So far, Li Ka-shing, an Hong Kong billionaire has not made
his money by growing business but by buying and selling them. He
started life by selling plastic flowers in the street. Presumably he then
bought the plastic flower stall next to him, sold it at a profit, and so
on. He is now one of the richest men in the world with, among many other
assets, all the wharves of Hong Kong. You'd have a job to be much richer
than that.
But, for a change, Mr Li's conglomerate, Whampoa, has budded a new
business -- called Three. There is a Three Hong Kong, a Three UK and a
Three Italy. He will not rest content until there are a hundred Three
companies all round the world and tens of thousands of Three stores.
Three started because he had already bought (and sold) large chunks of
two mobile phone companies, Orange and Vodaphone, extremely profitably.
In their early years, these companies had already spent billions of
pounds, deutschmarks, and francs, to gain 3G licences in Europe and had
hoped to bring off the greatest consumer coup of the second millenium --
the all-singing, all-dancing, 3G mobile phone, able to send moving video
pictures of yourself or surroundings to your interlocutor anywhere else
in the world, to roam the internet effortlessly and, if necessary conduct
a great many important activities of one's economic life and, if you
needed refuelling, to guide you by the optimum route to the nearest
choice restaurant in whatever city you happened to be.
The article which follows is mainly about whether the assets of Li
Ka-shing's Whampoa are sufficient to pull this off -- or, at least, will
be able to sell the present generation of the 3G phone (truly only a 2.5G
phone) to a wide enough public to justify the vast expenditures he is
having to make. Indeed, some eminent commentators are saying that the
whole enterprise will bankrupt Whampoa -- Hong Kong wharves and
all.
But this is not what interests me. It does not signify in the slightest
whether Whampoa and Three succeeds or fails. What is of the greatest
interest is that 3G is considered to be what I am calling a 'status good'
-- that is, a consumer good that is so significant that it sweeps all
before it, starting with the trend-setting middle-class and then working
its way downwards, producing vast profits as it does so and producing
wide swathes of further investment as byproducts. In short, rather like
the real status goods, the motor car and the TV, of the last
century.
On the face if it, the 3G phone ought to do so. It is meeting several of
my criteria for 'status goods', although it is far from achieving its
ultimate specifications. The 3G phone is sufficiently novel, useful and
entertaining that it is desirable. Its cost is high (about $600) so it
will be affordable by the middle-class only at first and can therefore be
brandished around as a status symbol for a year or two. It doesn't
actually use up a great deal of the consumer's time because he will
usually use it on the hoof or while he is doing something else, and
therefore it doesn't cannibalise on watching TV or driving a car and thus
tending to diminish their sales. And, finally, it will subsequently be
able to be produced increasingly cheaply and therefore make its way down
through all the lower socio-economic consumer groups, making profits all
the way.
Unfortunately for Mr Li, however, the 3G phone is not a status good in
the same way that the mobile phone was. Initially, the latter was
prohibitively expensive for most people but enough of them were sold for
manufactuers to be able to re-invest in successively better, smaller and
cheaper mobile phones until, now, it can be afforded by almost any
consumer. Because of this, and because consumers will treat the 3G phone
merely as a technicolour embellishment for their usual phone (which
already does the important things that people expect of it), the 3G phone
will not be able to be sold at a high price. The 2.5G phones that
manufacturers have already tried to sell at somewhere near profitable
prices have been spurned. Instead, Mr Li will have to bear most of the
initial cost, sell the 3G phone for little more than an ordinary mobile,
and hope that monthly revenues will gradually pay him back.
So Mr Li is actually selling a 'normal' consumer good, not a blockbusting
status good. And, in my opinion, even this consumer good is still too
expensive. The normal running costs of Three's 3G phones in England so
far is working out at $50 per month and, if it's used for sending colour
photos or downloading street maps and such then it will cost another $30
a month -- at a minimum. Using it extensively -- though not excessively,
as some use the ordinary telephone --and it could run away with $100-200
a month. No wonder therefore that, according to the article below, the
Three shops in London and Rome are thinly attended by enthusiastic
customers.
There is no doubt that, in due course, 3G phones will be able to do
everything that the enthusiasts claim, but it might take many years
yet and it will only be successful if the price and running costs are
comparable to normal phone costs. It is going to be an interesting and
delightful consumer good I'm sure but, in principle, of little economic
importance to the overall market place as, say, the car and TV were in
the last century.
A little squeek of something like reality appears in the FT
article below. This is uttered by an anonymous Hong Kong-based fund
manager who is obviously worried at the amount of time and energy that
Canning Fox and Frank Six, (senior executives of Whampoa) are
spending on the 3G phone campaign. Not only does this fund manager reveal
his anxieties about Whampoa but, considering that Whampoa is large enough
to be able to finance almost anything that could be a good seller, he
wails:
"Where is the next big thing going to come from? Do Canning and
Frank spend any time thinking about expansion or do they just manage the
daily business?"
"Where is the next big thing going to come from?" indeed! In my
view, the 3G phone, however, versatile and wonderful it will ultimately
become is no more than a nice little earner. A widely selling earner, but
only with modest profiits. It won't have the same economic effect as the
car, nor even perhaps the digital kitchen scale. I don't think there will
be a next big thing -- as a consumer good in the usual way
I seriously think we have reached the end of the yellow brick consumer
road. There is nothing I can think of which will cost, say, between
$1,000 and $10,000 -- an amount that middle-class consumers can afford,
but few others could to start with, that is also mass producible so that
the cost can come down steadily and steeply as other socio-economic
classes yearn for it, that is either vastly more exciting to use in the
home than the TV/DVD/PC or doesn't involve extra leisure time (which
would then cannibalise on TV/DVD/PC sales and thus have no net effect on
the economy).
There is one exception which meets all the above criteria. This is
non-rejectable replacement organs -- hearts, lungs, livers, kidneys,
whatever. Life-savers, obviously, in millions of cases every year. Grown
in accelerated fashion from the consumer's own stem cells so there is no
possibility of rejection, organ transplants will be the big seller of the
future. However, it will start as status goods existed a very long time
ago in our history when, for example, only kings could afford bronze
swords or, a little later, only regional iron age chieftains ruling over
thousands could afford chariots with iron-rims.
Organ transplants will be for the very, very rich. Li Ka-shing could
probably afford one (and would no doubt need one, if he were to live long
enough -- he is 75 now). There are a few hundred billionaires in
the world, and a few million millionaires in the world, so let's put the
starting price at about $500,000-$1 million. That would be realistic.
Yes, the price could no doubt come down to, say $5,000 (virtually the
cost of the necessary surgery) over the very long future and you could
say that this would be affordable by everyone. (The average credit card
holder has more debt than this now -- mainly for trivialities.) However,
considering the qualifications of retail staff who would be involved in
making this consumer item available, and the infrastructure required, we
could hardly expect that this consumer good, once successfully developed,
could be available for everyone for another generation at least. So I
don't think organ replacements are going to save the existing consumer
economy as it runs into the buffers. Organ replacements, as a status
good, and subsequently as an ordinary consumer good, will have to be for
the next type of economy, whatever that is going to be when the oil runs
out.
Keith Hudson
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THE WRONG CALL? HOW LI KA-SHING'S GAMBLE ON 3G TELEPHONY IS SQUEEZING
CASH FROM HUTCHINSON WHAMPOA
Problems with the third-generation mobile phone business in Euope are
being felt across the group -- prompting talk that Hong Kong's richest
tycoon has lost his touch
Francesco Guerrera and Robert Budden
Hong Kong's port teems witn me on a typically sweltering December
morning. Sailors run round the ships cursing; truck drivers shout as they
hurry to their vehicles; the giant red cranes at the water's edge lift
container after container to the shore. Such incessant activity at the
world's largest port is welcome news for Hutchison Whampoa, the
conglomerate controlled by the tycoon Li Ka-shing that owns Hong Kong's
international terminals. Every shipment passing through to feed China's
insatiable appetite for raw materials, every container of Chinese goods
sent from Hong Kong to the west, helps to pay for a risky business gamble
thousands of miles away.
Three, Hutchison Whampoa's fledgling third-generation mobile telephone
business, has had only a trickle of customers in its shops -- whether in
London, Rome or Stockholm -- in recent weeks. NEC and Motorola, suppliers
that between them had pledged to deliver 3 million telephones for Three's
"autumn offensive", suffered technical problems and could
supply only a fraction of the volume required. As a result, Three's
customer numbers have failed to take off.
The contrast between Hong Kong's bustling port and Europe's silent shops
exemplifies the dilemma facing one of the last remaining global
conglomerates. A group with sales of more than $9 billion, diverse
operations in 41 countries and a market capitalisation of $31billion is
finding a large part of its cash flow swallowed up by a heavily
lossmaking venture using promising but untested technology, with forecast
revenues of just $239 million this year.
The financial burden of 3G has being weighing on the conglomerate since
it spent an estimated $12 billion to buy 3G licences in 10 countries in
2000 and 2001. Having committed $22 billion -- $17 billion of which has
been funded -- to the venture, Hutchison now says it may have to find up
to $10 billion over the next three years to fund 3G. That is $3 billion
more than planned, taking the total investment to $24 billion.
Last month Mr Li warned that the delay in handset deliveries would
postpone the profitability of the 3G business to the end of 2006, a year
later than planned. The tycoon also abandoned the much-vaunted target of
signing up 1m customers in both the UK and Italy, its two most advanced
markets, by the end of this year.
"We expect that 3G may potentially wipe out Hutchison's earnings in
2004 and 2005," says David Cut, analyst at Merrill Lynch in Hong
Kong.
As the 3G business guzzles cash, there are growing worries among
investors, analysts and credit rating agencies that a serious problem is
developing for the whole company. "Hutchison is becoming
increasingly dependent on cash flows from its diversified operations,
from additional borrowings and from business disposals to support its
telecoms expansion," says Elizabeth Alien at Fitch, a rating
agency.
The concerns are twofold. First, are the financial pressures created by
3G so severe that they are affecting Hutchison's traditional ability to
buy and sell businesses at a profit? Second, has Asia's richest tycoon
lost his legendary dealmaking touch and plunged Hutchison into what could
be its biggest crisis since he took over the British-owned conglomerate
24 years ago?
Next year will be crucial in answering those questions. With 3G expenses
likely to rise sharply because of handset subsidies, network roll-outs
and mounting operating losses, achieving profitability depends on a
combination of internal resources, debt and asset sales.
In an interview with the Financial Times, Frank Sixt, finance
director, admits that the latest delays to the original business plan
could force Hutchison to raise a further $2.4 billion on top of the $6
billion it already needs for 3G up to 2006. To absorb the impact of these
spiralling costs, the group will become even more reliant on its core of
cash-generating divisions.
Cash and other liquid resources totalled $21 billion in the six months to
June -- a 27 per cent rise on the end of 2002. The increase was helped by
steady cash flow from 32 ports around the world, property investments,
supermarket and drugstores in Asia and Europe, and Canada's Husky Energy,
an oil and gas producer. These resources compare with net debt estimated
to reach $10 billion this year- - up from $6.2 billion last year -- and
likely to increase markedly in the next few years.
Merrill Lynch forecasts an increase in Hutchison's net debt/equity ratio
-- a measure of indebtedness -- from the current 18 per cent to more than
60 per cent by 2005-2006. Merrill also expects the interest cover ratio
-- how many times a company can pay its interest bill out of operating
profit -- to decline from 5.7 times in 2002 to just 1.4 times in 2005,
before recovering to near 6 times by 2008.
Rating agencies have already warned that sharp increases in indebtedness
could trigger a downgrade that would make it more expensive and difficult
for Hutchison to raise funds. "Hutchison's entry into the
telecommunications market is having a material impact on the company's
business and financial profiles," says John Bailey at Standard &
Poor's, which downgraded the company from A to A- this year.
Mr Sixt dismisses projections of large increases in debt as
"absolute nonsense", saying the company's debt to total capital
ratio -- a different yardstick from that used by analysts -- would peak
at about 30 per cent in 2005-2006. "There are a lot of idiots with
calculators, but that's not how we run our business. It gets a little
tiresome because ... we have proven ourselves time and time again in
terms of financial and fiscal prudence."
He points to last month's surprise decision to raise $5 billion with a
sale of bonds -- Asia's biggest global debt issue outside Japan -- as a
sign of the company's excellent access to capital markets. The offering
was raised from the planned $3 billion owing to strong investor
demand.
Creditors of the 3G business have also set vital financial targets during
2004. In March, revenue-based banking covenants kick in for Three in the
UK for $2.5 billion of bank borrowings. Failure to hit
targets contained in the covenant -- a possibility, given recent poor
sales -- will force Hutchison Whampoa to renegotiate with its
lenders.
Bankers to Three UK warn that some of the 16-strong group of lenders
could take that opportunity to withdraw their support. "Whether
there is appetite for further financing in the bank market is
doubtful," says one. "Bank appetite for telecoms has changed
since the peak [of the market] as some banks have had their fingers
burnt."
Mr Sixt indignantly rejects the possibility of a covenant breach.
"No Hutchison subsidiary will ever breach a covenant," he says.
"Give me a break. It's my job to make sure that never happens and
believe me it will not happen."
The most likely compromise, should 3G fail to meet the revenue targets,
is that the banks will push for new loans with different maturities and
possibly higher interest rates or require a cash injection from Hutchison
into the 3G division.
Hutchison has a wide array of businesses that could be sold to fund 3G.
Mr Li, 75, began amassing his $7.8 billion fortune by selling plastic
flowers and is nicknamed "Superman" for his ability to buy at
the bottom of the market and sell at the top.`"[Buying and selling
assets] is our trademark... When something is good value, we don't shy
away," says Canning Fok, Hutchison's managing director.
The initial funds for 3G came from the sale of Orange, the mobile
telephone operator set up in 1994, to Germany's Mannesmann in 1999 -- a
brilliantly timed disposal that eventually netted Hutchison a profit of
some $15bn. Other astute disposals followed, such as the sale of most of
Hutchison's stake in Vodafone and Deutsche Telekom.
With Mr Li still firmly in control, many investors feel 3G is unlikely to
cause a near-term cash crunch. But with potential buyers now all too
aware of the huge 3G funding requirements, Mr Li's ability to trade
assets at huge premiums could be constrained.
Hutchison has said it intends to spin off its Indian mobile phone
business and Hong Kong fixed-line operations -- two small units that are
unlikely to net anything like the lucrative gains of earlier
years.
Critics talk of a company and a management team preoccupied with 3G to
the detriment of other divisions. "Where is the next big thing going
to come from? Do Canning [Fok] and Frank [Sixt] spend any time thinking
about expansion or do they just manage the daily business?" asks one
Hong Kong-based fund manager.
Mr Fok rejects the complaint. "It's not the top management, it's the
whole company that is obsessed with 3G. The direction we have given to
the whole team is that... this is the challenge ahead. Those who are
directly related to 3G, they have to do a good job. Those [in other
divisions] have to produce better operating results."
He points to last year's $1.5 billion acquisition of Kruidvat, a Dutch
retailer, and the $3 billion invested in ports over the past three years
as examples of corporate activity outside 3G. "The machine did not
stop. You don't run a group like this by [being]
lopsided."
Even so, some investors and analysts wonder whether 3G is proving one
deal too many for Mr Li. The ageing entrepreneur, they note, has never
embarked on such a large financial transaction before. His fortunes, and
those of thousands of investors who follow him, were built on small and
medium-sized acquisitions. Even Orange -- like 3G, a risky venture built
from scratch -- had much less impact on the overall group. Orange's
attributable losses never amounted to more than 10 per cent of
Hutchison's reported earnings.
The Hong Kong retail investors who rush to touch Mr Li's coat on his way
to the office still trust his judgment and 20-year record. But some
international institutions now say that other conglomerates, such as
General Electric of the US, France's Bouygues and Smiths Group of the UK,
have stronger balance sheets and better short-term prospects than
Hutchison. Hutchison's shares have underperformed this year, rising 12
per cent against the 28 per cent increase in Hong Kong's Hang Seng
index.
The management believes the group is being treated harshly by analysts
and the press. Mr Fok argues that the company's status as an Asian new
entrant into the mobile phone industry has upset large Europe-based
telecoms groups. "We are like David against Goliath. Normally people
go for David, but this time around everybody is supporting Goliath even
though David is trying very hard," he says. "For God's sake,
give David a chance. We have the capital, the people and the imagination.
We are going to do it."
At the Hong Kong port, workers have a reliable rule of thumb to gauge the
health of the company's operations: business is good if the piles of
containers stacked up on the shore are at least five high. At the last
count, they were seven high. Mr Li, and all Hutchison's investors, must
pray it remains that way until Three's shops in London and Rome fill
up.
Financial Times -- 4 December 2003
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