Analysis: Big boys and expensive toys

For a few months last year in Europe, the so-called third generation wireless networks proved as popular as the fabled Dutch tulip bulbs. Europe’s phone companies dug deep into debt to win auctions in Britain and Germany.

But now they are running the other way. In late January, a ballyhooed sale in France fell flat. Policymakers should seize on the debacle in Paris as a chance to re-evaluate the auction process.

Otherwise, Europe’s superiority in mobile phone technology could collapse under the weight of billions in added costs.

The price is too high
The French sale was supposed to be a revenue-raising triumph for the government. Last year, Germany and Britain raked in a combined Pounds 52bn by selling third generation licences. Paris calculated that by fixing the price at what appeared to be a reasonable rate – Pounds 2.8bn each for four licences – the government could mine some spectrum or cellphone gold – but without crippling the competitors.

In today’s downbeat market, the price is far too high: only two companies, government-controlled France Telecom and a Vivendi-Universal-led consortium, stepped up with the money. That leaves the other two licences airwave begging.

This is bad news for the French public, which faces a likely price-gouging duopoly unless the government hustles up another player or two on the cheap. But at current prices, it’s a tough sale. After all, the victors face a heavier debt and an obligation to build a hugely expensive new phone network, all to compete in a market where the payoffs are both distant and hypothetical. A costly bet? That barely begins to describe it. According to a Forrester Research study, building third generation will be so expensive that mobile operators’ earnings will nose downward in 2003, go negative in 2007, and stay in the red through 2013.

Banks warned on telecom loans
The third generation licence auctions are turning out to be one of Europe’s biggest public policy blunders. It’s clear now that the UK and German governments erred by using the auctions as an up-front tax on a nascent industry. The phone companies had to bid, since to renounce those key markets was to die. That left the telcoms only one choice: risk drowning in debt to survive.

Now the entire industry is staggering under an extra Pounds 78bn debt, draining capital markets from New York to Frankfurt. Late last year UK financial watchdog the Financial Services Authority told banks to be ‘acutely aware’ of the risks of making further loans to the telecoms industry.

The warning came amid the telecoms industry’s growing trend of share price depletion, profit warnings and decreases in credit ratings.

The FSA wrote to the chief executives at major banks that had made loans to telcos, enquiring about their policies and safeguards. It has also issued guidelines and suggestions on handling future telecoms debt.

‘Given the importance of the telecoms industry and its massive investment programme, sizeable bank exposures to it are not surprising,’ said Michael Foot, managing director of the FSA. ‘In an industry where financing demands are high and exposures can be rattled up very rapidly, firms should remain alert to the deterioration of conditions.’

Even then the FSA warning was viewed by some as too late. ‘It’s a case of shutting the stable door after the horse has bolted. The FSA should have said this 12 months ago. Having failed to say it earlier, it has an obligation to say it now,’ said Tim Johnson, principal analyst at telecoms consultancy Ovum.

A new approach needs to be taken
Something has to happen – something radical. Here’s a suggestion. Even though most of the licences have been granted, Europe’s governments should grant the telecoms huge refunds on them, giving back much of the licence fees to finance the network investments. In exchange, the telcoms would agree to honour tougher provisions for future service, perhaps agreeing to sell excess capacity to industry newcomers. And then, once the networks are in place, the governments can make back the money by taxing profits. These are bound to be larger in a vibrant industry.

Politically, no doubt, granting refunds would be a nightmare. For the left, it means taking back money already earmarked for pensions and healthcare and, in effect, giving it to some of European industry’s fattest cats – companies like Vodafone, Deutsche Telekom, and BT. For conservatives, it means forsaking the results of an auction, surely the most impartial system, and giving billion-dollar decisions back to politicians.

Yet the stakes in the third generation build-out are far too high to soldier on with a failed policy. Without a fix, Europe’s mobile net runs the risk of falling flat. Worse, the combined costs of licence fees and build-outs would cripple most of the telecom industry players in Europe and lay the groundwork for a market domination that could exploit consumers.

Smaller fry will struggle to survive
The problem is competition. Market leader Vodafone Group can afford the overpriced licences, even if its stock sinks and its debt rating risks a downgrade. But the smaller fry in each market will be hard-pressed to survive. Take the Sonera – Telefonica – led consortium in Germany. It faces Pounds 4.8bn in licence payments and a Pounds 4.2bn network investment. This is all to grab 13% of Germany’s third generation market.

Smothering competition by overcharging for licences could cost Europe dearly. The Europeans lost out on the first round of the internet but can catch up and leapfrog America with the mobile web. Indeed, Europe is ahead in the mobile race precisely because of its successful industrial policy in the early 1990s.

While the US left its mobile system to the forces of markets and wound up with a fractured system, Europe settled on one technology standard, charged little for licences, and raced ahead. The mobile web is Europe’s chance to extend its phone lead into cyberspace. That’s not likely to happen, though, if government ineptness hobbles the entire field at the gate.


Auditors worried over 3G mobile costs

  • By Business Week’s Stephen Baker in Paris and Kerry Capell in London and Jonathan Howell-Jones from Computing in London.

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