Will Telmex Be Left On Hold?

The television ad shows a young woman boarding a rickety bus in a Mexican desert town. Distraught because her boyfriend has failed to see her off, she crumples up his photograph. But as the bus wheezes into motion, he suddenly appears outside her window. As he gestures that he'll telephone her, she smoothes out the photo.

So goes a fledgling effort by Mexico's private telephone monopoly, Telefonos de Mexico, to improve its unsympathetic image. Long known for spotty service and surly operators, Telmex has a long way to go before it wins over its customers. But it doesn't have much time. The Mexican government sent legislation to Congress on Apr. 24 laying out the framework for licensing competitors in the fast-growing local and long-distance telephone markets. Legislators are expected to pass the law shortly, setting the stage for a rush of new rivals, including AT&T, MCI, and GTE, ready to invest billions (table).

THREE MONTHS. Carlos Slim HelPound , the 55-year-old Mexican billionaire, knows Mexico's monopoly carrier is in for a tough ride. His holding company, Grupo Carso, along with partners France Telecom and SBC Communications Inc., own a controlling stake in Telmex. "We believe the competition is going to be very intense," says Slim in an interview with BUSINESS WEEK. "Our share is going to shrink, but the market is going to grow--it's going to be very big."

Telmex has been busy rebuilding since it was privatized in late 1990. The company has invested $8.5 billion to create a national digital network backed by a 17,000-kilometer network of fiber-optic cable. Telmex has added more than 3 million new telephone lines over the past four years, and now 9.6 out of every 100 people have a phone, up from 6.6 before privatization. What's more, the wait for a new line has dropped to less than three months, from three years.

Even so, the improvements at Telmex won't deter a stampede of new entrants. In mid-1996, the company loses its monopoly, and on Jan. 1, 1997, callers will be allowed to choose their carrier. With the onslaught of competition, Juan Carlos Garca, a senior vice-president at Santander Investment Securities in New York, predicts that Telmex' current operating margins of 42%--among the highest in the world--will drop to the low 30s.

The newcomers are attracted by estimates that Mexicans will spend up to 14% more minutes each year on long-distance calls in a market now worth $4.5 billion. Topping the list is Avantel, a joint venture between Banco Nacional de Mexico (Banamex), Mexico's largest bank, which brings its blue-chip client list and a private communications network, and MCI Communications Corp., with its marketing savvy and technological knowhow. The joint venture plans to compete head-on with Telmex in long-distance service. "We're going ahead as though we had a license," says Dan Crawford, Avantel's chief operating officer. "I won't say I have the shovels to start digging. But I can get them tomorrow if we get the license."

FRIENDLY SERVICE. Just as formidable is a recent joint venture between AT&T and Grupo Alfa, a Monterrey-based industrial conglomerate with major interests in steel. And then there's GTE Corp., which already controls telecom companies in Venezuela and the Dominican Republic, and Bancomer, Mexico's second-largest bank. Grupo Iusacell, Mexico's second-largest cellular operator, has also teamed up with a powerful partner. Last year, Bell Atlantic Corp. paid over $1 billion for a 42% stake in Iusacell, which owns a nearly 40-year-old radio frequency concession that it hopes to use to launch a national fixed-wireless network. Other potential challengers include Motorola Inc., Italy's STET, and Spain's Telefnica.

To counter the new competition, Telmex needs more change. The company will have to retrain its 49,000 employees--holdovers from the years of state-run telephone services--in the art of friendly customer service and efficiency. The company has avoided layoffs until now. But with competition looming, analysts don't think it will be able to for long. Telmex is also planning to roll out many of the advanced services that its large multinational corporate customers need. It will begin offering new services such as call waiting within three months. And its recent partnership with Sprint Corp. will give corporate customers in Mexico and the U.S. one-stop shopping for sophisticated global telecom services.

Slim himself has tried to use his clout to try to slow down the arrival of new rivals--so far unsuccessfully. In his meetings with government officials, Slim lobbied heavily for licensing fees, arguing that otherwise competitors would have an unfair edge. "These competitors can come in, investing very little, and take advantage of Telmex' huge infrastructure," says Slim.

The government finally decided against charging an upfront license fee for long-distance rivals that agree to lay fiber-optic cable, as most are expected to do. That will leave the newcomers with extra cash to invest in marketing and technology. And though competitors will have to pay Telmex to hook up to its local network, the government also plans to auction radio frequencies, which will give rivals a way to bypass Telmex' network, helping them avoid interconnect fees.

PRICE WAR? Hammering out these rules hasn't been easy, and many of the details won't be ready for a few more months. Although the government hopes competition will result in better service and broader phone coverage, it also wants to preserve Telmex' strength, since the established carrier is key to expanding the country's less profitable local phone service. "There's concern of a price war and Telmex hemorrhaging," explains Mickey Schleien, head of Latin American research at James Capel Inc. in New York. He points to Chile, where a flood of competitors last year briefly gave Chileans the cheapest long-distance calls in the world but drowned several of the new entrants in red ink.

Telmex' stock has suffered from the uncertainty over government regulation. Even before the crash that came with the Dec. 20 peso devaluation, Telmex shares traded on the New York Stock Exchange as American Depositary Receipts (ADRs) had slipped more than 30% from their Feb. 8, 1994, high of $75.50, mostly on fears of coming competition. After the crash, they collapsed to the mid-20s but have since recovered to around $30 along with the rest of the market.

To offset the inevitable erosion of its market share, Telmex will need to do nothing short of changing the way Mexicans answer the phone. Instead of saying, "Hello," they now say, "Good?" as if they were testing the line. By August, 1996, Telmex better make sure customers have no doubts.

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