The Deals Are Good, But The Dial Tone Isn't

Argentina's "Spidermen" dressed in black and prowled by night, like cat burglars. For a price, they would scale a wall, cut loose a phone line, and run it through alleys, up your wall, and into your phone. When the government put the phone company on the block in 1990, the "hombres de arana" were a force to be reckoned with. They offered overnight service in a country where people often waited five years for a phone. Of course, for each satisfied Spiderman client, there was a loser who picked up the phone the next day and heard dead air.

Sound like a congenial place to run a phone company? The Spanish, Italian, and French national telephone companies, along with Citicorp and J. P. Morgan & Co., think so. When Argentina split state-owned Entel into two companies, Telecom and Telefonica, those foreign investors created consortiums that bought majority control of the new entities for a combined $650 million. What a bargain: The companies' combined value, based on prices for minority shares since sold by the government, has soared to more than $9 billion.

Nearly overnight, Latin America has become a telephone-industry bonanza. These booming economies desperately need better phone service to accommodate growth. And governments, recognizing they can't do the job themselves, are selling their phone companies on terms that allow buyers to earn healthy returns.

Last year--its first as a private company--Telefonos de Mexico (Telmex) racked up $2.3 billion in profits on revenues of $5.4 billion. "God doesn't allow such profits," marvels a U.S. consultant to the company. But governments, not the Almighty, are promoting such returns by granting monopolies of 4 years to 10 years so the companies can spiff up their networks before they face competition. A $10,000 investment in Telefonos de Mexico six years ago is now worth roughly $300,000.

MUSEUM PIECES. Whether the next half-dozen years will be as profitable for investors is a matter of intense debate on Wall Street. Salomon Brothers Inc. analyst Stephanie Georges, pointing to continued growth and receding inflation in the region, says Latin American phone companies should blossom. "Telecom is infrastructure, so it's the cleanest play on the local economy," she says. But favorable economic conditions alone won't keep phone-company shares on their upward climb. To do that, the new owners of phone companies must fashion the real miracle: making Latin American phones work.

It's a long, costly job. In spite of careful scrutiny, buyers have been taken aback by the decrepitude of the networks they inherited. In Mexico, many phone lines running under the capital are being gnawed bare by rats. The new owners in Argentina discovered switches that belong in museums, one dating from 1913. "Entel hadn't invested a penny for the last 8 to 10 years. There were no diagrams of the network," says Telecom spokesman Giulio Senni. In Venezuela, fully 1.6 million lines are not even soldered properly into switches. That leads to eerie howls and deafening crashes on the line.

Even with monopolies, the phone companies can't simply raise rates to pay for new gear. Customers won't stand for it. Already, Chile's phone company has been accused of profiteering by hiking rates. Telmex drew howls when it raised rates 16% last December. National Consumer Council Director Alfredo Baranda, who led the old Telmex, says the new owners should think "more of the consumer and less of profits."

GTE Corp. finds itself in a particularly tough spot. Last February, two months after a GTE-led consortium completed the purchase of a controlling interest in Venezuela's CANTV, the military attempted a coup. Now, even though the phone company needs to raise rates to help pay for modernization, it has delayed an Apr. 1 increase indefinitely, partly out of fear that it could spark more civil unrest.

Meanwhile, the phone companies must keep to costly government timetables for improving and expanding service. If they fall short, the governments can open the doors to competition ahead of schedule. Telmex, for example, must invest $7.5 billion from 1991 through 1993 to increase the number of lines by 12% per year and link up 8,000 rural communities. Last year, the company invested $1.8 billion. It met expansion targets but lagged in improving service. Mexican phones continue to be out for weeks ata time.

GREAT EXPECTATIONS. Phone executives defend their progress to date. They have plenty of obstacles, including strong labor unions and iffy mail systems for sending bills. And they must do business with the same miserable systems they're trying to fix. "It took a long time for the phones to get this bad," says John H. Atterbury III, president of Southwestern Bell's International Holdings Corp., a minority owner of Telmex.

True, but long-suffering customers had been led to expect more. "They will pull a lever, and it will get better," Finance Under Secretary Jacques Rogozinski predicted last August. Now Rogozinski, who presided over the Telmex sale, says the company has been hindered by difficulties such as heavy rains last summer and new antipollution rules that make it more difficult to dig up the streets to lay cable.

None of those concerns is deterring investors looking for the next Telmex. Their latest favorite is Brazil's Telebras, the biggest phone company in Latin America, which is likely to sell off a majority stake in the next two years. Minority shares in the government-controlled company have ballooned twelvefold in the past year. Yet Salomon Brothers' Georges says Telebras is still valued at only one-sixth the price of Telmex, based on the market value per phone line in service.

After Brazil, no big phone companies will be left to sell off. Then investors will have to start scrutinizing the real risks and rewards of the campaign to wire Latin America. This is one battle that truly will be decided in the trenches.

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