Hutchison's 3G Teething Pains

China's telecom giant is racking up huge losses on its new 3 cellular network. But Li Ka-shing is determined to make it a winner

When a businessman nicknamed "Superman" starts a new venture, you can bet he'll put plenty of muscle into it. So when Li Ka-shing -- the chairman of Hutchison Whampoa Ltd., often likened to the Man of Steel by the media -- decided to get into third-generation cell-phone service, he didn't cut corners. Since 2000, Hutchison has laid out $16 billion for 3G licenses and equipment. Now, even though the service has attracted just a half-million customers in the three countries where it has been available longest, Hutchison is piling in even more aggressively. The company is opening networks in four new countries this fall. And, ever-confident, Hutchison even picked up a new 3G license in Norway on Sept. 2. "The business is getting better every day," says Canning Fok, Li's second-in-command at Hutchison.

Sure, Hutchison's service -- marketed as "3" in Italy, Britain, and Australia since early this year -- hasn't taken off as quickly as Li and Fok had hoped. Nonetheless, Fok is ordering 3 million new handsets for the network to meet the surge in demand he's expecting. He insists the company, after a renewed marketing blitz, will come close to meeting earlier targets of signing up 1 million customers in both Britain and Italy by yearend. And he vows that the 3G operations will break even on an operating basis in two more years. "I know there is a lot of skepticism about what we are doing," Fok says. "Hopefully by continuing to deliver we will change people's minds."

Others are less bullish on 3's future prospects. The 3G technology it uses still isn't as reliable as the second-generation GSM services that it competes with, many say. Moreover, 3G phones are relatively bulky and have poor battery life, and the network isn't anywhere near as extensive as the one for 2G systems, according to financial researcher First Global in London.

Even though 3G's strength is supposed to be the high-speed delivery of cool -- and pricey -- services such as video calls and downloadable music, relatively few people are making use of their phones' data capabilities, says Philip Taylor of market researcher Strategy Analytics Inc. In fact, about the only data services that have really taken off are clips of soccer matches and pornography, he says. That has forced 3 to drop the price of its voice tariffs from about 24 cents per minute to 8 cents. "They have realized that the service they're offering is so poor that the only way to compete is on price," says Richard Windsor, mobile analyst at Nomura Securities International Inc. in London.

Even the doubters, though, don't count Hutchison out. The company is continuing to invest in its networks, and by midyear the service covered 70% of the British population and 50% of Italians, up from 50% and 40%, respectively, in March. And when its phones didn't sell at their initial price of $635, 3 quickly started offering handsets for as little as $78 to subscribers who signed up for a one-year contract. New phones from Motorola Inc. and Sony Ericsson Mobile Communications will be sleeker and more capable, and as more customers sign up, analysts expect services such as video-telephony to pick up. The company's "teething problems," such as its clunky handsets and limited network coverage, "will likely be solved by yearend, making Hutch a more formidable competitor," says First Global analyst Devina Mehra.

Hutchison has another big advantage: Cash. Lots of it. As of midyear, Hutchison had $23.6 billion on its balance sheet. The 3 phone network is just a tiny part of Hutchison Whampoa's global operations. It is the world's biggest port operator, with facilities from Panama to Rotterdam to Shanghai. Hutchison's China operations in particular have benefited from that country's fast-growing global trade. It controls Husky Energy Inc., a Calgary-based oil company whose profits doubled in the first half, to $608 million. Its retail and manufacturing arm is riding high, thanks in part to the acquisition last October of drugstore chain Kruidvat Group in Europe, and a joint venture with Procter & Gamble Co. in China that makes and distributes soaps and skin-care products. Indeed, with its cash hoard and range of profitable operations, Hutchison's overall health isn't in danger even if its telecom foray flops.

Even as the 3 cellular venture racked up a $500 million operating loss on sales of only $31 million in the first half, Hutchison's global net profit increased to $778 million, up 2% from the year-earlier period, on sales of $8.4 billion. That has helped Hutchison's share price jump by nearly 25% this year, although it remains at less than half its 2000 peak. The profit outlook for Hutchison's basic energy, ports, and retail operations, meanwhile, is good. "We have huge opportunities for growth," says Fok.

Skeptics, however, say that the slow start of the 3 network isn't Hutchison's only problem. Hutchison is one of the biggest companies in Greater China, and -- because of Li's close ties with government officials in both Hong Kong and Beijing -- it has become a lightning rod for anti-Beijing sentiment. When Hutchison tried to take over bankrupt telecom carrier Global Crossing Ltd., some U.S. officials cried foul. Hutchison was forced to withdraw from the deal and wrote off a $400 million investment in Global Crossing. And the company's acquisition of a port in Burma is attracting increasing attention.

Then there's the issue of succession. Li is now 75. His elder son, 39-year-old Victor, is deputy chairman of the group, which makes him the odds-on favorite to take over the company. His younger son, 36-year-old Richard, runs rival telecom operator PCCW. As with any family company, there is no guarantee that Li can successfully pass the business on to his children.

It is still not clear whether Hutchison's big investment in 3G will turn out to be a Kryptonite bomb that weakens Superman's cash machine or whether it's one of history's smartest bets. Li's track record, though, would indicate that he has a pretty good chance of overcoming the hurdles he faces. Back in the 1990s, Li built cellular carrier Orange from a British bit player into a strong competitor by keeping prices low and relentlessly expanding the reach of the network -- just as he is doing with 3 today. And he knew when he had to cash out, too: Li sold Orange to Mannesmann (which was quickly purchased by Vodafone Group PLC) at the peak of the telecom boom for nearly $20 billion. The money from that deal funded his current push into 3G. So don't count this superhero corporate chieftain out of the 3G battle anytime soon.

By Mark L. Clifford in Hong Kong and Andy Reinhardt in Paris, with Kerry Capell in London

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