THE LAST FRONTIER
Chile may be the most happening telecom market in the world right now. Last November, in an effort to jump-start its woefully inadequate phone system, the government threw long-distance and international calling markets open to competition and eliminated rate regulations. The number of carriers serving Chile's 14 million people shot from two to nine, and demand skyrocketed. Chileans made 10.2 million minutes' worth of long-distance calls between January and July, twice as many as in the same period a year before. International calling minutes soared 77% in 1994's fourth quarter. Calling revenues are rising at an annual rate of 14%, twice as fast as the overall economy.
Problem is, nobody's making much money. The free-for-all pushed international calling charges as low as a penny a minute in December--Chileans were calling China just to find out what Chinese sounded like. In the first quarter of this year, Chile's phone companies were among the handful in the world that didn't turn a profit. It doesn't help that their billing systems are primitive: In December, one woman was billed just $18 for seven hours of calls to the U.S., Malaysia, Israel, England, Sweden, and Australia. In July, one 22-minute call to Canada cost her $180. Telex Chile's hand-delivered bills arrive long after payment is due. Entel, the former long-distance monopoly, sent customers four sets of monthly bills in five weeks.
So who would want to do business in Chile? How about BellSouth, Bell Atlantic, SBC Communications, Italy's STET, Telefnica de Espaa, and Samsung Group? They're already in, and Sprint and MCI Communications may decide to join the fun. BellSouth, which saw its share of the Chilean long-distance market double from January to July, to 7%, plans to invest up to $300 million in the country by the year 2000. "We knew it would be difficult coming in, and this has been confirmed," says Gerald Breed, general manager of BellSouth Chile.
That's life in the lands that the Information Revolution forgot. From South America to Africa, Asia, and Eastern Europe, less-developed and emerging economies around the world are the last frontiers for the telecommunications industry. As Chile's wild ride shows, the road to a wide-ranging, modern telecom system is seldom smooth. What with changing political regimes, collapsing currencies, widespread corruption, union opposition, and unpredictable surges in nationalism, any foreign company doing business in an emerging nation must be prepared to hang in there for the long haul. After all, it can't just rip out its lines and go home when times are hard.
But the near-term hassles and risks pale beside the potential gains: The world's developing countries have laid out plans to spend on the order of $200 billion in the next five years to bring their phone networks--and nations--into the 21st century.
PRIMING THE PUMP. Granted, planning and actually spending are two different animals. And it might seem a lot easier for the world's biggest telecom companies to stay home. Deregulation and new technologies are making telecommunications hot in the U.S. and Europe, too. But those regions are moving toward liberalization in fits and starts. And even if Congress agrees on a telephone deregulation bill and nations such as France and Germany open up their markets, there won't be the same potential for growth.
No, for the biggest returns, it pays to look to the developing world. Right now, a handful of high-income countries, with only 15% of the world's population, lay claim to 71% of the world's main phone lines--the ones that connect the subscriber to the central switching office (map, page 100). More than 50% of the world's people have never even used a phone. So dire is the situation that the International Telecommunication Union (ITU) defines universal service as when everyone in a country lives within five kilometers of a phone. Forget about a handset in every kitchen.
That kind of scarcity makes the telecommunications business as sure a thing as death and taxes. Despite a widespread recession, constant demand for more phones caused the annual growth in main lines around the world to steadily accelerate for the past decade from 4.5% to 5.2%. The future looks even brighter, according to the ITU: The world's countries want to spend some $60 billion per year through 2000 to build 310 million main lines--two-thirds of which are targeted for developing nations. These countries, home to 80% of the world's population, plan to increase the number of phone lines by an average 11.7% a year for the next five years, compared with 3.7% for the world's 24 highest-income countries.
China alone is a huge market and challenge for equipment makers. The world's most populous nation wants to install 100 million digital lines by the end of the decade, at a cost of $40 billion. Its goal: Elevate telecom penetration from 3 lines per 100 people to 8 in five years. That means it will have to install a network the size of Bell Canada each and every year. "China is the hottest opportunity in the world," says James R. Long, president of world trade for Canada's Northern Telecom. "Everybody is trying to get in there."
Whether it's in China or Chile, there's good reason for this phone frenzy. Emerging nations realize they cannot develop their own economies or hope to compete in world markets without top-notch communications systems. For proof, all they need do is plot their gross domestic product and the number of phone lines per capita on a graph. There is a one-to-one link: The higher the number of lines, the higher the income. With the global economy shifting more toward services, countries that aren't adequately wired will fall further behind--especially if they want to be more than the sweatshops for the world and attract high-tech, high-salary businesses. As one U.S. government official says: "If you are not connected to the global network, you are nowhere."
In nation after nation, a modern communications infrastructure is priming the economic pump. Take a look at Turkey. It started upgrading its network in the 1980s, pushing the number of phone lines per 100 people from 3.5 in 1983 to 16 by 1992. Today, Turkey's calling revenues are high enough to pay for development of the network itself, eliminating the need for foreign loans to prop up the phone system. A domestic telecom-equipment manufacturing sector has also emerged, exporting switches. In the same period, Turkey's GDP per capita rose to $1,905 from $1,460.
Still, poor nations can't start their network upgrades without massive infusions of foreign investment, skills, and technologies. To get them, countries are loosening regulations and opening their doors to foreign telecom companies of all types. Equipment makers flood through first--AT&T, Motorola, and Northern Telecom from North America; Alcatel Alsthom and Siemens from Europe; NEC from Japan. The developing nations may lack capital and technical savvy, but they do have a future source of cash--a steadily rising stream of calling revenue once the gear is in place.
In a typical deal, the foreign equipment maker or phone company funds the network and maybe even runs it--getting a guaranteed stake in future revenues. Foreign telecoms are swamped with opportunities in the developing world to buy equity stakes in phone companies, snap up cellular licenses, or build and operate a network for a number of years before transferring it back to the country. "There are many, many development projects where we as the manufacturer must take a share in the risk of providing and installing equipment to developing nations," says Bert de Grave, director of operations for Alcatel Alsthom's international division.
For the really big projects--building 3 million lines in Argentina, for example--countries are willing to sell off the phone company to a foreign operator. But there are lots of variations for smaller deals: Soft loans, joint ventures, build-operate-transfer agreements--all are becoming commonplace for equipment makers who elsewhere simply install the equipment and move on.
Motorola Inc., for example, is best known as the top supplier of cellular-phone equipment. But it set up a unit in 1988 to operate systems in the developing world through joint ventures with local partners. It now runs 20 networks. "At the start, we saw it as a good way to kick-start equipment sales," says Michael Norris, head of Motorola's joint-venture business. "But it's been a very good revenue stream."
PRETTY PAYOFFS. Where are the opportunities? Start with the list of nations that are set to sell off their state-owned phone companies. There are 26 phone-company privatizations scheduled for the next three years in emerging markets (time line). At the same time, licenses for new wireless networks are being issued at a head-spinning pace. India, for example, is auctioning off 40 cellular licenses--two for each of 20 operating regions.
Where markets open, capital quickly follows. "In Europe, they are liberalizing in order to introduce competition. In the developing world, they are doing it to raise cash for the network," says William W. Ambrose, president of Pyramid Research Inc., a telecommunications consultancy in Cambridge, Mass., that specializes in developing nations.
The money won't flow, however, if the local governments can't be trusted. Right now, investors are wary about bidding in India's cellular auctions because the government abruptly canceled a $2.8 billion contract with Enron Corp. to build a power plant, even though construction had already started. If one deal is shaky, though, the money will quickly flow to the better ones. "There is a substantial amount of capital in search of investment opportunity," says Michael T. Masin, president of GTE's international business.
For the companies that choose wisely, there are big returns. Northern Telecom's annual sales in the Asia/Pacific region have tripled in the past three years, to $1 billion. U S West Inc.'s $100 million investment in a Russian phone company in 1991 has also risen threefold in value. Nynex Corp. bought a 15% stake in a newly formed Thai phone company, TelecomAsia, for $470 million in 1992. At the time, analysts complained that Nynex was overpaying. Today, its stake is valued at $1.2 billion (page 102).
Those kinds of payoffs have filled the air routes to Asia, Latin America, and Eastern Europe with telecom executives from companies large and small. "You can't be a player in this business if you're not in the developing countries," says Martin Shum, chief executive of ACT Networks Inc., a California-based manufacturer of equipment that increases satellite network capacity. "That's where all the growth is. That's where all your competitors are."
But doing business in developing regions requires a leap of faith that the conservative phone companies of the industrialized world have rarely needed to make. And the risks are as much political as financial. A developing country's state-owned phone company does a lot more than transmit calls. It is often a nation's largest employer. Phone tariffs can subsidize everything from schools to the presidential palace. And international calling revenues--boosted by huge surcharges--are a primary source of hard currency for poor nations with few exports. "Telecom is an intensely political business, and not just because of the size of the investment," says Ken Zita, a consultant with Network Dynamics Inc., a New York-based telecom adviser to developing nations. "There are so many really fundamental macroeconomic and political issues involved."
In some cases, politics have sandbagged ambitious telecom upgrade plans. Take Kenya, where the World Bank tied a telecom loan to deregulation. The national phone company would have had to eliminate thousands of jobs to become more efficient. "They tried to get the funding and pretend they were laying people off," says Richard Brolly, Sprint Corp.'s director of business in Russia, the Mideast, and Africa. "It's a big political hotcake."
There is also the disquieting sense on the part of some nations that they are selling off a valuable piece of their patrimony to their former colonial rulers. "Countries are really struggling to come to grips with this situation right now," says Northern Telecom's Long. "They may have had outsiders in as consultants before, but never as owners."
Nationalism can slow development: China, long suspicious of outsiders, continues to ban any foreign equity ownership, operation, or management of its telecommunication sector. "Whenever I talk to the Chinese about foreign investment they say: `Well, we're studying the issues,"' says Surinder Hundal, corporate relations manager for British Telecommunications PLC's Asia/Pacific operations. "The phone company is quite a valuable asset, and I think they would prefer to keep control in government hands."
ONLY THE BEST. China has, however, put the machinery in motion to bring in foreign assistance. It created a second phone company, Unicom, to challenge the Posts & Telecommunications Ministry's iron grip. Unicom has signed several memorandums of understanding with foreign companies that involve minority stakes. But, says one adviser, "they usually aren't worth the paper they're written on." Laments Ahmed Laouyane, director of the ITU's development bureau: "However much we try to narrow the development gap, local and international politics and policies will always be in the way."
Still, telecom is such a guaranteed moneymaker that few companies are willing to miss out--especially on a market the size of China or India or Indonesia. By 2000, 40% of the world's population will reside just in those three countries. Another prospect is Brazil. It has the ninth-largest economy in the world but a phone-line density of only 6.8 per 100 inhabitants. Russia holds enormous promise, too, pending the resolution of its many political and economic problems.
Beyond the giants, such countries as El Salvador and Bangladesh are seeking to develop their telecom networks any way they can. Even Africa, home to the world's poorest nations, is starting to attract some buzz (page 114).
None of these countries will settle for any old equipment, though. Developing nations, unencumbered with decades-old copper wires, are installing digital switches, fiber-optic lines, and the newest cellular technology. The most sophisticated networks in the world are in Djibouti, Rwanda, the Maldives, and the Solomon Islands, where 100% of the main lines are digital, compared with 49.5% in the U.S.
Advances in cellular technology also are showing up first in developing countries, because the technology allows them to put up a first-rate phone system in a matter of weeks or months rather than the years it can take to lay cable. Telecom companies can try out such state-of-the art technologies as digital satellite or fixed wireless, where the final link to the home in a fiber-optic network is a low-powered cellular connection, without having to worry about incorporating an existing huge network. Chile plans to throw the switch in December on a wireless personal communications service (PCS) network months ahead of the first U.S. system.
PHONE LUST. Foreign phone companies are often surprised by how quickly poor nations take to phone service. Put a phone in, and someone will call from it. No matter how poor, when a country builds up its telecom network, demand for phones and calling minutes rise. "Their willingness to pay for phones is far higher than anyone ever thinks," says Roger A. Dorf, president of AT&T network systems in Latin America and the Caribbean. "It is always underassessed in every country."
For the world's telecom companies, then, the biggest problem is not finding a place to invest but deciding which of the many places are the best. Gary M. Epstein, an international-telecom specialist at the Washington-based law firm Latham & Watkins, advises companies interested in buying into a developing country's newly liberalized phone market to first decide how much liberalization is enough. Most would prefer to avoid Chile's free-for-all and instead have competition phased in while they prepare the antiquated network for competition.
The toughest issue, though, is figuring out whether an investment opportunity is fairly priced. "You have to look at the government's reason for selling," says Epstein. "There should be certain goals and targets, like the provision of universal service. If they're selling it just to make money, chances are it's not a good deal." Pakistan is often cited as a potentially bad deal. The government sold 10% of its phone company's shares to the public last year and is now seeking a strategic investor. The government values its carrier at about $8 billion. But with Pakistan's weak infrastructure, poverty, and political turmoil, "most of the world doesn't believe it," says Sprint's Brolly.
Even the best-assessed deals can turn sour. GTE, AT&T, and Spain's Telefnica have learned that lesson all too well. They spent $1.8 billion for a combined 40% stake in Venezuela's monopoly phone company, CANTV. Last year, a financial crisis caused Venezuela's government to impose currency-exchange controls, preventing CANTV from making payments to foreign holders of its hard-currency debt. It defaulted, and the government reneged on a commitment to let CANTV raise phone rates every three months to keep pace with inflation.
"PLEASE PRIVATIZE!" Still, the foreign operators are hanging in. They just renegotiated CANTV's debt, and GTE says it was at the breakeven point on its investment at the end of last year. "You have to go at this with a mentality that you're going in there to stay, and ride over the rough spots," says AT&T's Dorf. "It's awfully easy to say things are tough in Venezuela and pull out, but then your credibility is shot in the rest of the region."
Not a good idea, given Latin America's enormous markets. Phone companies there are privatizing and liberalizing at a faster rate than in any other region, and welcoming foreign investment. The technical sophistication of networks is among the highest in the world. Telecom Argentina, the country's northern operator partly owned by France Telecom and Italy's STET, has plans to build a combination cable-TV/telephone network. Even Mexico's peso crisis, which rippled through the region, has failed to scare off investors. Bell Atlantic and SBC saw the value of their holdings plummet, but the crisis pushed the government to speed up liberalization to raise money. "You still have every major U.S. operator eager to jump into Mexico," says Linda Barrabee, analyst with Pyramid Research.
Latin America's biggest prize--Brazil--is just about in reach. It has a growing economy, 156 million people--and a wholly inadequate phone system. Says former Finance Minister Mrio Henrique Simonsen: "If you are in Rio and trying to call from Ipanema to the neighborhood of Botafogo, after 15 minutes of not getting through you want to scream, `Please privatize the phone company!"' This August, the Brazilian National Congress voted to do just that, passing a law loosening state-owned Telebrs' monopoly and allowing private and foreign investment. Privatization of Telebrs' 27 regional phone companies could begin in 1997.
First, though, cellular phones are likely to be opened to competition, creating eye-popping chances to make money. About 721,000 Brazilians have cellular phones, and 1.5 million are on waiting lists. The number of subscribers is expected to zoom to 6 million by 1998.
In Asia, while China and India crawl toward liberalization, other nations are bolting ahead. "When you look at India and China from a head-count perspective, they are clearly enormous," says Roy A. Scholvinck, the Los Angeles-based director of global operations for EDS's management consulting group. "But when you look at the disposable income, it gives you a different perspective."
Indonesia's perspective, for example. The nation of 190 million has twice the per-capita GDP of China and wants to install 5 million phone lines over the next 3 1/2 years--at a cost of $6.8 billion. The country opened its market to competition last year, and 30 different international consortiums submitted bids. State-owned telephone company PT Telkom selected five consortiums this past June, led by Nippon Telegraph & Telephone, Telekom Malaysia, Singapore Telecom, France Telecom, and Australia's Telstra, to build and operate the networks for 15 years. Significantly, two companies linked to the family of President Suharto were eliminated after they failed to submit the highest bids, a harsh brush with fairness.
Foreign investors are also eyeing the former East Bloc. But the enthusiasm that erupted after the fall of the Berlin Wall has dampened. Changing political regimes have slowed the decision-making process to a standstill. There have been five different post and telecom ministers in Poland and there has been similar turnover in the other new democracies--and each change has been accompanied by a new plan.
Financing is another huge problem. Phone tariffs in some former Soviet republics are nonexistent because of a lack of billing equipment, so the regions can't pay for any massive improvements themselves. Siemens still manages to do "several hundred million marks" per year of business in the region, says Jurgen Lagleder, head of public telecom sales for Siemens, but not all of it is exactly liquid. Siemens sold a telephone exchange to a local government in Russia on the Caspian Sea recently--for $6 million worth of caviar.
Still, not a bad deal if you like caviar. And once the government gets a modern telecom infrastructure in place, it might start exporting its own caviar and use the money to build more phone lines. It's a vision that all developing countries share, in one form or another, and if it happens, it should lift the entire global economy. Wouldn't it be nice if everyone could phone home?
Calling For Investment
Telephone company privatizations in developing countries
*Russia's 86 long-distance companies
**Sale of Rostelecom, Russia's long-distance and international carrier
DATA: PYRAMID RESEARCH INC.By Catherine Arnst in New York, with Susan Jackson in Santiago, Michael Shari in Jakarta, and bureau reports