Irresistible or fatal attractions?
European electric utilities are moving into the deregulated telecoms market but analysts are divided about their prospects.
Prospex Research Ltd
Not content with managing constant upheaval in their core electricity operations, several European utilities are launching into an even more fiercely contested and fast-moving business: telecommunications.
Analysts are divided about their prospects, shareholders may have reason to worry about the billions of dollars in medium term costs, and managers must learn an unfamiliar game in months or even weeks, after decades of electricity monopoly stability.
So what are the attractions? These depend on the nature of specific investments, and the markets they target. There are some general themes underpinning most communications investments.
– Network: Arguably the biggest advantage utilities have is their transmission and distribution networks, which criss-cross big slices of national markets, or even entire markets. The power lines are not of much use yet, but PowerLine technology developed by Canada`s communications equipment group Nortel and UK utility Norweb could change this. But even if PowerLine fails, many utilities have already strung sophisticated fibre optic networks along their pylons. Suitors from the traditional telcos to flashy new entrants are eyeing those assets with keen interest, and are ready to improve and augment them rather than starting – expensively – from scratch.
– Cash: In some markets, clever new entrants can buy telecoms capacity wholesale and resell it at a handsome profit, without having to pour money into network build-up. But most telecom ventures involve at least some asset investment, either to offer better services than the competition, or to avoid using the network of incumbent telcos, or both.
Certainly owned assets provide the long term security that resellers can never have. The price, though, is heavy investment with no certainty of a payoff even in the long term. Here European utilities` cash mountains can play a central role. Instead of leaving liquid funds on the balance sheet, attracting the attention of shareholders and analysts who would rather have the money back, utilities can put the money to work, and absorb the losses along the way. Long term, they hope, telecoms growth and profits will roll in, providing a much better reward than reserves parked in bank deposits and bonds. Naturally telecom industry players are more than glad to have such rich partners.
– Multi-utility: Utilities endowed with networks and cash might seem like big, wealthy, but possibly passive partners. This may not be the case. The multi-utility concept is gaining ground in the UK, precisely because utilities can offer some commercial action alongside assets. Their endless customer lists and massive billing operations offer a goldmine of information and opportunities for synergy to any telecoms venture.
One billing centre covering two revenue streams will obviously be more financially efficient than a centre covering just electricity, barring complete incompetence on the part of the multi-utility. Add in yet more revenue streams, such as gas and water, and the cross selling and unit cost cutting opportunities may be highly attractive.
– Cable: Cable television networks have long been a losing proposition all over Europe, but today they are at the centre of promising convergence business. Digital broadcasters want to pipe their hundreds of channels through them, telcos want to use them for voice and data business, and e-commerce specialists hope to take advantage of their capacity, security, and defined demographics, all of which can beat what is available on the Internet. And in some European markets, it is the utilities that own or are building the cable networks.
– Because it is there: Whatever your core business, the telecom market is huge and irresistible. Prices are plummeting, yet revenues are soaring. The European Information Technology Observatory (EITO) puts the value of the Western European telecom services market in 1997 at Ecu150 billion ($173 billion). Add in converging markets for IT hardware and services, and the broad market was worth Ecu356 billion ($413 billion) last year, or around four fifths of the entire GDP of Spain, the region`s fifth largest economy. For 1998, even the bitterly contested traditional telecom services sub-sector is expected to grow three per cent, while hot sub-sectors will continue to spiral upwards.
West European mobile services should post a 20 per cent surge after rising 26 per cent in 1997, while data services will jump 17.5 per cent. You will not find growth rates like these in the European electricity business except in niches, and successes in those niches will be neutralised at any big utility by pressures in stagnant core business.
Indeed such a rosy outlook is hard to find anywhere, and this has not been lost on stock markets like London`s, which has bid up telco shares in a frenzy of enthusiasm. That support is still in place even when everything else in international financial markets, including the shares of international power groups stuck with foreign misadventures, is banking on bad news from Asia, Russia and Brazil.
Utilities cannot be blamed for wanting a piece of the telecom action, especially if they can deploy the advantages outlined earlier to win in the long term, rather than just follow fashion.
Contenders line up
There is no end of variety in the emerging utility telecoms business. Some groups go for full service, integrating fixed and mobile and adding multi-media or IT interests, at home and abroad. Others concentrate on a single product niche or regional market. It is early days, but the sheer scale alone of the commitments made by a few players, let alone their early victories and defeats, command attention. Four key names, o.tel.o, VIAG Interkom, Wind, and Energis are reviewed below.
– o.tel.o is a joint venture between Germany`s top two utilities, Veba and RWE. It is developing a full service offering, from fixed network voice, data and network-related services to mobile, the latter through a majority stake in the E-Plus network. Mass and corporate markets are in its sights.
The exercise will be costly: power line rights of way and existing communications and cable operations make things easier, but spending of DM7 billion ($4 billion) into the early years of the next century is planned. Sales were just DM166 million ($96 million) in 1997, and the venture will lose money up to 2002. But for 2005 the partners are aiming for a profitable top position in a big German competitive market, and annual revenues of DM7-9 billion.
o.tel.o has plenty of resources and financial clout, but so far it has struggled to make a mark in the German market, which is contested by dozens of players. Its chief rival, Mannesmann Arcor, got its offerings off the ground quickly when the German market opened in January 1998, while o.tel.o was not fully ready.
Its pitches too have not hit the bull`s-eye: others have offered competition on price alone through five digit codes customers dial before the number they are calling, and won lots of volume with a simple transaction (customers still get one bill, no matter whose codes they punched in for calls).
It seems o.tel.o was going for more than a transactional relationship, but has finally had to give in to customers` ambivalence. Then there is strategic uncertainty: talks with US telco BellSouth fell through in September 1998, leaving o.tel.o without a strong foreign partner, unlike just about every other major new venture in the global web of alliances that is the new telecoms industry.
– VIAG Interkom groups Ger- many`s third largest utility, VIAG (45 per cent), UK telco BT (45 per cent), and TeleNor of Norway (ten per cent). As with o.tel.o, full service everywhere from residential to high end corporate markets is the target. An integrated fixed and mobile network is under construction, requiring investment up to 2006 of an impressive DM7.5 billion ($4.3 billion).
In 1997 VIAG InterKom`s sales were DM214 million ($123 million), but the top line is expected to soar. Indeed, to break even in 2001, sales would have to be DM4 billion ($2.3 billion). By 2006/7, sales are expected to reach no less than DM10 billion ($5.7 billion).
VIAG Interkom, just like o.tel.o., has struggled to keep up with Mannesmann Arcor`s flying start. It must also contend with scepticism about its ambitious investment plans, when leasing capacity from the incumbent Deutsche Telekom is so cheap (thanks to a pro-market regulator) that successful operations can be built on nothing more than some seed capital and comparatively inexpensive switching equipment. But at least UK telecom giant BT is on board, conferring a lot of credibility other ventures lack.
Rumours flew this summer that Interkom and o.tel.o would merge. BT would probably support just such a move, even if its own recent alliance deal with AT&T complicates things – AT&T is backing Mannes- mann in Germany.
– Wind is a 1997 alliance between Enel of Italy, Europe`s second largest utility, France Telecom, and Deutsche Telekom. Enel has 51 per cent, and its partners share a 49 per cent interest. Other investors, including the Franco-German duo`s US ally Sprint and stock market investors, may be brought into the group in the months and years ahead.
Wind will be a full service operation, offering its own fixed network, based on Enel`s communications backbone, and mobile services thanks to its win of Italy`s third license this year. Mobile in particular is hot: the Italian market has zoomed from stagnation to phenomenal growth in recent years, and now boasts an amazing 13 million mobile subscribers in a country of some 55 million people. And some observers say the market should keep rocketing and hit 30 million subscribers within five years.
Wind has everything to prove. Its commercial operations will not be fully up and running until 1999. Meanwhile the incumbent Telecom Italia and a grouping of Olivetti and Mannesmann are racing to shore up their businesses and grab all the growth they can. Neither is a weak opponent, even if Telecom Italia has not entirely shed its sleepy monopoly legacy. But the combined strengths of Enel, which is shaping up its core business more than cynics might think, and its foreign partners may be formidable, and Italian consumers` appetite for new communications services insatiable.
– Energis of the UK has already earned a place on the success list in utility telecoms. It was launched in 1993 by the UK`s National Grid, which owns 74 per cent of Energis, with the rest floated on the London exchange. Energis has built its high capacity national fibre optic network mainly along the National Grid Com-pany`s electricity network. It offers high volume business services to communications industry players like Internet service providers. High profile clients include the BBC (British Broadcasting Company) and top UK pharmacy operator Boots.
In its early days Energis struggled to reach agreements with a host of lukewarm suitors from overseas, such as AT&T, and some investors balked at its high spending in light of the slim margins wholesale business services might offer, especially in light of its inexperience in the telecoms industry. But investors eventually realised its state-of-the-art network and its strategy mirrored many similar moves in the US market. The USA saw new competitive ventures based on the high tech lose lots of money initially but then cash in when demand for their services and well-placed assets took off.
Sure enough, in April 1998, MetroHoldings was created by Energis (50 per cent), and DTFT (50 per cent), which in turn is a 50/50 alliance of Deutsche Telekom and France Telecom. MetroHoldings will build or acquire networks in the UK`s main cities, starting in London, and deploy the latest fibre optic technology. Energis shares have traded as low as ٟ.09 ($1.84) a share over the past year. Today, they stand at £6.72.
Be careful out there
But for every sparkling Energis there is a dismal failure in a dizzying business like telecoms. The challenges are so varied, potent, and ever-changing that only the most nimble can keep up. Here are just three of the myriad warnings any fair advisor should be throwing at utilities trying to break into the market:
– Being big helps, but not if it reduces agility. Utilities should not mistake raw strength they may have in electricity as something that can be simply cashed in and converted into telecom strength. The power plant approach – plan, plan, design, redesign, assess, build, review, complete, test, double check, and only then open – has no place in this business. It`s more like selling and then designing.
– Multi-utility business is promising, but getting results is not simple. Simply buying up every related utility business in one`s region is often not an option, and if there is a geographic patchwork of interests, how will it be tied together? More importantly, can a multi-utility truly argue it will be one of the best in all of its segments (which may be the minimum criterion for holding on to customers)?
– If giant and venerable telcos like Deutsche Telekom can be hit by upstarts like Colt, a venture capital idea of Fidelity Investments which has turned into a multi-national contender for metropolitan business services and stock market superstar, what hope is there for utilities? Do they really have a compelling advantage that will help them withstand competition not from a few other big names, as in electricity, but dozens of passionate contenders with a new idea every minute? If not, buy one or more of those upstarts quickly rather than throw money into holes in the ground.
Do not expect the utilities to listen to any of their critics. The telecoms club party is in full swing, the bar is stocked, the queue outside is lengthening, and they will not be left out. But the hangover may be another matter for all but a few with something more to celebrate than getting past the doormen.
© The biggest advantage utilities have is their transmission and distribution networks
© Western European information technology and communications market value by sector, 1997. Source: EITO