Germond: unbundling the local loop is the key

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Cegetel, France's leading alternative operator, already has close to seven million mobile subscribers. In fixed, it is advocating rapid unbundling of the local loop. It is developing a multimedia strategy, drawing on the benefits of its main shareholder's interests in BskyB and Canal +. Cegetel's CEO Philippe Germond talks to Global Telecoms Business about its plans.

Cegetel, the leading alternative service provider to France, has been calling on the French government to unbundle the local loop. Khaled Beydoun, a utilities equity analyst at HSBC, examines the unbundling issue and the role of France's regulatory authority, ART: "Cegetel feels very strongly that the regulator is siding with France Telecom on the unbundling issue. In theory the regulator had promised a decision some time in the early part of this year. That hasn't come. This has clearly affected Vivendi's expectations and performance on the fixed line side. The local access issue is a very important part of their multimedia strategy, as it gives them access to the client."

Vivendi, one of the world's biggest water utilities, owns 44% of Cegetel. It is also owned by such established international operators as British Telecom (26%), SBC (15%) and Mannesmann (15%). The operator's prime asset is its mobile operation SFR. By the end of 1999 it will have over seven million subscribers. Beydoun talks about the operator's mixed cellular performance this year: "On the mobile side, they were doing very well until the early part of this year, when they started to lose market share to Bouygues Telecom. It was quite clear what was happening. France Telecom was holding on to 50% of the market, while Bouygues was taking market share directly from SFR. At the end of the year the actual number of subscribers at SFR is going to be higher than the initial target. They will have about seven million subscribers, compared to a target of about 6.2 million subscribers in January this year. So there is clearly an improvement, but the declining market share is obviously a worry and it seems to be continuing."

As Beydoun explains, Cegetel has concentrated on signing contracts with customers, rather than the pre-paid market: "I think that the pre-paid market in France has become the key focus for all mobile operators, but as far as Vivendi is concerned, they prefer the contract customers and they clearly have a much higher ARPU than the pre-paid users. In addition the acquisition cost of pre-paid users is much higher. I think that it was about Eu100 ($103) a customer, which is significantly higher. I know that their position in the pre-paid market is quite small. A very small percentage of their customers is pre-paid. So we could continue to see them lose market share, as the market grows on the pre-paid side. Their percentage of net adds does not reflect the increase in the pre-paid market."

Cegetel's success will be dependent on its ability to bundle services. The operator has begun trialling ADSL services in Monaco, where it has a majority stake in Monaco Telecom. Cegetel's multimedia strategy has been consolidated by a number of key moves by its main shareholder. Vivendi has acquired a 25.5% stake in BSkyB and has increased its stake in Canal +. There is clearly potential for co-operation between Canal + and BskyB, which could give Cegetel a foothold in the digital TV market. Beydoun talks about this strategy: "I think that they are going to use their advantage on the media side. I think that they are going to use that advantage on the Internet side where they have Canal + and part of BSkyB. I think that they want to use the integration of those activities to boost their communications strategy. They seem to shifting from previous attempts to be a major pan-European mobile operator to become more of a European multimedia leader, where they can also offer value-added services by using the other assets that they have in the communications division."

As Beydoun explains, Cegetel is a possible acquisition target: "At the end of the day, they have one of the most attractive assets in Europe. Vivendi and Bouygues are nothing outside France. So the likes of Mannesmann, Vodafone AirTouch and British Telecom would love to gain control of a French mobile operator. To date, however, they have not had a chance to do so. The immediate future will see the company continue to try and gain access to the local loop and also continue to boost its number of cellular subscribers. The fixed line market continues to be competitive, with new entrants such as Tele2 adopting aggressive pricing strategies to gain market share, which has put Cegetel's "Le 7" offering under pressure."

In an exclusive interview with Global Telecoms Business, the CEO of Cegetel Philippe Germond talks about the telecoms market in France and explains how Cegetel aims to keep the pressure on France Telecom.

Do you believe that the French government has been effective in unbundling the local loop? Do you believe that the market dynamics favour France Telecom?

The French government has made progress on unbundling, but its position remains very minimalistic. It is true that a French daily financial newspaper wrote last summer that "other than a military coup d'etat, unbundling in France seems impossible".

A few weeks later, however, the French minister, Mr Pierret, issued a positive statement on unbundling, limited to high speed Internet access (ADSL) and did not rule out total unbundling eventually, in other words for telephony. Today, despite favourable statements from ART and the minister, the situation remains uncertain and there is still resistance from France Telecom, including for ADSL access.

You recently spoke out quite strongly against the French government, questioning whether the government has been acting more in the shareholder's interests, rather than those of customers. Why do you think that this has been the case?

France Telecom really understands that, as long as they are in a monopoly position in local access, there is a huge cash flow to be generated by local access. They can see competition in some of their activities. Let me provide an example. Over the past five years the subscription fee to fixed telephony increased by 60%. Local calls did not increase at all over the past five years, while national and international calls decreased by more than 60%.

So where there is no competition, there are no price decreases. There is just a price increase in the monthly subscription fee. That is why we think that it is time to open up competition in local access. If we can't compete against France Telecom in local access, the French consumer will be the loser and we will be placed in a weaker position, as France Telecom will be free to continue its dumping practices on mobility, data and long-distance.

How is the unbundling issue affecting your operations? Are you confident that the French regulatory authority will handle the unbundling issue effectively? How do you perceive developments in this area?

I am more confident today, because Mr Pierret has, as I said, made some positive comments about implementing some form of unbundling, which is kind of a half open door. I believe that the regulator is keen to generate real competition in access. Today we compete with France Telecom on access through fibre-optic local loops. But the economics of fibre-optic local loops is only good where you have a highly dense business area. So you can only compete in locations, such as the centre of Paris or the La Defense district near Paris or in the major cities in France.

Broadband radio technology will provide another way to compete against France Telecom in local access. National and regional licences will be allocated in early 2000. Cegetel will do its best to obtain a national licence. The other way is just unbundling. In my opinion it is critical to have competition in the residential and the operations market and unbundling represents the only solution. The regulator will assume a position over the next few days or few weeks. They will incentivize us to negotiate with France Telecom. Sometimes I am very optimistic. Maybe I can imagine that we will reach an agreement with France Telecom.

If there is no agreement with France Telecom, we will go back to the regulator to arbitrate on this issue. It is our understanding that we may be in a position to deploy an ADSL strategy during the second semester of 2000 or even earlier if possible. As a matter of fact, we just launched an experiment with ADSL unbundling in Monaco Telecom. As you know, we are the number one shareholder in Monaco Telecom. Monaco Telecom's network was deployed or implemented by France Telecom. As it involves exactly the same equipment as in France, we can really test ADSL as if we were on French territory.

What do you believe to be your competitive advantages over France Telecom?

In terms of competitive advantages, firstly we have to compete on price. In terms of positioning we have to be cheaper than France Telecom on the new services we offer in fixed telephony. This does not account for the positioning of SFR, which has to be at the right price level. But price is the entry strategy.

Then we want to differentiate full services through value-added services. For example, SFR is a metro company. We have more than 40% market share in value. So we don't need to compete simply on price. We have the right price in front of France Telecom.

So we charge almost the same price as France Telecom, but we try to differentiate by offering better network quality and value-added services that we put on the mobility network and the handsets. How can we be less expensive? It is just a question of cost structure. We have to be a low-cost company, compared to an incumbent. We have to implement new technologies and new service platforms as early as possible. We have to implement Internet services as soon as possible.

How do you benefit from the presence of British Telecom and Mannesmann as shareholders? Do they assist you most in wireless and value-added services?

It is a considerable advantage to have shareholders that are also major operators and provide us with experience of their national markets. We have no specific commercial agreements with Mannesmann, but we inter-connected our backbone with Mannesmann's backbone in Germany and Italy.

We are the exclusive distributor of Concert products for British Telecom. This is one way in which we differentiate ourselves from some other new entrants, as we can provide international services to large international companies linked to BT. So we have an exclusive distribution agreement. It will last for at least the next few years.

Do you envisage any changes in Cegetel's shareholder structure? Mannesmann has hinted that it would like Internet services to be sold by Cegetel in France. Does this create a potential conflict of interest with British Telecom and its Concert services? In your opinion, how could such a problem be resolved?

The Cegetel pool is remarkably stable, despite the divergence of interests, which may divide our shareholders on other European markets. Obviously, if one of the minority shareholders wanted to leave Cegetel for specific strategy reasons, Vivendi would exercise its pre-emption right.

How are you targeting the Internet services market? Which services are you offering corporate customers in France? How do you view the potential for E-commerce services?

As you know, France is a late arrival on the Internet compared to the Scandinavian countries, Germany and the UK. I am not talking about the US. So we can perceive considerable potential.

In terms of Internet services today, we provide Intranet services to our enterprise customers. The second step on this Intranet is to specifically provide voice over the data network Internet. We can now provide voice services over that data network from one site to another. This single point differentiates us a lot from France Telecom.

The next step, which is not only a Cegetel step, concerns the overall vertical portal strategy leading to E-commerce. It is something we do at the Vivendi level with Havas and Canal +. Evidently, there will be a lot of synergy with Cegetel in that area. We have shared customers and we really want to leverage that strategy. We do a lot of things in that area.

First of all we have initiated some investments - some at an early stage, some later on - which help us gain an entry into new start-ups and really understand what the business will be in the Internet world. Secondly we signed an agreement with Softbank, a JV to create an incubator in continental Europe.

So we will be a host and 50% shareholder in the European subsidiary of US Internet companies that are already well known. We launched recently five new companies through that incubator, including E-Loan, BUY.COM and MessageMedia.

If I could continue on the creation by Vivendi and Softbank of a $100 million wireless Internet investment fund, which is buying stakes in companies such as E-Loan and BUY.COM. How will these investments benefit Cegetel's operations?

Let us take MessageMedia as an example. It is a message management service. The services of MessageMedia can be sold by Cegetel Enterprises. Let us take the example of Inter-Alliance. It is a web hosting, web forming company. So their services will be sold by Cegetel Enterprises.

We fully benefit from the experience of these companies in the US and implement their business model in Europe. A company such as Inter-Alliance has a very strong industry process for web hosting and web forming. In terms of the cost of web hosting, we will be extremely well positioned. This will constitute another differentiator for Cegetel Enterprises.

How many wireless subscribers do you have? How do you intend to raise average revenue/subscriber? How do you view the wireless market in France? What levels of churn have you been experiencing?

We have just released the figure of six million customers. We will have over seven million customers by the end of this year. If we look forward one year, I believe that we will have over 10 million subscribers by the end of 2000. So it is really a booming market. We take a fair share of that market.

Our market share dropped slightly in September, as we decided not to follow the crazy promotional tactics of our competitors that started to celebrate Christmas three months early. We initiated our promotions in October, which is a little earlier than in previous years. If I can make one comment about the French market, acquisition costs are far higher than the average for Europe. So I believe that the mobile strategy followed by some of our competitors is extremely dangerous. The acquisition costs are increasing, while the ARPU is declining, as there are more and more pre-paid card customers.

I believe that it is critical for France, like the UK, Germany or Italy, to decrease its acquisition costs to improve the profitability of mobile operators. Let me turn to your question on ARPU. I believe that ARPU will continue to decline in 2000 and may start to increase in 2001, thanks to value-added services and HTML web applications.

The rate of churn this year was about two points a month. It has risen to 2.5 points. So we have launched a number of loyalty programmes to decrease that churn level. It is really critical to have the lowest churn level possible. If I were to consider negative developments in 1999, I would rank at number one the level of churn, which is slightly higher than that of our competitors. But we have witnessed a strong improvement over the past few months owing to the loyalty programmes that have been launched.

How do you view the potential for wireless data applications? Do you believe that this is a segment where you have an edge over competitors in France? Which data applications are you planning to launch? Which companies are your main handset suppliers?

On the data side we were the first ones to launch an HTML WAP (wireless application protocol) platform. Today it is very limited with respect to customer numbers. But if I look forward for the next two-three years, I consider that to be a major opportunity in terms of market share and growth.

I believe that many people in French industry will have two handsets, as will be the case in any other country One will be a very small handset for the voice. The other one will be for data. I believe that data is going to be a critical application for mobility in the future. We are going to implement GPRS on our network in 2000.

GPRS will represent a very strong improvement in terms of speed and data usage rates. So we need to be very competitive in terms of data applications, mobile portal environments, E-commerce on mobile. We do a lot of work around that. Alcatel was the very first supplier for HTML WAP handsets. By the end of this year there will be many other suppliers, such as Motorola, Nokia and Sagem, which will launch HTML WAP handsets.

Why did you decide to terminate your Tam Tam paging services? Why do you think that paging services never took off in France?

There is no future for paging services in France. There are a few reasons for that. Firstly, paging in the US is still a very active business for one very basic reason. When you have a mobile phone and receive a call, as a mobile user you pay for the call you receive. This not the case with GSM. So you keep your handsets on all day in France, Germany and the UK, which is not the case in the US. This is one reason for the very high activity in the paging business in the US.

Secondly, you can obtain a free handset when you subscribe to a mobile service, whereas you have to pay about Eu50 ($51.5) for a pager. So people are moving more and more into mobile telephony rather than paging. So the children's market was the only real market for paging. But you generated a very limited amount of revenue from children. In fact you cannot make any positive gains from that business. That is why we decided to stop selling new pagers about a year ago and spend about a year to convert our pager customers to mobile telephony through a number of promotions, which have been very successful. Therefore we decided to stop the service and the network.

How much are you spending on fixed network modernization in 1999? Which are your main suppliers? What has been the main focus of your capital expenditure programme?

It is not network modernization, as our network was built very recently. The principal investments were made during the second semester of 1997. So it represents more of an investment in expanding our network. In fact we connect to five-six additional local switches of France Telecom to achieve better termination costs.

We are investing above all in the expansion of our fibre-optic network. We will spend this year investing in fibre local loops. Investments in our joint subsidiary with the SNCF, Télécom Développement, will total about Fr1 billion ($157 million) in 1999. We are focusing on network expansion and connection to more and more France Telecom local switches. It is quite easy for us, as we are using the French railways. In most cases the local switches of France Telecom are located in cities downtown at the railway stations. So it is quite easy for us to do that kind of inter-connection.

When do you expect to launch customer trials for ADSL services? How extensive will these trials be? What are the benefits of DSL technology?

This is quite a difficult question to answer, as it really depends on the decision of the regulator, the minister and France Telecom. We will launch trials as soon as we are allowed to do so. That is why we are pro-actively testing the technology in Monaco, where we can do whatever we want, since we own Monaco Telecom.

The extent of our deployment of ADSL technology really depends on the economic environment. When I refer to the economic environment, I mean the price that is established for unbundling. What will be the price for renting a copper link and what will be the benefit?

I strongly believe that if you look forward 5-10 years from now, almost every single household in France will be able to access Internet applications at home and will want or require broadband access, and not narrowband, as you need to have broadband access, if you want to achieve good economies from the usage of multimedia applications or the Internet. So ADSL will provide the right way to provide broadband Internet access to households.

France Telecom is ready to offer full-scale ADSL services to customers. Are they likely to gain from having first mover advantage in this space? Do you believe that they have an unfair advantage in the provision of ADSL services?

Yes. That is why we have been fighting quite a lot against the possibility of France Telecom's deployment of ADSL everywhere in France. So far they have been allowed to run up to six tests. There are six districts in Paris, where France Telecom is allowed to deploy ADSL and three cities around Paris and that is it. So they are not allowed to deploy any ADSL on a national basis. I strongly believe that it is totally unfair to allow France Telecom to do this, while preventing the competition from doing so. It really provides them with a strong advantage. It would be very difficult for a new entrant to recover, if France Telecom was allowed to deploy ADSL on a nation-wide basis.

Could you tell us about your plans to offer telephone services over the Internet? When do you plan to offer integrated fixed and mobile phone services to businesses? How important is the issue of number portability?

In response to your first question, we launched new business services about two weeks ago. One was voice over IP. If you are at an enterprise and a customer of Cegetel for data communications, you can put voice on IP with Cegetel on your data network. So that service is now available from Cegetel.

If I turn to your second point, as a business today you can integrate the numbering of mobile phones in the internal phone system of an enterprise. We announced the integration of mobile telephony into an enterprise's Intranet a couple of weeks ago. So this really is fixed/mobile convergence on the one hand, and Internet telephony convergence on the other hand.

How do you view the prospects for Internet telephony? Do you believe that voice over IP is a feasible proposition?

Yes. We are already offering it for businesses with enterprise-dedicated networks, which we control from end to end. In the short term, however, I do not think that voice over IP will take a major share of the market, in particular owing to quality concerns. It will be an incremental business for companies, rather than a major area over the next few years, especially in the residential market.

This year the company is expecting turnover of about Eu425 million ($438.6 million), compared to Eu288 million in 1998. What have been the main growth generators this year to spark this big increase in profits?

There has been significant growth in mobile telephony. We had 4.1 million customers at the end of last year. As we will add three million customers this year, this represents significant growth in 1999.

In addition, le 7, which is a long-distance service, will triple its turnover this year. So it has recorded very significant growth. Cegetel Enterprises will double its turnover. Depending on the size and area of different businesses, they are not experiencing the same growth levels. But every single business is accruing very high growth. All together it will represent more than 50% growth, which is very high for that part of the company.

Can you see a point in the future where Cegetel may enter the stock market as an independent entity? Do you envisage a point, where you would need to go to the capital markets to fund ambitious expansion plans?

No. Cegetel does not need to be listed for one very simple reason: we have sufficient capital today to cover future investments. In fact our debt level is below our equity level. So we don't have any issue with raising money through debt.

Cegetel will be net cash flow positive next year. We are in a very sound financial position. For example, we have the requisite finances, if we want to deploy extensive ADSL in the French market. There are no grounds for raising capital through an IPO.

How do you view Tele2 as a competitor? Tele2 launched the concept of a single tariff, maintaining that customers value easy-to-understand telephony services.

The interesting thing about Tele2 is that when they launched their service in April, they proposed 44 centimes a minute for off-peak and peak hours. So they were cheaper in peak hours and more expensive in off-peak hours. But they offered the same price for every single minute. So it was a pretty good move and pretty creative. Unfortunately, I was very surprised when Tele2 came back in September with a new proposal and new pricing of 38 centimes a minute. So this is a price decrease. But at the same time they have an invisible first minute of 60 centimes.

So in fact they had said at the very beginning of April that they would be simple. And that they would not be like France Telecom or Cegetel. But they are not simple any more. I don't understand exactly why they changed their pricing strategy, but now they have exactly the same structure as Cegetel, except that they don't have peak and off-peak hours and are more expensive in off-peak hours than we are.

They have been quite successful. They say that they have about 400,000 customers, but they have not released any information about their turnover, usage and traffic. Consequently we don't know anything else about Tele2.

Do you expect to see prices for telephone calls dramatically fall over the next 12 months? Do you believe that there is still room for widespread decreases? How would you compare your prices to those of France Telecom and Tele2?

Currently, our prices are about 30% cheaper than France Telecom. So this is pretty aggressive positioning. Prices have declined more than we expected at the beginning of the year. In fact, when we forecast the price decreases - at some point in time after the arrival of Tele2 on the French market - we asked ourselves whether we should follow Tele2 or not. We decided to follow Tele2, expecting some pricing elasticity.

We achieved that pricing elasticity: we initially issued a forecast of 1.1 million lines connected to "7" by the end of 1999 and we will reach 1.4 million lines. So this was a good move. Is there any additional major room for price decrease? When I look at the prices for long distance in France, we offer some of the cheapest prices in Europe. We are not far off US prices. Therefore, I do not believe that there is that much room for additional big price decreases in 2001. There will be some price decreases, but not the 20% or even 30% price decreases that occurred in 1999.

Do you believe that inter-connection rates are fair in France? The agreement which sees France Telecom pay Cegetel 3.8 centimes a minute for Internet inter-connection marks the first time that separate voice and data inter-connection rates have been agreed. How do you view this agreement?

Globally speaking, the inter-connection rates we pay to France Telecom are always too expensive. They are currently in the medium range expensive level for Europe. We expect an additional price decrease, as does any other country every year.

So we expect at least a 15% price decrease or even 20% in 2000 compared to 1999. We also expect a specific Internet inter-connection rate lower than voice inter-connection (France Telecom is currently proposing a surtax on Internet inter-connection).

Secondly it is clear that the 3.8 centimes we receive from France Telecom for the Internet termination fee is really low, compared to the costs that we incur. I heard that a fee of 3.8 centimes had been set really to hurt free access providers, rather than the local loop operators. But the 3.8 centimes hardly covered the cost of local loops. So we were a bit disappointed with the 3.8 centimes termination fee. Now that we have made an effort on our inter-connection rate, France Telecom must do its bit. This is an issue we are debating strongly with the regulator.

Could you tell us about the goals of the Télécom Développement JV? Could you tell us about your partnership with the SNCF?

The mission of Télécom Développement, which is a 50/50 JV between Cegetel and the SNCF, is to deploy, operate and maintain the backbone. That is their mission. They provide switched minutes to Cegetel. They provide these line services to Cegetel. That is the mission of Télécom Développement.

Télécom Développement was very efficient in deploying their backbone in 1997 and 1998. They do a very good job expanding that backbone. So we are very satisfied with this deployment and with the network quality which benefits our customers.

It is a very good partnership between Cegetel and the SNCF. Télécom Développment is in a very good financial situation and will be EBITDA positive in 2000, which represents the third year of operations. So that is a very good performance.

How do you view the regulatory environment in France? Do you believe that the French market lags behind its western European counterparts?

Not really. I believe that in some areas the regulatory environment in France has improved significantly. We expect the regulatory environment to be more dynamic in some other areas, especially with respect to the issue of local access.

I always talk about that subject, because I firmly believe that it is a critical issue. I look at France Telecom as the monopoly with local access: it is able to generate huge cash flows based on local access. They can totally squeeze the competition in those areas of communications. Therefore it is absolutely critical that the regulator understands that and really promotes real competition on local access.

This has been understood by most regulators in Europe. In France we are late. But we are not only late owing to the regulator. You really have to understand the economics of the new entrants. It is also attributable sometimes to the political environment. However, as I told you, I have seen some improvements recently and I am more optimistic about that subject now.

What are your hopes and ambitions for the company over the next two-three years? Where would you hope to position the company on the European telecoms landscape? What trends do you see emerging in European communications over the next five years?

Our ambition is to continue to grow as much as possible and to provide a return on capital/employee for our shareholders, and also have happy and satisfied customers and employees. But any company would tell you that.

We have set the following target for 2003: to have about 20% market share in long-distance telephony, 40% market share in the cellular market in terms of value, 20% market share in the enterprise services market, and something like between 5%-10% in the local access market. This figure is dependent on the possibility of effecting the unbundling process in France.

In other words the company would probably have something like 25% of the dual telecommunications market at that time. Currently I believe that we have about 15% market share of the total telecoms market in France today, including mobility, local access and other services. So we expect to grow quite a lot. Cegetel is a company, which will resemble within the next four-five years a Eu10 billion ($10.3 billion) kind of a company, and will hopefully be a very profitable company, at least sufficiently profitable to provide a good return for our shareholders.

Is there anything would you like to add?

You asked a question about Cegetel in Europe. Cegetel is not allowed to invest in Europe. It is a purely French operator, as stipulated in the shareholder agreements. But Vivendi is allowed to invest in Europe. The shareholder agreements of Cegetel do not prevent Vivendi from investing in Europe. So we can't really look at different opportunities.

If you look at One-2-One, we were surprised by the price paid by Deutsche Telekom for One-2-One, which is 24 times the EBITDA value of the operator for 2000, which is a lot. At the same time we were a bit surprised by the price paid by Mannesmann for Orange. It is almost a world record in terms of the price/customer. It works out at about $9,000 a customer.

If we apply the same multiples to SFR, the value of SFR would probably be about Eu50 billion ($51.5 billion). The market consensus accords us a value of Eu30 billion or a little more. So when we looked at the prices paid by some of the players in Europe, which are highly dilutive acquisitions, we decided not to go for this kind of aggregation.