Text of WSJ -- Europe's Telecom Firms Paid Billions For '3G' Licenses, Costs Still Loom
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June 5, 2001
Europe's Telecom Firms 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."
Write to Almar Latour at almar.latour@wsj.com
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