TELMEX targets regional growth opportunities

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At the beginning of 1997 Telefonos de Mexico (TELMEX) lost its monopoly in the long-distance market. After initially surrendering significant market share, TELMEX may now gain ground and recover some revenue losses. It is also acquiring companies, as it expands regionally. TELMEX's CEO Jaime Chico Pardo talks to Mark Holmes about the operator's high-growth strategy.

At the beginning of 1997 Telefonos de Mexico (TELMEX) had to relinquish its monopoly on long distance. This was followed by liberalization of the local market in 1998. Many of the world's biggest global players have entered the market, such as MCI WorldCom, Bell Atlantic, AT&T, Qwest and Korea Telecom. TELMEX has lost less market share than anticipated and, as prices stabilize, may well recover some revenue losses.

TELMEX is benefiting from a favourable economic climate, with expected GDP growth of 2.8% in 1999. This is likely to lead to an increase in the number of lines and a rise in cellular subscribers of over 70%. TELMEX has invested in PCS licences and cellular companies such as TOPP Telecom. Telmex plans to use the experience it has gained through its wireless subsidiary in Mexico, Telcel, to enter other wireless markets in Latin America.

According to Oliver Mizne, a telecoms analyst at Credit Suisse First Boston, TELMEX benefits from a flexible regulatory environment in Mexico: "One of the points that is making TELMEX so strong is the fact they can still keep all their accounting together. In Argentina, both Telefonica and Telecom are kept as one entity, but the accounting has to be separated. So you see how much each segment is making. The big challenge facing TELMEX is to try and keep the company as one entity as long as they can. I don't think that will last forever. Under the concession contract they already have, they will eventually have to split the accounting."

Although a new regulatory agency, COFETEL, has been established, the telecoms ministry retains significant powers that may well favour TELMEX, as Mizne explains: "They also have another structural advantage in Mexico: COFETEL was created as a separate entity from the ministry, while the communications and transport ministry was kept as the entity that could issue a fine or grant you a renewal or non-renewal of your concession. That power lies with the telecoms ministry, not COFETEL. This is very different from the Brazilian structure for example, where Anatel has the power to impose fines."

TELMEX aims to increase its presence in other Latin American markets. It has formed a joint venture with SBC to buy Puerto Rican cellular operator, Cellular Communications. Mizne notes: "TELMEX has strongly stated for a while that they wanted to expand their share of businesses throughout Latin America and that this would be the vehicle they would use to grow within the region. I think that it makes sense to buy some partners, such as the Puerto Rican company."

The company recently decided to dissolve a joint venture with Sprint to provide long-distance services to the US Hispanic market. Mizne talks about the operator's international strategy: "They had differences with Sprint over their strategic direction. It makes some sense that they would go their own way eventually."

TELMEX also benefits from a strong financial base which it can leverage to finance further acquisitions in the region and buy back shares, as Mizne explains: "TELMEX is one of the best positioned companies in Latin America to acquire other assets. The Brazilian companies have EBITDA margins of 60% and have been investing 75% of EBITDA. In other words, they have EBITDA margins because they need to. Their regulator requires them to invest and be able to grow and meet the regulator targets. TELMEX has a 55-60% EBITDA margin, but only needs to invest 27% of what they make of that EBITDA. So they have a huge amount of free cash flow which they have been using to buy back shares, but apparently they have now been shifting more of that cash into acquisitions and growth in other areas."

In an interview with Global Telecoms Business, the CEO of TELMEX Jaime Chico Pardo explains how the company is going to expand its service offerings in Mexico and exploit opportunities in Latin America.

Mexico's telecoms market has become highly competitive in a relatively short time. TELMEX appears to be thriving in this new environment. To what do you attribute this strength?

Chico Pardo:
Mexico has achieved a lot, developing a market that is in many ways more competitive than other countries in the world. It is easy to lose sight of these tremendous accomplishments, as they have occurred in such a short time frame. You are right. TELMEX is doing well. We have many opportunities in this rapidly changing market. We are close to the US, the largest telecoms market in the world, while our own market has a variety of strong, new players.

TELMEX's strength derives from three main elements: our strategy, which envisioned the changes to come and prepared for them, our investments in high-tech infrastructure and our people, who have made outstanding advances in knowledge and customer service. We have invested in training over the past eight years. We have raised the educational level of our employees from the 7th to the 14th grade, which compares favourably with several leading international telcos. The value of this investment in our personnel can be seen in their loyalty towards the company and our success in an aggressive competitive environment. Owing to our employees' improved skills, we have also been able to develop productivity and efficiency in times of rapid change that will continue to benefit TELMEX.

We have also been able to aggressively pursue the commitment we made at the time of privatization to bring additional telecoms services throughout our country. Our extensive communications infrastructure reaches close to 85,000 rural communities in Mexico through wireline and wireless services. TELMEX's footprint covers most of Mexico's territory. We provide products and services tailored to the economic characteristics of our customers.

Let me provide one example of how we make these services flexible for our customers. We introduced an innovative product, Linea Virtual, in the most remote places in Mexico, where there is no telephone coverage. With this service - which we are extending nation-wide - we provide our customers with a telephone number and voice mail where they can receive messages. When a message comes in, they are notified through a pager. They can retrieve the message at any public or rural phone for the cost of a local call.

What do you perceive to be TELMEX's competitive advantages over other operators in Mexico such as MCI WorldCom and Bell Atlantic? How will you maintain market share?

Chico Pardo:
We can leverage the following advantages: firstly we know more about this country. Secondly, we have our staff and, thirdly, our network, which is one of the most technologically advanced infrastructures in the world. Market knowledge, in other words knowing what our customers require, coupled with our advanced infrastructure and the loyalty of our people, enables us to develop a better market presence. We are entering the second stage, growing outside our home market, particularly in North America. That is where we want to develop a presence. It has taken a long time for us to enter that market. It will help us remain competitive in our own market.

How would you compare the Mexican market to other countries within Latin America? How do you view the regulatory environment in Mexico?

Chico Pardo:
Apart from Brazil, Mexico is the largest market in Latin America. It is the single most important market in terms of long distance, for example. It has attracted the attention of the biggest telecoms players. That is why we have AT&T, MCI WorldCom and Bell Atlantic. We have Korea Telecom. Telefonica is investigating the market. No other market in the world has opened up to competition as quickly as Mexico.

In Mexico the new competitors have gained a 30% market share in only two years: in the US it took 10 years for competitors to capture that much market share from AT&T. In Mexico 80% of the market was opened to competition in just one year, while it took five years to reach that level of competition in the US. You don't find the same developments in Argentina, Colombia, Chile and the rest.

Secondly this market has greater potential than in any other country owing to its sheer size and economic situation, compared to other countries in the region. Mexico also differs in another way: we initiated this process many years ago. In that respect we are more advanced in terms of modernization, competition and globalization.

I think that we also have a very advanced regulatory environment. It has taken the new competitive environment into account. I think that the regulatory issue is very fluid in every country, as telecoms is changing dramatically. Each country has to look on its own at regulation in terms of the impact on that country's development. We are talking about an industry that will in my opinion play a strategic role in the next century. We need regulations based on our national interest and should then link them into the industry's global environment.

What do you perceive to be the benefits of SBC as a strategic partner? How did this partnership affect your decision to buy the Puerto Rican cellular operator?

Chico Pardo:
In SBC we have a partner with extensive business experience and common interests in this region. Together we take a long-term view. One of the advantages of partnering with SBC is that we have known them for nine years. We know how they operate. We know them personally. The relationship is very valuable if you are launching more alliances and joint ventures. We know what each partner can contribute to the venture. We have developed a great deal of mutual respect.

At the same time TELMEX has initiated a strategy of internationalization based on our successful experience of innovation and accelerated development in the Mexican market.

Cellular Communications of Puerto Rico represents an excellent opportunity for both TELMEX and SBC. TELMEX has significant experience in the development and marketing of the cellular business and pre-paid products. SBC has a well-known brand and a strong presence in parts of the US, where there are large Puerto Rican communities.

SBC caters to a large proportion of the Mexican American population in the US owing to its location. How do you react to claims that a cross-border merger with SBC would be beneficial to TELMEX owing to the traffic flow and demographics?

Chico Pardo:
As we have said publicly before, TELMEX is not planning to merge with SBC, nor is this a prerequisite for business development or the search for market synergies.

Our relationship with SBC is a successful strategic alliance of long standing. We think that we can continue to build up business through this relationship in the future. However, in such a highly integrated and global industry as telecoms, alliances can take many forms. So TELMEX has made a considerable effort to develop additional alliances with strategic partners to benefit the company. Let me cite, for example, TOPP Telecom. TELMEX recently acquired most of the shares in TOPP Telecom. It will compete along with SBC in the pre-paid cellular market in the US.

What have you learned from your partnership with France Telecom?

Chico Pardo:
When TELMEX was privatized, France Telecom contributed its experience in plant expansion and modernization. We have continued to work together on technological and other issues.

In public telephony, for example, we developed solutions that ensure that more people gain better access to telecoms services. As a result TELMEX is installing technologically advanced digital phones that accept pre-paid cards. We also plan to work with France Telecom in cellular, enabling them to take advantage of our experience, knowledge and expertise in this market. France Telecom is an excellent partner for TELMEX. We continue to look for opportunities to expand the relationship in areas of interest to both companies.

Why did you decide to dissolve your JV with Sprint to provide long-distance services to the US Hispanic market? Will you look for another partner to provide services?

Chico Pardo:
After 18 months of negotiating to operate and compete in the United States, we launched a set of products to test in the market. Mexico en Linea was very successful among consumers. It offers Mexican Americans and Mexicans who live in the US the possibility of paying for the installation and use of telephone lines for their families and friends in Mexico. Mexico en Linea performed better than the services in which Sprint was particularly interested. So we made a joint decision to continue marketing our services and products independently.

What potential do you perceive for wireless in Mexico? What are the current levels of penetration? How many subscribers would you expect to acquire over the next two years?

Chico Pardo:
The potential is enormous. We are growing by 90% a year in terms of subscribers and traffic. Our current infrastructure can support growth in customer numbers. We have the right marketing strategies in place. When we started the pre-paid programmes in Telcel a little more than three years ago, everyone thought that we were crazy and that we were going to bring in business with lower consumption rates. We developed the right product for present market conditions: namely the customer requires telecoms services, wants mobility and at the same time wants to control expenses.

You can see it throughout Mexico. Taxis have pre-paid wireless. They advertise their phones to customers. If you take into account new wireless technology for data transmission, the business is bound to grow. We are using wireless technologies to access areas of Mexico that it would have been very difficult or expensive to reach otherwise. We are planting wireless technologies throughout the market. Telcel has developed and evolved as an independent company that can implement such a strategy.

Can you expand on your pre-paid offering in Mexico? You have a 65% market share, which seems a high figure in a competitive market. Do you think that you will be able to maintain such a high percentage?

Chico Pardo:
A major part of the successful growth of wireless telephony in Mexico is attributable to the introduction of innovative products, such as the Amigo pre-paid plan, which Telcel introduced in Mexico three years ago. Telcel's Amigo system has been one of the most important marketing strategies developed in the cellular industry world-wide. To date, 71% of our customers are in the Amigo plan.

Innovative products, modernization, coverage and Telcel's service have given us leadership in the wireless market. We actually entered this business after the competition. We have had some very important competitors, such as Motorola and Bell Atlantic over the past eight years. We have been able to increase our market share. That is our aim and objective in the future.

Why have you decided to accept implementation of Calling Party Pays in Mexico? Why did you initially resist such efforts?

Chico Pardo:
TELMEX opposed Calling Party Pays for two reasons. First of all, the rate of $0.25 a minute is extremely high, practically double the cost of a domestic long-distance call. This affects TELMEX's customers directly and therefore the company. Secondly, from the point of view of the shareholder of the main cellular company in Mexico, Telcel, we believe that it does not make sense to modify the operating plan of an industry that is growing by more than 80% annually. A business of this nature doesn't require incentives. On the contrary, it needs space to operate freely.

What was the significance of the recent agreement over settlement charges? Another contentious issue in Mexico has been the resale of international services. It has been estimated that 30% of international traffic in Mexico is handled by call-back operators, backed by new technologies. How are you managing that situation?

Chico Pardo:
We have just signed an agreement with AT&T that regulates settlement rates at 19 cents a minute for the period 1999-2000. The agreement establishes a highly competitive level. It recognizes market tendencies. Operators that gain from these negotiations effectively pass on the benefit to the consumer through lower rates.

It should be borne in mind that an industry's competitiveness is not solely determined by a single factor such as the accounting rate. It should be assessed on a series of factors such as the rates to the public, volume, operating costs and other variables. Even so TELMEX has acted on industry trends and has made great strides towards lowering accounting rates over the past four years.

The by-pass matter affects TELMEX and the other operators that have invested millions of dollars in infrastructure in Mexico, particularly those that started operations recently. By-pass draws revenues away from the industry and away from Mexico. As a company that is accountable to its shareholders, TELMEX is bound to be concerned about this issue. However, we also understand the dynamics of competition and the long-term benefits of succeeding in a competitive environment. Ultimately regulators will have to decide what is best, based on the long-term interests of an industry that is strategically important for the country.

The Mexican regulator COFETEL does not have the power to impose large fines or take away concessions. Do you believe that they should have the power to impose stricter penalties?

Chico Pardo:
I think that COFETEL has that power indirectly, as they can exercise that authority through the Ministry of Communications. Most importantly, one should consider what COFETEL has accomplished in a short time. We are talking about an institution that is three years old at most. As COFETEL continues to develop, I think that it will institutionalize a body of people, experience and expertise that will make it even better. But I think that they have done quite a bit already.

It is quite remarkable when you consider what has been achieved in Mexico. Part of that change is attributable to dramatic regulatory change in our country. The market has been opened. I think that it is now imperative to create and maintain a market where competition works. Opening the market and supporting a successful competitive environment are separate issues. I think that the second one is more relevant.

In that context, it is quite clear that regulation, which allows our competitors to primarily focus on the top end of the market, while at the same time restricting TELMEX's ability to compete in that market segment, adversely affects the industry's development.

Much of the competition is likely to come from data communications. What has been the impact of data services on TELMEX? Why did the largest ISP in Mexico change its name to Prodigy Internet de TELMEX?

Chico Pardo:
Data transmission has been one of the main activities of TELMEX in recent years. Today this business, which didn't even exist three years ago, is thriving. That kind of growth provides incentives for the company to invest in this business.

One example concerns our purchase of a controlling interest in Prodigy. It is a major provider of Internet services in the US with 850,000 customers and a network that reaches 750 cities. Additionally, Prodigy was the first ISP to introduce Internet services in the Hispanic market. The presence and brand recognition of Prodigy motivated us to change the name from Internet Directo Personal to Prodigy Internet de TELMEX. This has given us the benefit of a well-known brand and adequate platform, with content specifically directed at the Spanish-speaking market.

TELMEX is promoting greater use of Internet services, by selling PCs to consumers at cost price. Surely there is a risk that you may fail to sell all the inventory and that the PCs at your disposal may become technologically obsolete before the benefits of increased usage are perceived?

Chico Pardo:
Strategically, the Internet business is very important to TELMEX. We wanted to stimulate market growth and expand the customer base in the country. So we launched a promotion to sell Internet services along with the computer, and then provide financing over a two-year period. So now more customers have access to the Internet. There is an additional benefit: the price of this PC is affordable for our customers, who may decide to upgrade their equipment at the end of two years.

How do you view the potential for Internet telephony, as it can cost 90% less to send a long-distance voice minute over the Internet than a standard wireline phone? Do you think that TELMEX needs to cannibalize its own revenues through Internet telephony to retain clients?

Chico Pardo:
The name of the game is the Internet, not just for the future, but for the present. In our view, the Internet is not just another product, but rather a rapidly evolving business that integrates communications, commerce, entertainment and advertising.

So I would not use the term cannibalize, but rather development. We are trying to add, not subtract. If the Internet provides more added value, it is bound to become a substitute for the telephone as we currently know it. But this is a situation of technological convergence, rather than simply supply and demand.

As CEO of one of the biggest operators in Latin America, how are you handling the transformation of TELMEX into a more IP-based telco that offers a whole multitude of services? What are the main challenges?

Chico Pardo:
I think that one of the main challenges is to make sure that we constantly keep updated about new technologies. This is the single most important commitment we have to our customers. In other words, we have to make sure that we have the right technologies at the right moment. We have to adjust those technological requirements to our customers' requirements. I think that this is the big challenge. It is not just about having the technology. It is knowing exactly what your customers want and in turn developing the products and services for them. Even though TELMEX is a very big company, we have to operate as a small company, as flexibility is an important strength.

Global Telecoms Business recently conducted an interview with the CEO of Level 3, James Crowe, who explained how a new operator benefits from building a state-of-the-art network from scratch. Do you think that TELMEX has been successful in bridging the gap and becoming a forward-thinking, data-based company?

Chico Pardo:
We are going in the right direction. The data business has evolved within TELMEX over the past three years. We are moving forward with strategies that will position us better in that business. The recent alliance with Williams Communications is in line with that strategy. TELMEX and Williams Communications will connect their fibre-optic networks to jointly develop a new competitive platform of voice, data and video services, which will enable us to serve an integrated North American market.

We need to take the assets that we have and evolve them into assets for the new businesses of the future. That is the constant challenge that everyone faces. We have that vision and we are working in that direction.

TELMEX's network is designed to provide high-speed service. It is one of the newest, largest and most reliable networks in the world. This is precisely why our competitors use it as a platform to resell their products and services in the Mexican market. This technological strength allows us to increase its capacity and evolve in line with technological changes. In this sense we have developed a strategy to evolve our network into a next generation network that will enable us to cater for the capacity required by the new communications protocols.

How do you view the corporate sector in Mexico?

Chico Pardo:
This is a very important sector. It played a key role in our competitive strategy in the long-distance market. We have been working with these large, corporate, multi-national customers for a long time to make sure that we deliver service at international quality levels. Secondly, we have given commitments that we will continually invest in our network, so that we will be constantly upgraded and updated in terms of services and products. Those two assurances are critical.

We have been recognized as one of the key suppliers. We have trained people. We have a group of executives who have gained a great deal of customer respect during the three years that we concentrated on the corporate sector. As a matter of fact, some of these multinationals have invited us to serve in other places outside Mexico.

To meet those commitments, we have to be able to provide one-stop shopping when customers have cross-border requirements. That is why we have relationships with all the carriers that customers have selected. If we need to link with AT&T for one-stop shopping, then we will. If it is Sprint, then we will do it. We will do whatever the customer requires.

How much do you spend annually on network modernization? Which suppliers do you work with in fixed? Which technologies will drive penetration rates?

Chico Pardo:
Our 1999 CAPEX programme totals about $1.6 billion. The focus of our investment programme is to continually update our infrastructure and enhance its capacity to ensure future growth and develop a modern systems platform to respond immediately to our customers and maintain strict network management. We also take our social commitment to our country and its citizens seriously. We continue to expand public and rural telephony and invest in long-term infrastructural construction that will ensure coverage and quality service nation-wide.

To be able to ensure the technological transfer and development of applications that fit customer needs, we have established strategic alliances with a limited number of suppliers world-wide, focusing on common strategies and businesses. So we have been able to develop technological solutions for TELMEX and its customers in our labs and with our personnel.

In this way we can exchange experience and make sure that the developments are innovative and appropriate for the real necessities of our market. Our advanced billing systems allow our customers to access their accounts in real time. Similarly we have diverse pre-paid platforms. These are examples of applied technologies that provide solutions to Mexico's specific needs.

Will you have to reduce staffing levels? How will the make-up of the company change?

Chico Pardo:
When TELMEX was privatized, we had two options. We could either reduce staffing levels or provide our people with new skills, so that TELMEX could evolve and grow without adding more people. We decided on the second option. I think that our success indicates that we made the right decision. We have developed a culture and organization that is unique in Mexico. We have developed loyalty that is very important in a business as competitive as ours.

Training is another very important aspect. Today we have one of the most qualified workforce in the industry. We have moved a lot of our operators into commercial responsibilities. We have 360 commercial offices that are very important to us. We have people in construction. We have a substantial amount of people in telemarketing. When you look at the breakdown of TELMEX's workforce, you will see that it differs from other companies. In other words you should take a closer look at productivity measures. You cannot judge merely from a simple statistic, such as lines/employee.

But as I have said before, that is not as relevant as having the right people, trained staff - the right attitude towards competition. These are major strengths for us. We have now more than doubled the company since we started. Much of that success can be attributed to the learning and productivity of our staff. We will continue along the same lines.

Why did you decide to repurchase $430 million of your own shares in the first quarter of 1999? Do you plan further share buy-backs this year? Do you plan to issue new shares to fund other network investments? Does this imply similar changes to the ownership restrictions of TELMEX?

Chico Pardo:
We have a repurchase programme that seeks to provide additional benefits to our stockholders. Actually, we have authorized a repurchase programme for 800 million shares. As our sound financial position allows us to pursue whatever type of financing we want, we don't need a new stock offering.

Our repurchase programme is not related to the issue of company control in 2001. Since privatization was first planned, it has been known that after 10 years shareholders would have the right to convert their shares to voting shares, representing up to 51% of the capital stock. We announced that Carso Global Telecom (CGT) had increased its stock participation in TELMEX from 5.2% in 1990 to 26.6% in 1999. Owing to its majority holding of 26.6%, CGT will control the company. Additionally, Carlos Slim Helu, President of TELMEX's and CGT's Board of Directors, recently confirmed again that CGT's interest lies in keeping control of the company.

Where do you hope to position the company over the next couple of years?

Chico Pardo:
Our aims and ambitions are to position TELMEX as the market leader in Mexico and, more importantly, as a major regional player in the North American market. We can achieve this goal through partnerships and alliances, while at the same time maintaining our independence. TELMEX will be a successful company in its own market, but will be well positioned in the globalization and integration of an industry that is moving very rapidly. In my opinion, this will enable TELMEX to create shareholder value and be successful in Mexico and our region over the next two to three years.