European Telecoms Paid Billions
For '3G' Licenses, Costs Still Loom
By ALMAR LATOUR
Staff Reporter of THE WALL STREET JOURNAL
On a visit to Tokyo early last year, Dutch telephone-company executive Gert Hofsteenge felt he was gazing at the future of his industry.
He came across teenagers playing games on their mobile phones. Others read news headlines on the tiny screens, or killed time standing in line by pecking out e-mails. "It filled me with enormous enthusiasm," says Mr. Hofsteenge, business-development director for the mobile-phone unit of Dutch phone company KPN NV. Back home in The Hague, he advised the KPN board to jump into the wireless revolution at almost any cost. "It was a matter of stepping into a dream and realizing it," he says.
That dream has turned into a nightmare for the shareholders of KPN and many other phone companies in Europe. After paying more than $100 billion for licenses to operate wireless networks for a new mobile-phone technology known as third-generation, or "3G," European telecom companies are in turmoil. Already choking on debt in many cases, winning bidders now likely will have to spend an extra $100 billion to build out networks for the unproven technology, which is taking longer than expected to put into service. Many are selling prime assets, considering share offerings and rethinking their entire strategies. On average, European telecom stocks are down nearly 60% from their peak 13 months ago. For some companies, including British Telecommunications PLC, the debacle may hinder their ability to compete globally for years to come.
Familiar Ring
If the 3G story has a familiar ring, it's because so many of the world's telecommunications companies have stumbled over technology lately. In the U.S., bankruptcies are mounting for upstarts that built costly infrastructure for a surge in Internet traffic that never materialized. By some industry estimates, as much as 97% of the fiber-optic cable laid in the U.S. isn't even being used. World-wide, telecoms have amassed a staggering $650 billion in debt.
Yet even against that backdrop, the 3G tale is remarkable. Seldom have so many seemingly savvy executives gotten their signals so crossed. And seldom have governments so successfully exploited out-of-control tech hype. The United Kingdom, for instance, hired two London professors to design an auction process that would drive bids for licenses into the stratosphere, maximizing revenue for the Treasury but saddling the winning companies with crushing debt.
"At some point," says David Brown, the chairman of London telecom consultancy Schema, "logic just went out the window."
Brutal Logic
Now logic is being reasserted, sometimes brutally. KPN, which paid 8.9 billion euros ($7.5 billion) for licenses, has slashed its work force by 8,000, or 19%, to help cut costs. Its shares are off nearly 88% since their peak in March last year, and the company is considering going back to shareholders to raise more cash.
Germany's Deutsche Telekom AG shelled out nearly 16 billion euros for licenses, helping swell its debt 53% in the past year to 56.8 billion euros. Its stock has tumbled 70% since its high last March.
Institutional shareholders of British Telecom, meanwhile, indignant at the 67% drop in BT's share price since early last year and alarmed by the company's debt of 28 billion British pounds ($19.8 billion), have pressured BT into abandoning its dream of becoming a global operator. In recent months, BT has replaced its chairman and finance director as it struggles to sell peripheral businesses and slash its debt. The company's new chairman, Sir Christopher Bland, last month announced a plan to split BT into two companies -- one for wireless operations, the other for everything else. BT also eliminated its dividend and is asking its shareholders to come up with nearly 6 billion pounds of new cash in a stock offering.
Love at First Sight
"We wish we hadn't paid so much" for the licenses, Sir Christopher says. "But there's not much use in looking back and wringing your hands."
Looking back, it's easy to see why executives fell for 3G. Hatched in the mid-1990s by a loose coalition of universities, industry players and government agencies, 3G -- also known as high-speed data transmission -- promised to unlock the full potential of the mobile phone. Unlike first-generation telephony, which handled analog phone calls but no data transmission, and the current, second generation, which allows for rudimentary data transfer via the Internet, 3G laid out the blueprint to give phones superfast "broadband" access to the Web.
Under 3G, handsets would double as electronic wallets to pay for merchandise and as keys to open doors. Wireless access to live video images would be possible anywhere, anytime. It wouldn't be long, backers predicted, before a busy executive could duck out of a late business meeting to say goodnight to the kids, "face-to-face" over the phone -- or to catch a live broadcast of a soccer game or rock concert.
To bolster their case that 3G's promise would pay off, European executives looked to Japan. There, a technology known as i-mode was taking the country by storm. Although far slower and more limited than 3G hoped to be, i-mode was nonetheless a commercial hit with Japan's gadget-loving consumers, some 24 million of whom now use it. I-mode developer NTT DoCoMo Inc., a unit of Nippon Telegraph & Telephone Corp., makes money by taking a cut of the revenue produced by other companies that develop applications for the service.
Perfect Laboratory
Europe -- where roughly 70% of adults have mobile phones, compared with only about 42% in the U.S. -- seemed a good laboratory to launch the 3G experiment. By mid-1999, the Continent was seething with innovative ways of marrying the Internet with second-generation cell phones. Equipment makers such as Telefon AB L.M. Ericsson and Nokia Corp. were spreading the gospel. Nokia's chief executive, Jorma Ollila, appeared on the cover of Wired Magazine in September 1999 with a text bubble saying, "put the Net in your pocket."
Having fallen in love with the wireless Web, operators in Europe launched splashy new ventures for wireless e-mail and other services. Sweden's Telia AB, for instance, started Speedy Tomato AB, which provides data services such as e-mail and short text messages to mobile phones, and its then-CEO Jan-Ake Kark vowed the service would become one of the operator's main revenue streams in a matter of years. He also said he hoped to have a network carrying moving images and audio within 12 months. In Spain, Telefonica SA's mobile-phone unit paid 230 million euros to acquire obscure wireless-service-producer Iobox Oy and entertainment-producer Endemol NV of the Netherlands, trying to marry television and the wireless and broadband worlds.
The swirl of new applications, as well as a spate of outages on second-generation networks caused by the exploding usage of traditional mobile phones, led European nations about three years ago to prepare to license 3G radio spectrum.
As plans moved forward, European business leaders and politicians could barely stop gloating. For once, the Old World appeared to be leading the U.S. in the development of an important new technology. Mobile telephony, they said, would create a brave new wireless world and perhaps even give birth to an economic miracle. President Clinton warned that unless U.S. tech companies quickly got involved in 3G, there would be a wireless gap.
For Europe's governments, 3G also promised to produce a revenue windfall. In Britain, communications regulators consulted two professors, Ken Binmore and Paul Klemperer, among others, on how to auction licenses for radio spectrum to operate 3G services. The duo used game theory to create an elaborate auction process under which several licenses could be sold simultaneously.
The professors designed the auction in such a way that the proceeds for the government would be maximized: Five licenses were to be auctioned off at the same time. Of those, four could be expected to go to incumbents, which each more or less needed to survive in their home market. The remaining fifth license could go to a new entrant -- and would drive the bidding process because it would attract newcomers eager to step in.
Checking the Faxes
When the auction started in April of last year, 13 bidders applied. While the auction was about high-tech licenses, the process was rather low tech. At the headquarters of the Radio Communications Authority, in a fluorescent-lit room overlooking East London, 13 government fax machines with secret numbers and scrambled lines were lined up on small desks, one for each bidder.
With the level set at a minimum of $750 million per license, the bidding started. Each contender faxed in bids for one of the five licenses in roughly six rounds per day. The results of each round were written on a white board and after each bid, the professors advised the government how to set the minimum bidding levels for the next round. Mr. Klemperer bought a mobile phone -- his first -- so he could be involved with the proceedings at any time.
It wasn't until round 94, nearly four weeks after the start of the auction, that the first of the 13 bidders dropped out, at a price level of more than $3 billion. Four other bidders followed shortly thereafter, leaving eight bidders for five licenses.
At round 150, France Telecom SA gave up and five winners were left: Deutsche Telekom's one2one, Hutchison Whampoa Ltd., Orange SA, BT and Vodafone Group PLC. Hutchison subsequently sold 20% of its license to DoCoMo and 15% to KPN, while Orange was acquired by France Telecom, which in that way secured a UK license of its own after the process. "1 billion pounds or 10 billion pounds, the psychology is the same," says Mr. Klemperer. "These bidders wanted a license at any cost."
From the government's point of view, their theories worked magnificently: The auction of five licenses last July brought in a total of $34 billion, more than seven times what was originally expected.
When other European countries saw how much money Britain had raked in, some of them came up with similar rules for their own auctions. If these licenses were so precious, politicians reasoned, phone companies should pay accordingly. The phone companies, figuring they couldn't afford not to be part of the 3G revolution, duly bid each other up higher and higher. In Germany alone, six licenses were auctioned for a total of $45 billion.
For the industry, though, the huge price tags in the U.K. and elsewhere caused a ripple of concern. "We did pay more than we had estimated in the U.K.," says Chris Gent, chief executive of Vodafone. Worried about its revenues, Ericsson also frowned on the high prices of the licenses, which would surely force operators to cut costs elsewhere, including in the building of 3G networks. "This will slow down the development of 3G," said Ericsson's chief executive, Kurt Hellstroem, shortly after the UK auction.
The Bubble Bursts
Then the stock market started dropping, led by the bursting Web bubble but followed quickly by tumbling technology stocks and telecoms. As license prices got higher in Europe, some operators bowed out of the race, while others banded together in consortiums, trying to find some way to pay for the license fees and the ensuing network construction.
In Germany, KPN's E-Plus unit paid 6.5 billion euros for a 3G license -- nearly twice as much as KPN thought it would spend. Hutchison Whampoa of Hong Kong, which was bidding jointly with KPN for that German license, bowed out of the race because it deemed the cost too high, leaving KPN to shoulder the entire burden. KPN, which also shelled out 1.5 billion euros for one of the five 3G licenses up for grabs in the Netherlands, wound up with the highest debt in relation to its revenues of any European telecom company.
In the past six months, wireless-technology firms across Europe have started going belly up, including many of those that aimed to build services for the wireless Web. Says Peter Sandberg, the former chief executive of venture-capital firm Emerging Technologies AB, which invested heavily in wireless technology startups: "Some investors made the same mistake as they did with e-commerce. Many of the wireless companies are built on bad business models where it is unclear when a break-even point will be reached."
For Europe's telecom giants, buying the 3G licenses was only the first step. The companies will have to spend roughly $100 billion for the transmission towers and other equipment needed to handle 3G calls, according to Morgan Stanley. That will require more borrowing by phone companies whose credit ratings already have been downgraded.
The building of the networks promises to be lucrative for equipment suppliers such as Ericsson and Nokia. For now, though, even those companies are suffering because their customers -- telephone companies around the world -- are being forced to pinch pennies and defer capital spending. Some of the equipment suppliers are doubly exposed because they provided generous financing to help their customers pay for 3G gear. It isn't only the debt that keeps bankers and phone executives awake at night. They also are increasingly nervous about how long it will take to overcome the technical hurdles that still stand in the way of 3G -- and when 3G services will pay off, if ever.
Japan's NTT DoCoMo in April was forced to postpone its much-trumpeted launch of 3G services by at least four months. Unlike most of its European competitors, DoCoMo wasn't burdened with having to pay billions of dollars for a 3G license.
BT then hoped to win the prestige of being the first operator in the world to showcase 3G services, through a test with 200 consumers on the Isle of Man. But BT announced last month that it, too, would have to delay its launch by at least three months. BT cited software problems with 3G phones.
Growing Pains
Growing pains are bound to proliferate as the construction of 3G networks gets started in earnest later this year. It's unclear exactly when 3G service will become widely available. Estimates range from 2003 to 2007 in Europe. In Japan, telecom companies hope to roll out 3G much faster, perhaps by the middle of next year. In the U.S., the 3G spectrum has yet to become available and auctions are expected to be held no sooner than 2004.
The technology for 3G remains in the experimental stage. Only a small number of test models of the handsets has been produced. So far, they tend to look large and clunky by today's sleek standards, partly because they need larger screens and some include cameras. Adding to the complexity, 3G phones will need to function on both second-generation and 3G networks during a transition period.
A bigger question is whether many people want the kinds of services that 3G technology promises, and if so, how much they will be willing to pay. Thus, 3G investments are largely an act of faith -- much more so than previous investments in new telephone systems.
The evidence from current services allowing mobile access to the Internet isn't very encouraging. While i-mode has been a hit in Japan, services offering mobile access to the Internet have flopped so far in Europe. One such system, known as Wireless Application Protocol, or WAP, was introduced by phone companies in Europe last year. After a huge marketing blitz, WAP handsets weren't widely available at first because of technical problems and component shortages. Then consumers found WAP services too expensive and slow. Some phone-company executives spoke ruefully of customers' "WAPathy." Growth has even stagnated in the region's most-advanced market, Scandinavia, where few consumers take advantage of their ability to pay for soda from vending machines with their cell phones, among other features.
Bridging the Systems
Now, operators are starting to roll out another mobile Internet system called Global Packet Radio Service, or GPRS -- sometimes dubbed 2.5G -- as a bridge between current systems and 3G. GPRS allows for sending long text messages with attachments as well as rudimentary video. It's too early to tell whether GPRS will prove more successful than WAP, but early indications are that the technology will offer more benefits to users: Phones can be connected to the Internet at all times, for instance, avoiding cumbersome and costly dial-in and log-in routines.
To be sure, 3G isn't dead. Having spent billions of dollars on the technology, operators are determined to find ways to get returns on their investments. To reduce construction costs for 3G, telecom companies are discussing proposals to share networks.
As for KPN's Mr. Hofsteenge, he's still a true believer. "The auctions are like asking grocery stores to bid in order to be allowed to sell groceries to their customers," says Mr. Hofsteenge. "We can't afford not to be involved in 3G." |
