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  1. Telecoms The Crash and the Road Backand the impact on IT Denis O’Brien IT@Cork 24 November 2003

  2. Context • Telecom’s Deregulation in USA in late 70s and early ‘80s. •  Landmark decision by Judge Greene on 8th January 1982. •  MCI led the way legally forcing deregulation in the USA. •  “MCI – a law office with an antennae on the roof!” •  UK Government licenced Mercury in 1984 to compete with BT. • EU adopted Services Directive in 1990.

  3. Context - continued • Member States deregulated gradually: mobile  fixed. • Nearly all of the emerging fixed players started life as resellers. • They realised that they could not survive on 15-20% gross margin. • EU infrastructure liberalisation led emerging telco’s to race to build their own networks. • Overestimated the network demand and consequently the financial returns. • Most of the management of emerging telco’s were engineers not sales people!!!!

  4. Background to the Telecom Boom • Benign economic conditions. • Historical valuation methodologies were thought inapplicable because of the anticipated growth in telecoms. • Huge amount of “smart money” was following the telecoms sector and investing aggressively and this was followed by “dumb money” from day traders. • All the capital markets were open: equity, bank debt, investment grade debt and high yield bonds.

  5. Background to the Telecom Boom • High yield financial instrument was tailor made for telecoms. No cap or inerest payment for up to 5 years. • Wall of money from Pension Funds (deregulation of the Pension Industry). • Switch out of bonds into equity by Pension Fund Managers. • Huge interest in new technology and its impact on day-to-day life. • Emergence of key new players in all major countries in Europe trying to compete with the big telco’s.

  6. New Entrant Telecom Operators IPO Date

  7. Heading for the Crash • EU wanted to create greater competition in the Mobile Industry. • EU wanted to be take the lead in the next technology standard just like GSM/2G.  • Mobile operators had discovered prepay and penetration soared to 65/70%. Original business model blown away.  • The EU believed that a new round of mobile licences would break monopolies particularly in Germany and France.  • Mobile operators were also looking at ways to move beyond voice to new unknown data services. • The E.U. was the catalyst in creating a crash.

  8. The Manufacturer’s duped the Mobile Operators • In 1995, the equipment manufacturers started to talk about the next paradigm shift – i.e. 2G to 3G.  • They started to push the proposed benefits of 3G to the public. The EU was sold on the idea of new players in the mobile market.  • It helped that the manufacturers were of EU origin (Sweden, Germany, France and Finland).  • 65%+ of people had a mobile phones (100% in Scandinavia).  Everybody bought the myth …..but the Manufacturers got ‘Roger’d themselves

  9. “Writing on the Wall” Ignored • WAP was “crap”. • Technology not user friendly • Equipment players awful record of over-promising and under-delivering. • Government hyping the social promise of 3G, while trying to raise as much money as possible for new licences. The EU + Operator + Manufacturer’s all got ‘Roger’d’

  10. Mobile Transmission Speeds

  11. 3G Services: “The Promise” • Customised Infotainment •  Multimedia Messaging Service •  Mobile Intranet/Extranet Access •  Mobile Internet Access •  Location-based Services •  Rich Voice (simple and enhanced voice)

  12. 3G Licence Costs • Country Cost of 3G Licence Date • (US$ per head) • United Kingdom 576 April 2000 •  Germany 567 August 2000 •  France 325 May 2001 •  Italy 74 October 2000 •  Netherlands 159 July 2000 •  Denmark 108 September 2001 •  Ireland 75 December 2001 •  Spain 11 March 2000 • Portugal 4 December 2001

  13. Where did it all go wrong? • Analysts in mid/late 2000 started asking questions following the 3G Auctions.  • Would mobile operators ever make a return? • This led them to reappraise all telecom’s operators. • PTTs gambled their balance sheets on 3G Licence at home and away (FT/DT/BT/KPN) • Overnight they were awash with debt, facing significant competition from new 3G Licences and emerging Fixed Line Operator (Esat, Jazztel, Tele2, Versatel) • Analysts started looking at publicly quoted emerging telcos and their mostly high yield debt Structure…..Let to price share collapse

  14. Case Study: Jazztel - Spain • Pure “fixed strategy” play branded in 1999. • Set up to compete against Telefonica (PTT). • No other significant competitors in Spain. • Constructed networks in 150 metropolitan areas and business parks in Spain and Portugal. • Raised $190 million in equity. • Raised $675 million in high yield. • IPO in December 1999.

  15. JazztelMarket Capitalisation US$MM

  16. Jazztel - 2003 Restructuring . . . • Market capitalisation down to circa. $220 million (from $7.2bn). • Revenues $220 million – EBITDA ($91 million). • Annual interest expense $110 million. • $675 million high yield converting into 82% of the equity. • Little or no conventional bank debt. • Original equity sponsor, Spectrum Equity, bought bonds with a $220 million face value for $60 million. Telefonica is stronger than ever……

  17. Jazztel - 2003 • The market has invested $1.5 billion to create $220 million of revenue. • $1.28 billion has been flushed! ($1.5bn less $220 million) • Reselling still makes up 55% of company’s revenues. • Jazztel will have little capital to build the business. • Banks have no appetite to lend despite elimination of high yield. • Smart insiders made money – but broader capital market lost heavily including a lot of Spanish retail investors.

  18. Case Study: Vodafone • Vodafone believed the myth but was financially conservative. • Bought Mannesmann Germany for paper/shares at the peak of the market. • Mannesmann owned Orange and had to be sold. • France Telecom bought Orange for €37 billion in cash in May 2000 • Vodafone used hyped cash receipts from France Telecom to pay for the hyped licences (“hype paying for the hype”). • Spent €24 billion on 3G licences

  19. The Ironies and Consequences • 3G Auction ultimately destroyed the competitive telecoms market in Europe. • The Incumbents have been severely impaired due to their debt intake but nothing compared to what happened to the emerging Fixed players. • The EU goal of creating an Information Society is in flitters. In effect they have taxed broadband wireless services should they ever materialise. • The customer/users have suffered due to consequential capex underinvestment. • The incumbents now face the weakest competition they ever had. • They are flexi2ng their legal and regulatory muscles by bullying regulators in price increase in area where they face no competition i.e. line rentals. • Real service level agreements for the delivery to resellers of DSL and leased lines are strong enough. • All the emerging Telecos (those that survived) are coming out of restructuring suitably chastened with the lenders controlling their equity.

  20. Ireland is Still a Competitive Market • Pricing has reduced by 60/70% in the last 5 years. • Esat / MCI Worldcom are giving Eircom a run for their money as their networks were mostly built out prior to the crash. • The SME / Residential Market has the least competition and consequent underinvestment. • Both Cable Companies – Chorus / NTL are not viable. • The Irish Glass Bottle example is relevant. Effectively their customers drove down the price per bottle produced to an uneconomic level. I.G.B. closed up customers now pay 30% more for imported bottles. • ESAT / MCI Worldcom should be supported and worked with. The incumbant has all the advantages

  21. There is now a Startling Opportunity… • We need to break the mould and throw it away • There is an opportunity to build a totally new broadband telecom co. • A new Telco could raise circa €2bn, 50% equity / 50% long term bond and continue the build out to 750k home/business/schools out of a total of 1m homes. • Bring 4mb through the front door and provide the capacity for a real information society. • Hybrid network leverage the Government’s Broadband backbone on a revenue share basis. • D.S.L. will never live amongst 4mb of capacity. • Revenue would come from – voice, high speed internet, VOD etc. • Eircom have €2.1 billion of debt at 8-8.5% coupon and €600m Ebitda • Eircom would be incapable of following this model.

  22. Convergence at last could now appear • Telco / Incumbants now awash with cash. • How they re-create a growth story for the Market. • Paying out increased dividends and share buy backs is the only a stop gap. • Focus has to be on getting a greater yield from existing customers • Telco’s will end up working more and more with IT solution providers particularly in Wireless. • Wireless IT Companies need to focus on Telco’s top 5 problems NOT top 50 – no attention otherwise

  23. What could happen ? • Telco’s may end up buying the top ten IT Solution Providers world wide. • This would integrate them further with their major customers. • This creates a huge competitive barrier for alternative Telco’s. • The key risk is whether the Telco’s would be able to manage these businesses.

  24. Where is the Opportunity for Irish IT Companies • Sell a relevant service that has high growth potential. • The opportunity is in selling, as a re-seller, value added services on behalf of the network owners and receive recurring a slice of recurring income. • The major Telco’s particularly in Wireless are not geared up to selling these services as they have a high cost base. • A business plan that is not cash flow positive in six months should be avoided. • There is now a wall of money available…….again.