years.
There were to be 15 "gateways" around the world, where
the satellite phone signals would be channelled on to
terrestrial phone networks.
However, Motorola wanted to offset some of the project's
huge cost and high risk. It therefore brought in
companies and consortia as owners and operators of the
gateways. Not only were they to pay to build the ground
stations, but they were also encouraged to become
investors in the project itself. In 1993 Iridium raised
$800m in its first round of funding from these and other
strategic investors. At this time, the Motorola business
plan for Iridium forecast 2m users by 2002, with profits
flowing even earlier.
By the time the Iridium service was ready for launch last
year, Motorola had diluted its equity stake to just 18 per
cent. It had also received $3.6bn in payments from
Iridium for the satellites and associated services.
Motorola's investment amounts to just over $2bn.
However, the choice of gateway operators was,
according to one Iridium director, a "mish-mash".
Telecoms giants such as BCE of Canada and Sprint of
the US would seem logical choices as investors and
strategic partners. But it is questionable whether many
of the other gateway partners were able to bring
significant expertise.
Investors in Iridium Africa, for example, include the
Mawarid Group, a large Saudi Arabian industrial group.
Iridium Andes-Carib, part-owners of the Latin American
gateway, is a consortium of private Venezuelan
investors, whose interests include foodstuffs and
construction. Another shareholder in Latin America,
Iridium Brasil, is owned by a diversified Brazilian
corporation. Iridium India is a consortium of local
financial institutions.
All were happy to increase their funding as long as
forecasts for the new market continued to be bullish.
These projections came not only from Iridium and
Motorola, but also from the half a dozen other rival
projects that were being planned.
By the end of 1996, Iridium had raised $1.9bn from
investors and secured a $750m facility arranged by
Chase Manhattan and Barclays Bank. It went public a
year later.
Mr Staiano had joined Iridium as vice-chairman and chief
executive in 1996 at the age of 60, following a successful
career at Motorola. His role in the Iridium saga was to be
crucial.
An engineer by training, Mr Staiano came with a solid
reputation. He had headed Motorola's cellular oper-ations
and was renowned within that company as a manager
who got things done.
His style was abrupt and sharp - he did not suffer fools
gladly. "Ed was a very strong character," says Mr
Richardson of his former boss. "He always got his way."
Another executive, who asked not to be identified, says:
"Ed Staiano was somebody you did not cross."
Mr Staiano's first task was to alter Iridium's strategy
radically. Before he joined, the satellite group planned to
compete directly with the terrestial cellular operators.
The new chief executive decided Iridium would partner
cellular operators.
"I knew straight away that it did not make economic
sense to compete with cellular, which would be able to
beat us on capacity, as well as pressure us on price,"
Mr Staiano said in May 1998.
Such foresight was soon to be in short supply. In the
run-up to the service's launch during 1998, it emerged
that Iridium handsets would retail for about $3,000, while
call rates would be up to $7 a minute.
This was at a time when the cellular market was
undergoing explosive growth, driven by falling handset
prices and call rates. Average handset prices fell
dramatically during the 1990s, driven by competition.
Subsidies from rival operators saw some models being
given away in Scandinavia and the UK. Call rates also
plummeted. In the UK, cellular rates declined 70 per cent
in the four years to the end of 1998, according to figures
from Oftel, the UK telecommunications watchdog.
Yet Iridium remained convinced that international
business executives would be willing to pay a significant
premium for the benefit of being able to make calls from
anywhere in the world from their mobile phones.
It was not just prices that were changing. Manufacturers
were coming to market with ever-smaller and lighter
handsets. The weight of a handset today is typically
about 120g. The now infamous small brick that Motorola
supplied as the Iridium handset weighed in at 500g.
The march of Global System for Mobile (GSM) as the
international standard for cellular operators was another
factor apparently ignored by Iridium. The European
standard was being increasingly adopted around the
world, outside the US. With it came "roaming"
agreements that enabled users to use their mobile
phones abroad - at once undermining Iridium's
use-anywhere advantage.
Iridium's other purported advantages were also
increasingly questioned. For example, it cited the
offshore oil and gas industries as another source of
revenue. However, as US investment bank Morgan
Stanley pointed out in research published last year,
there were only 275 active seismic crews in the world oil
and gas industry in 1996. The bank went on to question
all of
Iridium's forecasts for the potential size of its market.
Based on company predictions, Mr Staiano believed
Iridium would be cashflow positive by the end of its first
year of operation and profitable shortly afterwards. By
2002, when Iridium would have had three to four million
users, it would have paid off $3bn of debts and have a
further $3bn available to spend on its next generation of
satellites.
A glossy $140m worldwide advertising campaign was
launched in the middle of 1998. Full-page advertisements
were taken in the weekly business magazines with the
slogan "Anytime, anywhere". It was even suggested by
Iridium's marketing team that they get Bill Clinton, the
US president, to make the first call. Instead, they settled
for Al Gore, his deputy.
That period also saw the satellite phone industry thrown
into financial chaos. First, two Iridium satellites failed in
orbit. This reflected badly on a public offering from rival
ICO Global Communications, which was scaled back.
Then Iridium announced it was pushing back its launch,
planned for September 22, for six weeks due to
"technical problems". Finally, Globalstar, another rival,
lost one-fifth of its satellites in a launch explosion.
Shares of all three companies took a battering: Iridium
and ICO have never recovered.
The period from September to December 1998 is crucial
to the downfall of Iridium. The company required almost
$1bn of additional funding to get through its launch and
the next 12 months of operations.
However, its dwindling share price ruled out raising
further capital from the market. In addition, by now the
debt markets were wary.
Against this gloomy financial backdrop, Iridium was
facing further technical problems. While prototype
handsets had been delivered and trialled, commercial
versions had still not been delivered by October. In
addition, Kyocera of Japan - which was one of Iridium's
two handset manufacturers along with Motorola - was
experiencing software problems.
Meanwhile, some gateway operators and service
partners were saying they were not ready for Iridium's
launch. They had not received training in the use of the
handsets and lacked promotional material.
There was no greater evidence of this than their inept
response to the advertising campaign. This had produced
more than 1m sales inquiries and the excitement at
Iridium headquarters in Washington was palpable. Yet
those leads were to convert to just 10,000 customers
over the five months after launch - a cost of $14,000 per
subscriber from the advertising budget.
"I was vociferous in board meetings up until the launch
that we should postpone until into 1999," says Mr
Richardson. "We launched far too soon with a product
that was wrong. But Ed Staiano was determined to
launch at huge cost."
The move was nothing short of a disaster. Phones were
in short supply - Kyocera was out of the picture and the
distribution of Motorola handsets was held up by
arguments over customs duties.
Some of the gateways and service providers, as well as
being unprepared, were also unhappy about selling the
Iridium service. There were complaints that the phones
did not work indoors and other technical difficulties. But
it was not just about the product and price.
<b."We were not prepared to sell Iridium because they
could give no guarantee of the security of the network,"
says one of its biggest European service providers. "We
were not prepared to let other Iridium users on to our
network without any fraud compensation. It was a
shame, because there was a huge amount of interest
from the public."
In a recent report, Dataquest, the market research group,
is damning in its criticism of Iridium's launch
preparations: "The network had not been properly tested.
Gateway operators and service providers were
unprepared for the service; the salesforces were
untrained and customer support was virtually
non-existent."
Iridium will not disclose how many subscribers it had by
the end of 1998. Yet it was towards the end of December
that the company signed a banking arrangement, again
led by Chase and Barclays, with extremely challenging
subscriber targets as covenants. It was this arrangement
that was ultimately to lead to bankruptcy.
The $800m loan that was agreed was supposed to see
Iridium through the next 12 months. However, the loan
depended on Iridium meeting targets of 52,000
subscribers, $4m cash revenues and $30m in payments
due, by March 31 1999.
Given that Iridium managed just 10,294 subscribers by
that date, and the severe supply difficulties it was
experiencing, it can only have attracted a few thousand
users at most in the two months before the banking
covenants were agreed. It was a baffling decision by the
company and the banks to agree such targets.
While refusing to comment publicly, Iridium's bankers
say the covenants were based on the company's own
projections, not their unreasonable demands. One of the
Iridium finance team that negotiated the deal says the
company was sincere in its belief that the target could
be reached. However, he adds that it was left with little
choice to agree to the banks' demands.
"Where else could we turn? The debt markets wouldn't
look at us, the investors were unhappy, so it was only
the banks that we could use."
Less than two months later, towards the end of
February, Mr Staiano raised the prospect that the
covenants were likely to be breached. In an interview with
the Financial Times, he blamed the service providers,
whom he accused of "inertia", and Motorola, which he
criticised for the size of the handset. He said the
problems would set the company back six to nine
months, but it remained financially on target.
Iridium now faces several lawsuits alleging a failure by
management to keep investors informed about its
difficulties at this time.
Mr Richardson, a tough-talking Australian, admits it will
be a difficult task to turn Iridium around.
Investors and bondholders are to be asked to take a
hefty cut in the value of their holdings. Mr Richardson
also wants investors to find a further $600m to give his
new marketing plan a chance of success.
Iridium has cut prices on handsets and tariffs. However,
a $1,500 phone may not be that much more attractive.
The sales force is being strengthened and trained, and
gateway operators are being given more support.
This is the strategy that should have been adopted 18
months ago, and it could yet succeed. But that depends
on whether investors and bondholders believe Iridium can
be turned round. More important, Mr Richardson needs
to convince them that what seemed a very good idea on
a beach 14 years ago is still viable.
¸ Copyright The Financial Times Limited 1999. "FT" and "Financial Times" are trademarks of The Financial Times. |
