The Phone Wars Spread To Hong Kong

As a high-growth company in a protected market, Hongkong Telecom has long been a darling of foreign investors. But when the company announced on July 21 that it will cut rates to the U.S. and Canada by up to 21% to brace for new competition, the market reponse was swift. HKT's stock plunged by 4.7% in just two days. Why the panic? Many investors had thought HKT, which gave up its monopoly on fixed-line local calls on July 1, would still be the exclusive long-distance provider for another 11 years. Instead, local competitors are rushing through a regulatory loophole to offer international service at lower costs.

For HKT, the phone wars have arrived--and will get more brutal. More price-cutting is expected by long-distance newcomers New World Telephone, New T&T, and Hutchison Telecommunications. "There will be more fireworks over the next few months," predicts Andrew Harrington, Hong Kong-based senior analyst at Salomon Brothers Inc. Investors, led by Britain's Cable & Wireless PLC (C&W) with a 57.5% stake, are keenly interested in how HKT responds. The company, one of the most profitable in Hong Kong, accounts for 10% of the Hang Seng index.

For a long-time monopoly, HKT is in surprisingly good fighting trim (table). Competition has spurred it to introduce new services, cut costs, and expand internationally. And it maintains perhaps its biggest edge, a fully digital system that will make it difficult for newcomers to get far ahead. "Hong Kong Telecom has as advanced a network as anyone in the world," says Andrew Hall, a research director for Kleinwort Benson Securities (Asia) Ltd.

Still, the rate cuts are worrisome, especially for C&W. Analysts are already cutting their estimates of HKT's profit growth by 10%, and that's likely to cause major problems for C&W. Last year, HKT accounted for 73% of C&W's $1.8 billion operating profit. C&W CEO James H. Ross dismisses as "oversimplified" the idea that HKT accounts for almost all of the company's market valuation. But any drop in C&W's price is bad news, since the company is already rumored to be a takeover target.

ROUNDABOUT ROUTE. HKT was forced into cutting rates by the growth of "call-back" services, which allow rivals to offer international calls by leasing excess capacity from foreign carriers. To use call back, customers in Hong Kong call an operator and then have their call sent back to Hong Kong at lower, incoming rates. New World offers rates to the U.S. for as low as 77 cents per minute, 15% under HKT. New World will cut more. "We will be adjusting quite frequently," says Anita Cheng, New World's director of corporate services.

To get ready for lean rivals, HKT has been slimming down. It has been trimming its payroll since 1990, from 17,800 to 16,000. And it plans to lose another 2,500 through attrition by 1998. It has found savings in other ways. By moving into a new headquarters in a less popular part of Hong Kong, the company will save $40 million this year.

Moreover, greater competition is leading HKT to introduce services that will help it take on local--and global--rivals. It plans to begin video on demand next year, a first step to full-scale interactive television. And on July 25, it announced a new videoconferencing service with Intel Corp., a cheaper alternative to one it started last year with PictureTel Corp. Such services are one way to make sure that locals don't give up on HKT's local service. "Without the network," says Susanna Ma, HKT's manager of video communications services, "the equipment won't work."

The greatest area for growth is across the border in China. Work is progressing on the company's fiber-optic cable to connect Hong Kong with Beijing. But a planned joint venture announced last year for a mobile-phone network in the Chinese capital has met significant delays. HKT is counting on its Chinese connections to eventually get the deal through; Beijing-owned China International Trust & Investment Corp. owns 12.3% of the company.

Already, China accounts for more than half of HKT's business, and that number is bound to rise. "There will be much higher volume on much thinner margins," says Hall. For HKT, the days of monopoly pricing are gone forever.

Hongkong Telecom Prepares To Compete

RATE CUTS Reduces cost of calls to the U.S. and Canada by up to 21%, with more cuts in long-distance charges to come

NEW SERVICES Forms new videoconferencing system and plans to start video on demand next year as a first step to full-scale interactive TV

RAISES PRODUCTIVITY Trims workforce by 10%, to 16,000, since 1990, with an additional 15% reduction planned by 1998