Magazine

Tale of a Bubble


Martin Bouygues thought he was the only sane man left in Europe. The cautious Frenchman ran Bouygues Telecom, France's No. 3 cell-phone network, and in the spring of 2000 he was under intense pressure to bid billions of euros for licenses to operate the so-called Third Generation (3G) of mobile networks. The technology behind 3G was certainly intriguing: It would turn a cell phone into the ultimate portable computer, the key to the mobile Internet. But shelling out billions just for a license in an unproven technology? To Bouygues, the scion of a French construction empire, this was sheer madness, a tulipmania that would bankrupt the entire European telecom industry.

So on May 6, he sat down to write a letter, a warning to the entire Continent. Three days later, it appeared on the front page of Le Monde. Many operators faced a grim choice, wrote Bouygues, between quitting the business--the price of not bidding for a license--or drowning in debt. "What should I tell my employees?" wrote Bouygues. "That we have a choice between a sudden death and a slow one?"

Few heeded Bouygues' warning. But sure enough, in the two years since he wrote that letter, the easy money has dried up. Europe's phone giants--after spending half a trillion dollars on licenses, acquisitions, and networks--are treading madly to stay afloat in a sea of debt. Chairman Ron Sommer of Deutsche Telekom (DT) is sitting on $60 billion in liabilities and casting about frantically for assets to sell. Onetime golden boys, such as Vivendi Universal's (V) Jean-Marie Messier and France T?l?com's Michel Bon, are struggling to hang on to their jobs. Handset manufacturers, such as Alcatel (ALA), Royal Philips Electronics (PHG), and even Ericsson (ERICY) are hurrying out of the business, and Nokia (NOK) Chairman Jorma Ollila has seen his high-flying stock fall by 75%. Even Vodafone Group PLC's (VOD) Chris Gent, 3G's biggest cheerleader, has fallen hard. In early 2000, he barely broke a sweat putting together $163 billion for his stock-and-cash takeover of Germany's Mannesmann. Now, Vodafone directors are debating whether to take a write-down on $25 billion to $50 billion of acquisitions purchased at the top of the bubble--a bubble Gent helped inflate to unheard-of proportions.

And the mobile Internet? Oh that. In fact, the high-speed project known as 3G is plowing ahead, though on a smaller scale than anticipated and a year or two behind schedule. Throughout Europe, phone companies are setting up the first transmission towers and testing the handsets that as early as next year will be able to shuttle data at the speed of a broadband connection--or even faster. But this time around, there won't be any blowout launch parties. Europe's phone industry has discovered that when 3G is mentioned, investors run. "3G is a frightening word," says Roel Pieper, a former executive at Philips and president of Favonius Ventures, an Amsterdam venture-capital firm.

What happened? Nothing less than a Continental debacle. This project for a new, high-speed wireless Internet was Europe's audacious bid to lead the world in a crucial 21st century technology. For Europeans, it was a megaproject, the equivalent in size, vision, and expense of America's Apollo space program in the 1960s. Yet 3G has stumbled from the get-go, a victim not just of miserable market timing but also of a host of local problems ranging from shortsighted and greedy national politicians to a regional policy that imposed a single expensive technology and pushed all countries to adopt it in lockstep. Compounding the damage, an industry built on transmitting the spoken word has failed utterly to create data services that customers will buy. "The industry has not been looking at the user," laments Niklas Savander, vice-president for mobile software at Nokia (NOK). "It's been looking at its own navel."

True, Europe has plenty of company. America had its dot-com implosion, and the U.S. phone business is wading through its own crisis. But the Old World has no computer industry to fall back on and, with the exception of Germany's SAP, is an also-ran in software. From Nokia and Ericsson to Vodafone and Deutsche Telekom, the phone biz is the soul of Europe's tech industry. Each of these companies was intent on riding 3G to global stardom.

And what do they get for it? Technology delays, downgrades on their bonds, and swooning stocks. Now Europe, which bet much of its tech future on a single technology, sees its champions bogged in a swamp of 3G debt. Consequently, the region is fast losing its edge in wireless. "The balance of power is shifting across the Atlantic, to Microsoft Corp. (MSFT) and other companies that understand applications," says Keith Woolcock, an analyst at Nomura Securities Co. in London.

This is the story of a monumental gamble and the blinders worn by a gaggle of eager telecom executives, technologists, bankers, investors, and, yes, journalists. Together, they toasted an industry that promised instantaneous information everywhere. And while some true believers still cling to that vision, Europe's painful stumbles in the past two years show what happens when a single shining dream lands in a maddeningly complicated region just as the easy money runs dry.

Anssi Vanjoki, Nokia's executive vice-president, remembers his first notion of the mobile Web. It was 1993, and Nokia, having bet heavily on digital mobile phones, was just starting to establish itself as a force in the industry. Vanjoki saw one of his new hires hunched over a strange-looking database on his PC and asked him what it was. Turned out the newcomer was online, using the Gopher search engine to browse through the library at the University of Texas. Vanjoki recalls: "I thought if he could do this on the computer, could we do the same thing someday on our digital phones?"

Across Scandinavia, lots of engineers were having similar thoughts. And what seemed like a fantasy in '93 was downright mainstream by mid-decade. Propelling it was Moore's law. With ever cheaper, stronger, and smaller microprocessors, developers not only envisioned shrinking an entire computer into a mobile handset by the turn of the century, they went to work on the project. As they pieced together 3G prototypes, the Internet was developing into a consumer business and Web startups such as Netscape Communications Corp. were stock market darlings. Maybe there would be enough Web-phoria in the markets to foot the bill for Europe's 3G build-out.

With the Brussels government mapping out the timetable and technology, Europe prepared to create a Continental network on a single 3G standard. A decade earlier, similar central planning had helped transform the region into the world's richest wireless market and turned Europe's wireless players, from Nokia to Vodafone, into global phenomenons.

But the mobile Net would prove far trickier to orchestrate. In the cell-phone business, operators simply invested in networks and sold handsets and the business took off. Subscribers produced their own content simply by talking. In the mobile Internet, operators would again focus on what they knew best, building costly and complicated networks. But this time, handsets are a problem. 3G phones may well cost $800--and devour batteries. Worse yet is the dirty secret of bandwidth: Without compelling content and services to sell, high-speed networks are a waste of money. "The [phone companies] are paying through the nose for something that's not very valuable," says Francesco Caio, founder of Omnitel, an Italian mobile company now owned by Vodafone.

The Europeans, of course, knew that software was crucial. In the late 1990s, planners in Scandinavia settled on a two-pronged strategy to turn Europe into a development mecca for the wireless Web. First, in 1998, they teamed up with the phone manufacturers in a London joint venture dubbed Symbian. This company would provide operating systems for 3G phones. The clear goal: to keep the predatory Microsoft from hollowing out the profits in the next Internet. "We understand mobility. Microsoft doesn't," said Juha Christensen, a prime mover of Symbian and the company's first marketing manager.

At the same time, the Europeans counted on venture capital to seed software startups throughout the region. These shops would produce the games, news services, and e-commerce programs to bring the mobile Web alive. Sure enough, the VC funds arrived as scheduled--and shook up entire societies. In Stockholm, students at the prestigious Royal Academy of Economics started to drop out en masse and write wireless business plans.

The 25-year-old Per Mosseby typified the trend. In 1998, he launched Melody, a Stockholm software company specializing in business applications for the mobile Web. Within a year and a half, he landed $10 million in venture financing, and Melody grew to 70 employees. And yet for Mosseby and hundreds of other Netrepreneurs, the timing was off. They were writing code for a mobile Net that barely existed. For most, the money ran out long before the first 3G transmission towers went up across the Old Continent. Early this year, Mosseby folded what was left of his company into a more successful mobile-music company, Mobilehits. "They're actually making money, which is very rare," he says.

But that rude awakening was in the future. While Mosseby and other twentysomething Netheads were landing some VC funds, their elders were gambling with bigger stakes. On the night of Oct. 19, 1999, Canning Fok, managing director of Hong Kong's Hutchison Whampoa Ltd., pulled off a sale that would ignite a buying frenzy. Following a week of round-the-clock negotiating, Fok and his bankers from Goldman, Sachs & Co. managed to sell Hutchison's European phone business, Orange, to Germany's Mannesmann for a rich $30 billion. Fok celebrated the deal with his bankers at 3 a.m., ordering hamburgers with onions at London's Sheraton Park Tower Hotel and washing it all down with a bottle of Chateau Petrus grand cru.

The chain reaction of deals had started. Buying Orange put the German carrier into direct competition with the titan of Europe, Vodafone. This would unleash the biggest hostile takeover in history. The Orange deal not only provided Mannesmann Chairman Klaus Esser with a valuable foothold in Europe but also amounted to a $30 billion poison pill. Mannesmann, he concluded incorrectly, was now too big to be swallowed. But the very night of the takeover, Vodafone's Gent summoned his bankers and organized his counterstrike.

What followed was a pitched two-month takeover battle. The race between Gent and Esser focused almost exclusively on the companies' stock valuations. Vodafone stock, after all, was Gent's currency, and a rich stock was Esser's defense. In this battle that raged at the height of the dot-com bubble, both men drove up their stocks by positioning their companies as masters of the next great thing, the mobile Net. In the end, Gent won by securing an alliance with Vivendi's Jean-Marie Messier. Together, they promised to deliver the entire digital world--television, music, e-commerce, and cell phones--from a single portal called Vizzavi to some 70 million subscribers. Vizzavi would provide services, said Gent, "through any device that accesses the Internet, to anyone who chooses to use it, wherever they may be." Vizzavi has since fallen flat in the marketplace. But its announcement helped drive up Vodafone's stock, securing the Mannesmann deal.

More important than Vizzavi, though, was its implication. In coming years, mobile-phone companies would be competing in a dizzying range of Internet services. For this, it appeared at the time, they would require big chunks of the digital economy, from phone companies to Internet businesses and even cable-TV stations. And in this period of plenty, they bought like mad.

Take France T?l?com. In Britain alone, Chairman Bon spent more than $40 billion to buy Orange from Vodafone and gobble up Britain's leading Internet service company, Freeserve, and 18% of the cable company NTL. Deutsche Telekom's Sommer matched him nearly step for step, buying Internet businesses in France and laying out $50 billion for the U.S.'s VoiceStream. "We all had easy money," says Bon.

Then came a surprise. It started in March, 2000, with a handful of British government employees in a single room in London. They had 13 phones, one for each bidder for British 3G spectrum. The Blair government imported the American auction system, judging that it was the fairest and most transparent contest.

Reducing the 13 bidders to five survivors took seven weeks and an exhausting 150 bidding rounds. It produced a windfall for British coffers and a disaster for the industry. Trouble was, as Martin Bouygues had noted in France, a loss in the auction was seen as a death sentence. So bidders didn't have much choice. What's more, investors were all too willing to bid up the stocks of the bidding companies--and punish them if they bailed. "If we dropped out, our market cap would fall by far more than the price of the license," said an exec at Spain's Telef?nica at the time.

There was one crucial difference, though. Operators would pay for licenses in cash, not high-flying stock. As the bids passed $1 billion per license and then $2 billion, $3 billion, and $4 billion, investment bankers put aside their carefully conceived earnings and cash-flow models. In a battle for survival, as the London auctions appeared to be, the numbers were mere details. "The bidding is not based on rational decisions," said one American banker advising Vodafone.

Officials at Nokia and Ericsson were getting alarmed. They had scheduled an orderly rollout of pricey networks and handsets for each stage of the mobile Internet. But the auctions, while ostensibly designed by the governments to speed rollouts, could drive small players out of the market and force even big ones to slow their capital spending. "I went to Chris Gent and told him it was madness," says an executive at Nokia. "He shrugged and said, `What can you do?"'

At the London auction, investors ignored not only the numbers but also early strong evidence that the mobile Internet was going to be a tough slog. Already, the first smart phones were hitting Europe. Their makers hoped to replicate the success of i-mode, the mobile Net service offered in Japan by cell-phone operator NTT DoCoMo (DCM). Yet compared with the zippy i-mode, Europe's services were slow and primitive. In March, 2000, at the massive Cebit technology fair in Hanover, Germany, Alcatel officials displayed a traffic map of Paris that looked, on the tiny black-and-white screen of a sample cell phone, like a pulsating amoeba.

It wasn't just that applications were in short supply. The service also failed to adjust to changing borders and languages--key issues in Europe. German travelers in Spain could check weather and movie schedules back home in Frankfurt but got nothing for Madrid. The phone was mobile, but the service usually was not.

The turning point for Europe's wireless industry came in Germany, where seven groups pledged a total of $45 billion for chunks of precious spectrum. The U.S. dot-com bubble had burst four months earlier, and some of the new skepticism, with its focus on the bottom line, was washing across the Atlantic. Hutchison Whampoa's Fok felt the change in mood. Halfway through the auctions, he stunned his partners, NTT DoCoMo and Royal KPN, by withdrawing from Germany. "It was just too much money," said Fok.

The party was over. Stocks plummeted across Europe. While the investment bankers considered their dubious handiwork, the rating agencies' time had come. They promptly downgraded the ballooning debt of France T?l?com, Deutsche Telekom, and KPN. Operators promptly slammed the brakes on spending. These days, it's as if Europe's mobile Net existed solely as a gloomy debt story.

Saddest of all, in the more than two years since those phones were introduced, Europe's offerings on the mobile Web have barely improved. To be sure, European telcos have slowly upgraded their systems for a faster data service known as 2.5G. But as if embarrassed at the hype they generated during the bubble, they barely promote the services. Instead, they focus on dependable revenue generators such as voice calls and the primitive short-text messages so popular among kids. These messages, which can be transmitted over any phone, now account for 10% of the operators' revenue. Some phone execs fear that if they promote the more elaborate Internet applications, they risk slowing the flow of profitable mini-messages.

Martin Bouygues had the last laugh. To entice him to even bid for a license, the French government had to slash the fees from $4.4 billion to $557 million. Bouygues now plans to roll out his new network--slowly.

Now, the leading company to trumpet its 3G offering in Europe is foreign: Hong Kong's Hutchison, which kept a European presence after selling Orange, is proceeding on a long-shot plan to roll out the high-speed service late this year in Britain, long before its homegrown competitors do. And after two years at Europe's ambitious software startup, Symbian, Juha Christensen tired of the feuding among the partners and went to work for the arch-enemy, Microsoft. "These guys understand the importance of applications," he says from his house in Seattle.

Nokia, Europe's only consistently profitable cell-phone maker, now appears to be bypassing Europe's application woes. The goal now, building on the success of short messages, is to encourage users to create their own content. One new line of phones, for example, features digital cameras. The idea: Users will snap pictures and spend perhaps 75 cents to send them to a friend's phone or e-mail. "People have little moments in the day with time to kill," says Nokia's Savendar. "If we can sell them something for those spare 5 or 10 minutes, it could turn into a big market."

Maybe. For now, though, it appears that Europe's telephone giants are content to service their huge debts and wait for the data markets to evolve. Analysts predict that 3G isn't likely to take off in Europe until the second half of this decade. The risk, of course, is that by muddling along, Europe once again will end up an Internet laggard.

The mood is grim. Just ask Anssi Vanjoki. The Nokia executive was gunning his Harley-Davidson through Helsinki last fall and got nailed with a $103,000 fine--the equivalent of 14 days of his stock-option-laden 1999 pay. (In Finland, speeders get fined according to their ability to pay.) Vanjoki appealed, noting that both the industry and his pay had taken a dive. The judge agreed--and this spring, lowered the fine to $5,500. Thus have the warriors of wireless fallen. These days, even traffic judges pity them. By Stephen Baker

With Mark Clifford in Hong Kong


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