Who will buy O2?
Opinion Simon Rockman is the publisher of What Mobile, a monthly magazine/buyer's guide for people interested in mobile phones.
The bursting of the telecoms bubble and the huge amounts paid for 3G licences are problems, which fed of each other. The effect will be felt for decades, perhaps even centuries. It's inviting future ridicule to sit here at the beginning of the situation, predicting what will happen. The folly of this can be seen in how bad predictions have been over the past few years, but I'm prepared to take that risk.
Within the confusion that is set to reign there are some things that are obvious - 3G will be late and networks will go bust. There are other things that are not obvious. Somewhere between the two are surprising things within the obviousness.
The UK has five 3G networks. They paid a total of £22bn pounds for them. That's £500 for every mobile phone user, about four times the market value or acquisition cost of an existing subscriber and of course none of these are acquired customers.
Someone in the UK will fail, and the question is "who?"
The obvious candidate is the new entrant. Even in the afterglow of the auction 'wins' Sir Chris Gent told me that he thought the business case for a fresh, ground-up start was weak. But Mandy-Rice Davies applies and more significant is the quality of the people at Hutchison 3G, now known as '3'.
The company known as 3 is run by Colin Tucker, the man who was the technical brains behind Orange, he's surrounded himself with some of the smartest people who built Orange and cherry-picked the phone industry for the best people.
And even more significant is the size of his wad. 3 is bankrolled by Hutchison Wampoa the company which did best out of the telecoms madness. Hutchison sold Orange to Mannesman. Mannesman bought Orange as a poison pill.
The German company thought that if it owned Orange there would be no risk of a takeover by Vodafone. No-one had ever managed a hostile takeover of a German company before and if Mannesmann owned a UK network then Vodafone would be unable to buy Mannesmann, the law doesn't allow you to own two competing mobile phone networks. Orange was also a good, well run and hugely profitable business. So with both a business and political incentive Mannesmann bought Orange from Hutchison. As part of this deal Hutchison received a significant shareholding in Mannesmann. Lots of shares at a great value.
But an Orange towel on the deckchair and centuries of legal precedent wasn't going to stop Vodafone. There are lots of telecoms companies that are adept at financial management and lots which are great at mobile phone technology. Vodafone is good at both. If you have to pick what it is best it, then the money side wins. Vodafone is probably the best company in the world at running its financial affairs, understanding what to buy, when to buy, what to fix because it is broken, and what to sell.
In the most audacious takeover, Vodafone bought Mannesmann. This took a lot of waving of cash at the German shareholders and so they came away with an amazingly inflated deal.
One of the biggest shareholders was Hutchison. In return for all its large value of Mannesman shares, Hutchison received a large number of Vodafone shares, which had been sold hard to the Mannesmann shareholders and had a value that reflected this. In short Hutchison sold Orange twice, winning on the accumulator.
Shortly after Hutchison sold a lot of Vodafone shares. So many that two brokers were appointed, one of the largest trades ever conducted. This left Hutchison with a lot of money. The kind of money that would launch a space project, or a 3G mobile phone network.
The UK network which will fail won't be 3. Nor will it be the astutely-run Vodafone. That leaves us with Orange, T-Mobile and O2. The first two have an intrinsic geographical advantage. They use 1800Mhz technology on GSM. The cells are smaller and so they need more of them. This means they have more land and so the cost of rolling out 3G is less for them than it is for O2 or Vodafone.
Orange is better placed than T-mobile, with more subscribers - the most in the UK and more cell sites. It might be a significantly less go-ahead company than the Orange of old and become a follower rather than leader, but it still has some of the old flair and has the real estate.
In time gone by One 2 One would have been the poor relation, but with the purchase by Deutsche Telekom there seems to be a new vigour, some of this, no, a lot of this is misguided. The company looks at how it was a poor number two to Mannesmann in Germany and through technical pioneering has overtaken the new Vodafone owned company to be number one. T-mobile thinks it can do the same here. What's wrong with this picture is the belief that technology was the driving force. It wasn't, xenophobia was. The Germans didn't like their company being bought by Sir Chris' mob and decamped to Deutsche Telekom. Of course in the UK the opposite applies, we might be more used to other nations buying our companies (Union Flag MINI anyone?) but similarly there is no patriotic incentive to leave Vodafone and T-mobile still has the smallest base.
As an aside the patriotism card shows the shrewdness of Vodafone's sponsoring Ferrari Formula One. An Italian car with THE German driver helps make the people feel part of the Vodafone family. Winning everything in sight helps, and making the OrangeArrows look feeble just warms the Vodafone heart. Expect T-Mobile to follow suit, perhaps with Ralph-brother-of-Michael's team Williams BMW. So Orange has the infrastructure and T-mobile the political will. That leaves O2, but you knew we were heading there anyway from the headline.
O2 is a very-badly run company. The decision making is confused and power so diluted that there is no strategy or direction. The company, like BT, is so self-absorbed that people there don't think of their rivals in business as being their opposite number at other networks, but as those people they work for or who work for them.
Purchasing is a complete mess. O2 ordered 165,000 RIM Blackberrys. In the first six months they sold 6,000. And were proud of it. The order has been cut back substantially but this means that O2 has lost its exclusivity and still has a stockpile. It's also not the way to treat suppliers, although such things are a habit with O2. Despite having warehouses full of £400 Blackberrys, O2 decided to take the HTC Wallaby. Remember O2 is a network not a handset manufacturer, and has little in the way of systems to merchandise, sell, train staff or run telephone support for handsets. Wallaby is a lot more than a handset, it's a Microsoft convergence product, a new version of Pocket PC OS, very difficult to support and generally unwanted.
HTC makes the iPaq and the Wallaby was originally designed for Compaq, Compaq didn't take it and so the design was touted around the mobile phone industry. No-one wanted it. No-one except BT Cellnet. Now renamed O2 they called the device the XDA. (Someone should find out who comes up with these names and take away his bag of Scrabble letters).
The XDA is an OK product, in a couple of years time once HTC and Microsoft have learnt a by the initial mistakes it will beget an excellent product, but the problem O2 has is quantity. The most successful PDA in Europe is the Nokia 9210; this sold 53,000 units in a quarter. Handspring is rumoured to have sold fewer than 20,000 treo's in Europe. For the XDA, O2 only has the UK and a minor presence in Germany and the Netherlands. A sensible number of units to buy would be 15,000. A wildly optimistic number would be 30,000. No, O2 is suspected to have bought 100,000. We've seen the first £100 price cut, expect more.
I don't know if O2 has been able to cut the order, the availability of the device in other parts of the world might mean this has happened or it might mean that Microsoft is so keen to get units out there it has persuaded HTC to sell it more widely. The likely answer is both.
Cutting orders is something O2 is getting a taste for, ask Quanta which was to have a phone sold exclusively to O2 with a pop group tie in, or Sharp, O2 ordered a very large quantity of camera phones and then cut the order by 80%.
Even with all these cuts, O2 has far too much stock, mobile phones age like fresh fruit, on What Mobile magazine we see something like three new phones a month, if a phone is still selling well after six months it is a classic. The XDA will soon be trounced by the Hewlett Packard 928 and the SonyEricsson P800, but O2 can't push either of those as it has XDAs to sell. Just watch the customers migrate to other networks. Getting new ones is expensive.
It might be interesting to dig through the O2 accounts and see how the shed loads of hardware is shown. Is it an asset or a liability? It might have a nasty habit of turning from the former to the latter.
Which makes O2 look frail. When the problems come home to roost it's going to look bad, worse in the light of Vodafone. Both Cellnet and Racal-Vodafone launched in January 1985, like rival siblings they grew up together, one became fantastically, world-conqueringly successful, the other didn't. When O2 hits problems it won't be alone there will be lots of networks around the world looking for suitors (and so depressing the price).
At the same time Vodafone will have bounced back from its sub £1 share price. While all the networks have posted disappointing results, Vodafone with a massive loss, I suspect there is an element of asking an accountant "what's two plus two"; the answer is "what do you want it to be". Vodafone's huge write down will lead to a strong turn around making Vodafone shares powerful currency when the time comes to shop for other networks. So while Vodafone will be buying O2 will be selling.
The customer for O2 won't be Vodafone, but there is no shortage of other candidates. Once again politics is as much of an incentive as business. One candidate is the only company bigger than Vodafone: Japan's NTT DoCoMo. Meeting Vodafone on its home ground is going to be hugely attractive, but there are other companies to entertain.
At the time of the 3G auctions there were a lot of companies, which were tempted to dabble in the profitable world of telecoms. The climate is different now and there won't be a headlong rush but the broadcaster Sky should not be discounted, nor should Microsoft.
This is more than a matter of looking to see who is rich, Microsoft having conquered the desktop and having made good inroads to the living room now wants the bedroom with x-box and your pocket with Smartphone 2002. But Smartphone is failing to impress handset manufacturers. The rival Symbian operating system is being used by Nokia, Motorola, SonyEricsson, Siemens, Matsushita (Panasonic) and Samsung. Just the top three from that list is 80% of the handset market. Microsoft has licenced to the new British start up Sendo, and the Far East PC clone makers TCL, Compal and HTC. Total current mobile phone market share less than 0.1%. Samsung also has a licence for Smartphone 2002, but is known to be working on Linux, and Palm devices as well as Smartphone and Symbian. None of this looks too good for Microsoft. It's worse because at the beginning of this year Siemens jumped ship from Microsoft to Symbian.
If Microsoft took an interest in O2, perhaps with long time friend BT 'saving' the company it had sold to 'help' shareholders then Microsoft would be in a position to specify the handsets it bought, and you can guess whose operating system it would choose.
This might lead Nokia, perhaps through the customer which got it into the GSM business in the first place, Sonera to have a sniff. The rivalry between Microsoft and Nokia is a major driving force in the industry, not usually for the good.
When valuing O2 there is the issue of the 3G licence. BT paid over £4bn for the licence but when O2 was floated it only took £1bn of the debt. It could be seen that the asset is worth £1bn, or it could be another liability. We've seen operators start to walk away from licences, perhaps it is worthless. The assets that are of most interest are the GSM network and 11 million customers. There is one company above all which could most use those. A rich company. 3.
The model on which 3G is being built is of islands of 3G in a sea of GSM, all phones will need to be dual mode to work outside the areas where 3G operates. The 3 network has said that when it launches it will cover 60% of the UK population, that's a much, much smaller geographical area and doesn't include in-building coverage. Something Colin Tucker taught the world with Orange, a lesson painfully learnt with Rabbit, is that coverage matters more than anything. To provide 3 with a GSM network there is a co-operation with O2. taking over the company would give 3 better access to the network and an element of control that is lacking in a licence deal.
An example of this is O2's refusal to adopt EDGE. Dave McGlade, O2's managing director, says that EDGE, which triples the data speed of GSM isn't needed because we have 3G. For a lot of the world it is needed because 3G will be late. For a joint deal between 3 and O2 (where's that Scrabble bag?) EDGE will be needed to give a respectable data rate when outside the islands of 3G. The 3 network could give O2 the management skills it so badly needs.
Removing one of the UK rivals must seem attractive to 3 but the O2 3G licence remains a stumbling block. The 3 network got the biggest amount of radio spectrum because it was the new entrant. If 3 bought O2 then Vodafone's legal department, which is almost as wily as the accountants, would no doubt contend that 3 and O2 no longer constitute a new entrant. The one company certainly can't have all the 3 and O2 spectrum, but if 3G is going to take off so slowly the need for more spectrum, and so the value of it - to use it you have to build better equipped cell sites - is questionable. Perhaps it is best re-farmed among the new quartet of the networks.