Kate Bulkley, Media Analyst.

Will Orange sink or swim?

By Kate Bulkley

The Independent

Jan 24, 2001

The future may not be as bright as the colourful mobile operator would have you believe. Kate Bulkley navigates the choppy waters of the Orange flotation

The TV ads Orange is running to promote its share offer next month are filled with happy young children. Both the company's carefree image and its slogan - the future's bright, the future's Orange - focus on making the customer's life easier and better. But as the market for mobile phones enters a new phase, the UK's youngest mobile phone operator is facing new realities and its own future, far from being as bright as the ads suggest, looks decidedly uncertain. Orange is not unique among mobile operators, but its planned share offer has put its particular business prospects under a harsh spotlight.

To say that Orange has not chosen the most auspicious time to float is an understatement.The stock market has been pummelling telecoms and tech stocks, and there is no promise of an early let-up. This is partly a backlash against the high prices all European mobile operators have paid for third generation (3G or UMTS) network licences. But there is also real concern that the take-up of new data and internet services over the next few years will not be enough to offset higher 3G operating costs and falling revenues from simple voice calls.

Despite the concerns, Orange's owner, France Telecom, is forging ahead and plans to offer up to 15 per cent of Orange's equity, or 728 million shares, plus a further euros 3bn (1.9bn) of bonds convertible into Orange shares at a premium to the final offer price. According to the offer prospectus issued this week, the shares will be priced at between euros 11.5-13.5 each, valuing Orange at between euros 55.2bn-64.8bn, which is about a third of what analysts had forecast early last year. "It's clearly worth more," said France Telecom chairman Michel Bon on Monday. "We have an IPO discount which is normal in a market that has been just so-so for the last few months. This IPO discount of 20 per cent is a little higher than you could find in a market that is bullish. In the analysts' reports the value [of Orange] was euros 70bn-80bn for 100 per cent of the company, which is hopefully the price that it will trade at very soon."

Proceeds of the Orange share offer and the exchangeable notes will come in at between euros 11.2bn-12.9bn, based on the mid-point of the institutional price range. If all goes according to plan, the stock will begin unconditional trading on 15 February on the Paris exchange, with a secondary listing in London. The low offer price range sets a low benchmark for other mobile flotations planned by Deutsche Telekom, Dutch company KPN and British Telecommunications for later this year. These could be delayed or de-railed entirely if the Orange share price underperforms. And an added pressure on the Orange offer will be from Japan's largest mobile operator NTT's DoCoMo, which plans a secondary share issue at the same time as Orange in early February.

Orange is considered a company with a strong brand, a proven record in innovation and a strong financial position. "We don't want to change Orange. We want to back it and build it," said Mr Bon at the press conference earlier this month announcing the initial public offering (IPO). But what Orange is worth is starting to resemble the ticket on a much marked down post-Christmas sale item. Last spring, the company's then new owner France Telecom had grand plans to float Orange once it was combined with all of the French firm's other mobile assets, at a valuation of euros 140bn-150bn. But times have changed. So why float now? Orange's senior management, led by its visionary and eccentric CEO Hans Snook, believes that it has a unique story to tell that can buck the market. There are also pressing cash issues for France Telecom that a float would go some way to meet. And although Orange is in the world's top five mobile operators with around 30 million subscribers, it is less than half the size of Vodafone. Having its own share currency will drive its growth.

If anyone can sell the Orange vision it is its CEO. Meeting in his office shortly only a week after the world's largest mobile-maker, Nokia, posted lower-than-expected sales figures suggesting that mobile phone growth may have levelled off, Mr Snook, looking relaxed and confident, says: "The business fundamentals haven't changed, they are excellent. In terms of where the competition is going, where the industry is going, where the revenue potential is going, in terms of the capital appreciation for investors and in terms of ultimate returns.I think [all] this stuff is wonderful." Dressed in jeans and his signature white Mandarin collar shirt with a little Orange logo tag just below the top button,Mr Snook dismisses the sceptics. "I remember in 1984 I went to an industry conference when cellular was just breaking out and people said, 'Oh, this is a white elephant, people are investing too much', and 10 months later it took off like a rocket. It happened again with GSM. People said, 'Oh, its an unknown technology which is more expensive so marginal usage will go down', but it became successful." When Orange launched in the UK in 1994 as the fourth operator, critics wrung their hands, recalls Mr Snook. "We have been through this three times and they want to do it again. I keep wondering how many times does one have to prove it?" So far he has been right and the spectacular growth of the mobile phone business has made him and his shareholders a lot of money.

Today two out of three people in the UK have a mobile phone, in Sweden and Italy the penetration rates are even higher, and Germany and France are catching up fast. But Mr Snook doesn't see wireless slowing down. He predicts penetration rates could quadruple to 300 per cent in the next eight to 10 years. People won't necessarily have three mobile phones, but they will rely on "wire-free" connections for lots of different devices to control all aspects of their life. Mr Snook thinks that by 2003 half of people will use their wireless connection almost exclusively. It will be viewed as a sort of remote control for all kinds of tasks from turning on the heating before you arrive home, to booking airline tickets to organising your digitally-stored music into a playlist and then sending it, wirelessly, of course, to your car stereo. In this future, Mr Snook says, Orange will be at the middle of a value chain that will include everything from voice services to data communications to buying and selling. "We sit at the converged point of all these, so we can make it happen a lot less expensively and in a friendly way and generate a lot of new revenue streams out of it," he says. "Can I prove this today? No. But it's just like the growth of mobile phones seemed self-evident because of what it does for people."

But this bright future may have to be built largely without Mr Snook's help. He is only CEO until the float is completed, after which he steps down in favour of Jean-Francois Pontal, a Frenchman who for several years has been running France Telecom's retail businesses, including overseeing its French mobile division. Mr Snook says he will still be around as a special adviser to Orange, but losing him on a day-to-day operating basis should be viewed negatively by investors. The man to be his replacement is one of Mr Bon's top lieutenants, having worked at French grocery giant, Carrefour, where Mr Bon was CEO, before he came to run France Telecom in 1995. Mr Snook will be a hard act to follow, and Mr Pontal starts with the added liability of speaking only halting English. A Paris-based analyst who knows him says he does not like the limelight, preferring to be in the background. Mr Snook is clearly torn about how the new management structure has played out. After much urging by Mr Bon, Mr Snook had agreed to become chairman of Orange after the IPO until news came that the French government would not waive capital gains fees of some 6bn-8bn for moving the French mobile business into the UK. "I am convinced that we could have fought that in court and won but while we were doing that we couldn't do the float," he says. Once it was clear Orange would have to become a French company where under local law a chairman has more executive responsibilities than in the UK, Mr Snook decided to step back. "By that time I had met Jean-Francois," he says. "His English wasn't great and I'd love Graham Howe [Orange's long-time CFO] to run the company, but there are so many things to be done at once that it probably will work best if they co-manage." Mr Howe will be deputy CEO as well as CFO of Orange after the IPO.

The new team Orange will run is much bigger and less integrated than the company purchased by Mannesmann in October 1999 and then sold to France Telecom in May last year. Orange SA, the French-based company it will become post-IPO, counts about 30 million subscribers, including the French mobile group Itineris with 14 million subscribers and the UK business with 10 million. These two markets alone contribute the lion's share of Orange's revenues, but it has interests in 18 other countries and big plans to more than double its Orange print to 50 countries by 2005. Like all European incumbent telephone companies, France Telecom has taken on masses of debt to fund moves into new, higher-growth businesses, including mobile phones, broadband (it owns 25 per cent of cable communications company NTL), data services and the internet. BT, KPN, Deutsche Telecom and Telefonica have pursued similar strategies with similar consequences: share prices have fallen and all of the companies have been warned by ratings agencies that credit ratings could be cut if debt levels are not significantly reduced. On top of wanting to reduce nearly euros 60bn (38.3bn) of debt, France Telecom also has a pressing cash issue: when it bought Orange last year from Vodafone (which had inherited it through its purchase of Mannesmann) it paid the euros 40bn (25bn) price with a mix of cash and its own shares. Under the agreement, France Telecom must buy back euros 6.7bn of its shares from Vodafone by March of this year (another euros 6.7bn must be bought back by March 2002).

The IPO is important for another reason as well. Orange needs a public share currency so it can join the acquisition trail. At the moment Vodafone, which has signed a flurry of deals from Japan to Mexico in the last few weeks, is leading this charge and Orange wants in. "One thing that is important for our growth is to be able to expand our footprint easily without using cash," says Mr Snook. Orange is the leading mobile operator only in France. In the UK it is in third place, but is closing in on BT Cellnet's number two position. It also owns a stake in Italy's number three operator Wind. Orange won 3G licences in all of these markets and Germany. But in the latter, Europe's biggest market, its partner Mobilcom is a telephone reseller, so its 3G network will have to be built from scratch. The biggest gap in its European Orangeprint is Spain, where Orange lost its 3G bid, and is waiting to see if the Spanish government will let it buy an additional licence. Orange already has operations in Northern Ireland, and, as UMTS licences will be sold in Ireland in April or May,"we'll look at it with great interest," said Mr Howe. Beyond Europe, Orange has big ambitions in Asia, but so far only has a small presence in Indian city Mumbai and plans to build a network in Thailand with CP Group. But the big prize is the USA.

The problem is that most of the big US mobile players are already tied up with Orange rivals. Deutsche Telekom is purchasing Voicestream, Japan's wireless company DoCoMo has bought a stake in ATT Wireless, while Vodafone owns 45 per cent of Verizon Wireless, the largest US mobile player of all. Operators like Nextel or Next Wave are possibilities, but they are relatively speaking much smaller players. Sprint PCS is a possibility, but France Telecom, which owns a 10 per cent stake in its parent Sprint, has signalled it plans to sell it to raise cash. Orange argues that it has greater growth potential than its bigger rivals, but when Nokia said it believed global handset sales were 405 million last year, 15 million less than originally forecast, even industry giant Vodafone's shares fell and analysts began to take a more sober look at growth prospects. Yet the mobile business is far from moribund: Nokia sold 128 million handsets last year, up 45 per cent from 1999, and there is still room for growth. The question is how much?

Jupiter Communications, a media research firm, predicts global mobile phone penetration will double by 2005 to 21 percent, or 1.4 billion subscribers. A staggering 83 per cent of these handsets will be internet-enabled. In Europe the forecast is even sunnier: 78 per cent of the population will own a mobile phone and 97 per cent of these handsets will have the always-on Net access. But fast wireless access to the Net may not be enough to compensate for declining voice-call revenues, according to a recent report from technology consultancy Forrester Research. Called Europe's UMTS Meltdown, the report says although there is fierce price competition today, falling prices have been somewhat made up for by current users using the phones for longer times and new converts joining the mobile ranks. But the launch of new networks, first with intermediary technology 2.5 (GPRS) and then 3G UMTS, will usher in a host of new operators that will lease their networks and use price to compete for a dwindling number of mobile-less users. A price war will begin that will cause a 15 per cent drop in operators' average revenue per user by 2005. Forrester's chilling conclusion is that operating profits will disappear in 2007 and take six years to return, forcing many mobile operators out of business.

The only good news in the report is that Orange should be one of five global players to survive. The other four are Vodafone, Deutsche Telekom, BT Wireless and some combination of Telecom Italia Mobile, KPN and Japan's DoCoMo. "The ones that win will be those with the deepest pockets and the most capability to leverage their resources," says Caroline Sceats, a Forrester analyst. "We've decided Orange can ride this out, but it will be a hairy couple of years." Orange and other operators accept the market will get tougher, but they are banking on being able to increase wire-free traffic and create compelling paid-for services. Orange is betting on the power of its lifestyle brand and its innovative approach to services to help it stand out.

In its offer prospectus released this week, Orange revealed pro forma revenues for Orange SA, of euros 5.41bn against a net loss of euros 582m for the six months to 30 June 2000. However, Mr Howe said the company "is comfortable" with analysts' forecasts that Orange SA will be making a net profit around the end of 2003. Mr Snook says one of his key jobs post-IPO will be to coordinate the re-branding. French mobile operator Itineris will be among the first to go Orange, with a goal of having the Orange brand in all the countries before 3G launches begin in 2002, a date that is now called ambitious by some mobile operators. "If it were just a coat of livery, we could do it tomorrow," says Mr Snook. "But it is about really making sure that all the key managers in all the mobile businesses are fully brand-washed."If the Orange psychology can be learned and exported, and there is no guarantee it will be, then the company could have an edge in what looks to be an increasingly competitive market. The fact that Orange SA will start with just euros 6bn of debt and a bigger growth potential than its biggest competitor, Vodafone, also bodes well. But Orange is up against a jittery market and a future where a lot of the potential is impossible to predict. And if the future didn't have enough question marks already, just this week two of Europe's largest mobile operators cast doubt on the timetable for the roll-out of phones for the new high-speed always-on internet system GPRS. Vodafone and Telecom Italia Mobile said due to technical glitches the new phones probably won't be available in quantity until early in 2002. There is also concern that 3G phones could also be delayed, perhaps by as much as two years, making their launch more like 2004.

On Monday, in its press conference, Orange stuck to its picture of a 2002 launch for 3G phones, but admitted this is largely in the hands of manufacturers. Orange is spending 20m advertising the IPO to retail investors, including a discount of 50 European cents for its own subscribers in the UK, France, Germany and Italy, which represents about a 4 per cent discount to the institutional offer price. But even though a customer's positive experience with the company may tempt him to consider buying shares, the key point is price and how much of the picture painted by Mr Snook about mobiles' bright future can be believed and how long it will take to get here.

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