December 24, 2000
“Nothing so undermines your judgement as the sight of your neighbour getting rich,” wrote JP Morgan in 1905. As I write, a telecom company is digging up the street outside the window, laying cables, promising me the world from my living room in a matter of months. The gouging out of Ireland’s road network is happening in every town and has been for the past six months at least.
It is contended that this new information superhighway will change our lives for good. That may well prove to be the case but my question is far grubbier and much less profound: will these telecom pioneers — whether they be fixed-line or mobile merchants — ever offer a decent return for their investors? Now that the vast majority of Irish shareholders own Vodafone as well as Eircom, the issue is whether a global bet on telecoms is better than a local one.
Innovation, according to Joseph Schumpeter, is the one outstanding fact of the economic history of capitalism and, where there is innovation, there is always speculation. The speculators are at the vanguard of the process and once the innovation has settled down, is proven to work and can guarantee decent but not dramatic returns, the speculator disappears and the investor takes over. The investor is a much more stable person, mainly interested in the way the company is managed today rather than the promise of vast riches tomorrow.
The other question for Eircom shareholders is whether companies such as Vodafone and the international telecoms market in general are still in the expensive innovation phase or have reached maturity? If we are still in the innovation phase, Eircom’s shareholders are speculators rather than investors.
In 1845, England was in the grip of a boom in railways. They offered the real prospect of linking the whole of England together efficiently for the first time. The general public was mesmerised by the prospect. Both Dickens and Wordsworth complained about the railway obsession while new expressions, such as “you’d better get up to steam”, entered the English language.
However, with the innovation came the speculation. The world wanted a slice of the action and, initially at least, investments in railway stock returned up to 50 per cent per annum. Given these returns, the number of railway projects exploded.
Most were financed on a `call’ basis, where 5 to 10 per cent of the money was put down in advance and the remainder would be ‘called’ when the project needed cash. All that was needed for a new line between two destinations was an act of Parliament. By late 1846, 1,200 projects were planned, all financed by punters on a `call’ basis. At the height of the boom, the paper value of certain projects had increased by 500 per cent.
By 1847 (in a way which showed just how removed Victorian England was from famine Ireland), 100 Irish railways were planned. They were to be financed by English investors, apparently oblivious to the suffering of the people.
During the boom, many speculators became fabulously wealthy. These included Charlotte Bronte who proved to be one of the master speculators of the day. The new wealth also changed the delicate social balance of Victorian England with new money usurping the power and prestige of the landed gentry. But storm clouds were brewing. In 1848, revolution abroad jolted confidence, prompting the Bank of England to raise interest rates. Faced with collapse in the feel-good factor associated with the easy money of previous years, many speculators found themselves caught between the falling value of their railway stock and the increased demand for cash in order to complete projects.
Thousands went bust overnight, as did many small banks that had underwritten such projects. Fortunes were wiped out and by 1850 railway shares had declined from their peak by 85 per cent. The total value of the shares amounted to only half the total cash invested in them. Average dividends amounted to a paltry 2 per cent and up to 25 per cent of projects never paid any dividends at all.
With that in mind, let’s look at telecom mania 1999/2000. Like the railways, telecoms promise huge returns for the ultimate winner, but with so much cash sloshing around, prices earlier this year became ridiculous. In April, hysteria kicked in with the next big thing: auctions in Europe. Five groups paid ï¿½37 billion or ï¿½630 per customer for five British 3G (third generation) licences.
In Germany, where ï¿½50 billion was invested, each customer was valued at ï¿½615. However, this month, similar Swiss licences went for a mere ï¿½20 per customer — a 96 per cent fall in value.
To finance the German and British ventures, Europe’s big telecoms companies went on an unprecedented borrowing binge. France Telecom is now carrying ï¿½65 billion in debt, up from ï¿½13 billion two years ago; Deutsche Telekom is ï¿½60 billion in debt, up from ï¿½30 billion; BT is ï¿½50 billion in debt, up from ï¿½3 billion.
Coinciding with this borrowing binge has been a sharp fall in their share prices and a disastrous launch of the Wap phone, which has been a conspicuous failure almost everywhere with the possible exception of Japan.
Maybe these are only teething problems, but when market leader Vodafone does not estimate a return from 3G until 2005-2007, deep root canal surgery rather than the cutting of milk teeth springs to mind.
On the fixed-line side of the business, competition has been so strong due to the new long-haul fibre-optic networks that the old indebted companies are losing market share by the hour and prices are plummeting.
The basic problem in global telecoms is far too much debt and a market that isn’t growing as quickly as most expected. Shareholders have been badly burnt and raising more cash is becoming increasingly expensive.
Two weeks ago the Bank of England warned investment banks against arranging new loans for telecom companies. Once the banks begin to get nervous we know we’re in trouble.
For Eircom investors, direct exposure to the international market via Vodafone might well be a godsend, but the climate suggests otherwise. It is difficult to see the telecoms fad generating serious returns for shareholders against a backdrop of diminishing global spending power and a requirement that bondholders be paid first.
For everyone else, the telecoms mania will leave some positive results. The railway mania in England left it with 8,000 miles of track by 1855. Likewise, the telecom mania will leave most of us with better communications, cheaper bills and a faster service.
But who pays for it? At the moment and into the near future, it seems that telecom shareholders have subsidised a better telecom service for the rest of the country. I suppose that is how democracy works but back in July 1999 it was all supposed to be so different.