Business Week: October 16, 2000
International -- Int'l Cover Story
Telecom Tremors (int'l edition)
Oops! Something is going very wrong with Europe's plan for the wireless Web. Who will pay?
A bold bid for the future--or a reckless gamble? That's what investors in Europe are trying to decide as they weigh the consequences of the huge investment in next-generation, Web-enabled cell-phone systems. With anxiety mounting about the cost, it's not at all clear that 3G is the dream technology for Europe. Here, BUSINESS WEEK examines what went wrong--and contrasts Europe's stumbles with Asia's surprisingly positive experience.
EUROPE: CONTINENTAL HANGUPS
Vodafone's Chris Gent started it. Deutsche Telekom's Ron Sommer followed, with France Telecom's Michel Bon right behind. The goal was to win a place in Europe's mobile Internet, and the strategy appeared disarmingly simple: Spend, spend, spend. First, spend from $50 billion to $200 billion to buy a stable of smaller mobile carriers. Then, pay whatever it takes to win next-generation mobile licenses at the priciest auctions in history. Finally, build up loads of mobile Internet services and start dotting the region with multibillion-dollar networks.
Nobody said it would be cheap. But now, as the Europeans prepare to spend $260 billion of high-speed mobile networks across the Continent, the long-adoring crowd of investors is taking a hard look at the numbers--and coming down with a bad case of the mobile-Net blues. Spooked by mounting expenditures and the haziest of projections for returns, investors have driven down former high-flying phone stocks by 50% since March. It's even rattling the global economy. Finance leaders struggled at the Prague International Monetary Fund meeting in late September to come to terms with an investment wave that is staking claims to 40% of the region's syndicated loans.
DEBT DAZE. Perhaps more dire, rating agencies have downgraded a host of carriers, from France Telecom to Holland's KPN--with Deutsche Telekom, according to Standard & Poor's Corp., coming up soon. DT is wallowing in net debt of $44 billion, up 29% in the last year. The downgrades should drive up financing costs. This will add yet another complication to the development of the broadband mobile systems known as Third Generation (3G), which is supposed to deliver a broadband Net connection at the click of a cell-phone button.
The bigger question, though, is whether the investments will yield returns--and when. ``Everybody's aware that there's a big risk,'' says Dominik Koechlin, strategy chief and board member at Swisscom. And 3G profits? They're five to seven years off, he says. That could be optimistic, say analysts.
It's feeling a lot like the morning after in Europe. An industry that has grown fat on the booming cell-phone business must now rush to master new specialties: Net services and computer phones. This pressure looks likely to force phone companies to outsource much of their Web development to pros, from Yahoo! Inc. to Stockholm startups. This should add much-needed zip to the mobile Net. And manufacturers, also looking to cut costs, will be prowling for joint ventures in Silicon Valley and Japan. The result could be a plethora of startling new mobile Web machines.
For now, though, the industry is beavering away to clean up its balance sheets. The phone companies are spinning off side businesses from wired-line companies to Internet portals. Former national champs, including perhaps Sweden's Telia and Telecom Italia, are lining up for mergers, a quick way to cross borders and cut development spending. And the entire industry is pressuring the network builders to help finance the 3G constructions on favorable terms. This could crimp earnings at L.M. Ericsson and even Nokia, whose stock tumbled 25% last summer following an earnings warning. Meanwhile, cutthroat competition may well push the phone companies to hurry construction of the high-speed 3G network. The build-out should start in cities from Spain to Britain by the middle of next year.
Still, Europe's 3G project, long viewed as a way to leapfrog the Americans on the Net, now proceeds grimly. Why? Even as they were trumpeting the Third Generation, Europe's phone companies were flunking their first Internet exam.
The introductory Web service, launched with fanfare a year ago, has bombed across the Continent. First there were not enough phones. And when the handsets finally arrived, users struggled briefly with slow data speed, primitive applications, and sky-high connections rates--and then logged off for good. A year into Wireless Access Protocol, or WAP, there are fewer than 2 million WAP-surfers in Europe--one-fifth of last year's estimates. This is a far cry from the nearly 13 million Japanese who trade e-mails and photos on NTT DoCoMo's far zippier i-mode. I-mode boasts scads of applications and, like a corporate intranet, its users are always online--a feature European telcos won't offer until upgrades next year.
Combine Europe's WAP failure with the now-stingy financial markets, and the phone companies are facing a painful rethink of their strategy. When the markets were showering money on anything wireless, the mobile-phone companies afforded themselves the greatest luxury: They would specialize in everything. They would not only own the voice markets, but become titans of the Web as well, not to mention kings of e-commerce. When the Web went wireless, the thinking went, the likes of Vodafone and France Telecom would be AT&T, America Online, and Yahoo rolled into one--and they'd ride in millions of pockets and purses all day long.
To stake a full claim to the riches of the mobile Web, the phone companies also set out to rule the portal. This is the screen viewers first see, precious real estate for anyone who wants to dominate the wireless Net. Throughout Europe, many mobile operators established ``closed gardens'' of applications on their portals. This limited the users' choices for weather, finance, and news channels--but kept all the business under control of the telcos, much like the early AOL.
But domination of an empty market, they learned, paid skimpy dividends. In the wake of the WAP fiasco, the phone companies' control over the vast expanse of Europe's mobile Web is devalued currency. Few investors these days waste time wondering which company's portal will rule. Their concerns are far more basic: Will Europe's wireless Internet, perhaps the greatest tech investment in its history, ever make money? ``No one knows what demand and pricing will look like,'' says S&P analyst Louis Landemann.
HARD DECISIONS. It's a make-or-break question. And it's likely to force phone companies throughout Europe to confront the hard decisions they postponed when money was easy, namely: picking a core business. With time, this process could lead to market segmentation, with some carriers, for example, specializing in data transmission, others in customer services.
In the short run, the answer is much simpler. The phone companies are good at voice and bad at the Internet. That should open Europe's mobile Web to Net companies. DoCoMo, after all, has managed to create a vibrant Web largely by staying clear of the software business: It merely provides the platform and opens it to the Web entrepreneurs, who entice DoCoMo's customers with applications by the thousands. Now in Europe, Net powers from Yahoo to AOL are prying open positions for themselves on the mobile Web. France Telecom, for example, has made space for Yahoo on its formerly closed portal.
But the Web giants stick mostly to trimmed-down versions of their standard offerings. The real magic on Europe's phones should appear as scores of software startups push their applications, from games to mobile chat rooms, onto the wireless portals. ``The open Silicon Valley model is going to take root here,'' predicts James O. Carter, U.S. chief executive of a Milan-based mobile portal, HiuGO.
To help shoulder the expense of buying licenses and building out the networks, phone companies will likely partner up more then ever--and not just with each other. Europe's leading brand companies are likely to bring millions of faithful customers to the mobile Web. Top-line car companies, for example, are looking to provide branded cell-phone service to customers, with all sorts of links to hotels, map services, and repair shops. And brokerages look at phones not only as a customer-service link but also as a way to cut down on churn. ``We're planning to offer our clients branded telephone service, with a secure link to the Web site,'' says Dominique Velter, president of Capitol, a French online brokerage.
The tumult of Europe's mobile Web also threatens to shake up the handset manufacturers. It was Nokia and Ericsson that pushed the industry toward WAP and drew the road map for 3G. But now the phonemakers must battle for the Internet against Web-enabled Palms and pocket-size Microsoft-powered machines. The development costs are huge. Nokia spends an eye-popping 9% of revenue on research and development, topping $2 billion this year. And Ericsson, struggling to keep up in the handset market, squeezes out only 1% margins on phone sales.
The likely result is a raft of joint ventures. In late September, Motorola announced a project with Palm. Other manufacturers, perhaps even Ericsson, may choose to cut development costs by linking their phone operations with other tech stars, from Sony Corp. to Apple Computer. Meanwhile, the phone-equipment manufacturers are facing pressure as well in the network business. The edgy telcos are busy squeezing the network companies to underwrite and subsidize the massive investments ahead. Nortel Networks Chief Operating Officer Clarence J. Chandran acknowledges that the financing takes place, but adds that it should not affect earnings.
It soon will, though. In a mobile Internet industry that's still groping for a way to make money, nearly all the companies face the thorny questions: How much are they willing to pay to be there, and how long can they wait for a payback? This game is getting a lot harder to play.
By Stephen Baker in Paris, with William Echikson in Brussels, Jack Ewing in Frankfurt, and Mark Clifford in Hong Kong
ASIA: DIALING THE RIGHT NUMBER
Could it happen in Asia? As tremors over the future of Third Generation, or 3G, wireless networks rock Europe, investors are wondering if Asia, too, is vulnerable. There's no guarantee that the 3G standard developed in Japan will take off as expected. After all, the country's previous homegrown cellular standard, known as PDC, failed to win acceptance outside the Japanese market. China's unpredictable shifts in telecom policy have left foreign investors baffled. And there's concern that some Asian states will follow Britain and Germany's lead and sell their 3G spectrum licenses to the highest bidders. Hong Kong, for one, just reversed its stance, announcing plans to hold an auction next year.
LONG RUN. Ignore the doomsday forecasts. East Asia appears to be well on course for a smooth rollout of 3G, paving the way for a wireless Net boom in some of the world's biggest mobile-phone markets. Certainly, there will be bumps on the road. Asian operators are about to experience a rush of mergers and acquisitions, and the entry of foreign competitors. But in the long run, and particularly in pacesetting countries like Japan and South Korea, the 3G age is about to dawn.
Credit careful planning, market deregulation--and the overwhelming success of NTT DoCoMo, Japan's top cell-phone carrier and a pioneer on the wireless Web. DoCoMo's i-mode service, which gives cell-phone users constant access to the Net, boasts nearly 13 million subscribers, who use it to send e-mail and download songs, stock quotes, and cartoons.
It's the most successful Net phone system anywhere, in dramatic contrast to the WAP-based services that have been shunned by so many consumers in Europe and parts of Asia. Thanks to DoCoMo, the Japanese have been the first to popularize the mobile Net. Next May, DoCoMo will roll out the world's first 3G cellular service, boosting wireless-data speeds from the current snail-paced 9.6 kilobits per second to 2 megabits by 2003. Web phones will come equipped with ``agents'' that will shop around for discounts and even alert you when your stock has hit a new low.
To make 3G a reality, DoCoMo expects to spend about $10 billion over the next three years. DoCoMo can afford to do so, unlike some of its counterparts in Europe. Between them, telecom companies in Britain and Germany have spent nearly $80 billion buying their 3G spectrum licenses. ``Operators will have to pass on the added cost to consumers,'' notes DoCoMo President Keiji Tachikawa. ``This could be a hurdle for the spread of 3G.''
In contrast, Asian governments plan to award their licenses for 3G services through ``beauty contests'' or a hybrid method that incorporates auctions. For the most part, the idea is to hand over precious spectrum not to the richest companies but to experienced mobile carriers that have a firm timetable for the launch of 3G services. Japan set an example last June when it awarded its three 3G radio spectrum licenses for free to the three main wireless operators--DoCoMo, KDDI, and J-Phone, the last partly owned by British Telecommunications PLC and Vodafone AirTouch PLC.
`THIS IS CHEAP.' South Korea will also award three licenses, but with certain conditions. Only consortiums, with no company owning more than a 50% stake, can qualify. And there will be a charge levied of around $1 billion per license--not unreasonable, considering the huge profits that license holders may eventually reap. ``This is cheap and won't pose a huge financial burden for companies,'' says Jeff Kahng, telecom analyst at Credit Suisse First Boston in Seoul.
On top of that, only half the license fee will be paid up front, with the rest to be paid over 10 years. That's readily affordable: SK Telecom Co., South Korea's largest wireless-phone company, is expected to post a profit of $1 billion this year. It should not have a serious cash-flow crisis because of its license fees for 3G. Moreover, SK Telecom is proceeding cautiously. It just started 2.5G services, to enable subscribers to send data at speeds of 144 kbps. It won't upgrade to 3G until data-delivery technology improves.
Hong Kong will adopt the hybrid model, along the lines favored by Italy and Switzerland. First, Hong Kong authorities will screen applicants, requiring them to commit to roll-out and investments before entering the auction stage. Regulators will also encourage generous tie-ups with new market entrants. ``This will be more of a burden for operators,'' says Andrew Low, telecom analyst for SBC Warburg in Hong Kong. But with licenses expected to fetch no more than $200 million to $300 million, possibly payable over time, companies won't find themselves completely buried in debt.
Asia's big advantage is its boundless enthusiasm for wireless. Asia-Pacific boasts 155 million mobile-phone subscribers, more than any other region in the world. Over the next few years, many Asians are expected to migrate directly to 3G, foregoing fixed-line Internet connections, which remain scarce in countries like China and India.
One issue the Asians are still wrestling with is standards for 3G. While the U.S. and some Asian operators support CDMA-2000, the standard developed by Qualcomm Corp. of the U.S., DoCoMo is pushing Wideband CDMA, whose development it led in Japan.
DoCoMo plans to leverage its edge in i-mode and 3G technology to lure other operators to the W-CDMA camp. Since last December, it has acquired stakes ranging from 15% to 20% in Hutchison Telecom in Hong Kong, KPN Mobile in the Netherlands, and Hutchison 3G UK Holdings, based in Britain. DoCoMo is also expected to purchase a 10% stake in SK Telecom Ltd., which in turn plans to introduce W-CDMA services.
The wild card here is China, whose ambition is to develop a homegrown 3G standard with a Western partner. Last February, China Unicom Ltd., the country's second-largest telecom, signed a deal to build a nationwide CDMA network with Qualcomm's support. Now the Chinese government has put that deal on hold: It may switch to a different 3G standard, known as TD-SCDMA, that China jointly developed with Siemens of Germany. With a fast-growing market of 62 million mobile-phone users, China's plan is to nurture a domestic industry that might compete alongside Nokia and Motorola.
DoCoMo itself has no choice but to look to global markets for expansion. It now serves 32 million subscribers, or nearly 60% of its domestic market. Through its recent tie-up with AOL, DoCoMo plans to take aim at Internet users around the world. The two companies agreed to jointly develop a new Internet service--first for Japan, then for markets elsewhere--that would mesh AOL's expertise in PC-based services with those of DoCoMo's i-mode.
Other deals are sure to follow. DoCoMo is rumored to be in talks with America's SBC Bellsouth, as well as operators in other parts of Asia. Thanks to DoCoMo, Asia could emerge triumphant in the wireless Internet. But the race has just begun.
By Irene M. Kunii, with Moon Ihlwan in Seoul, Bruce Einhorn in Hong Kong, and bureau reports
Copyright 2000 by The McGraw-Hill Companies, Inc. All rights reserved. Any use is subject to (1) terms and conditions of this service and (2) rules stated under ``Read This First'' in the ``About Business Week'' area.
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