Danger of Snook's mobile fantasy

Extraordinarily, the City seems to have bought Orange's mobile phone story hook, line and sinker
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HANS SNOOK, managing director of the Orange mobile phone network, has a dream; it is that one day all the world will be Orange, or at least that "within 10 years the great majority of people will have wire-free telephones", and that perhaps as much as a quarter of them will be Orange subscribers. This might seem like a challenging enough business objective in itself, but there's more. Much, much more.

Many of us might think the mobile phone is already one of the great iniquities of our time, but according to Mr Snook it has so far only begun to scratch the surface of its potential. In a time not too far distant he foresees penetration rates of perhaps 150 to 200 per cent. Yes, I had to think about that, too. What it means is that many of us will have more than one mobile phone.

As important, there will be legions of automated mobile phones which, for instance, will remotely inform the supplier that his Coca-Cola vending machine needs replenishing or that there's a problem with the superloo. Oh, and finally, Mr Snook reckons that in 10 years' time, some 90 per cent of all voice telephony will be mobile.

Starry-eyed stuff. The extraordinary thing is that the City seems to have bought the story hook, line and sinker. Analysts may be entirely right to take the bait in this way: this could indeed be the future. Rather more likely, however, is that it is not - or, certainly, that it won't prove as lucrative for Orange as Mr Snook hopes.

I would rate Orange's chances of meeting its long-term business objectives as at best 50 per cent and probably a lot lower. To be fair, this is not so far off the probability of success that could be applied to most business plans. The difference is, however, that Orange's share price has begun to anticipate that these objectives will be met in full. There's still a little bit of scepticism left in the price, but not much.

In the last six months the shares have doubled. This week they rocketed into the stratosphere on the back of the company's latest marketing initiative, a tariff-cutting exercise which will make Orange price-competitive with Vodafone, the market leader. Many brokers are saying there's another couple of quid to go at least, which if true would put a stock market value on Orange of more than pounds 8bn. All this for a company whose revenues have only just crossed the pounds 1bn a year mark, that will lose in the region of pounds 70m this year, and whose debt is pounds 1bn and rising.

Maybe the City is right to be optimistic, but here's what I believe might be a more realistic view. After a marked slowdown, the mobile phone market has resumed past rates of heady growth, with net new subscribers rising 27 per cent in the first quarter of this year. It is a statement of the obvious to say that the bigger a market gets, the harder it becomes to keep up past rates of expansion. Eventually it becomes impossible. But it is certainly true that so far the market has defied the sceptics.

However, in order to reach Orange's projection that 50 per cent of the population will have a mobile by 2004 (Vodafone predicts it will be a year later, but there's pretty much common ground here between the networks), the market is going to have to carry on growing exponentially.

For 30 million people to have a mobile by 2004 requires compound growth of around 25 per cent for the next three years, falling to 20 per cent in the final year. Given that there are only 31 million ordinary fixed phone lines in Britain, of which 8.2 million are business lines, this might seem just a little ambitious. Around 97 per cent of households in Britain have a phone, but the number of fixed lines per head of population has yet to achieve anywhere near the 50 per cent level Orange reckons will occur in mobiles over the next five years.

It is one thing to be sceptical about achievable growth rates, but perhaps as important is the quality of those going mobile. About half of net new subscribers right now are "pre-paid", a comparatively new area of the market which allows the subscriber to pre-pay for a certain amount of mobile usage. As yet it is unclear precisely how this new type of subscriber is going to behave. Obviously there's less credit risk with such people, but by the same token they seem not to spend nearly as much as ordinary subscribers. Furthermore, this part of the market might be quite small and quickly reach saturation point. In any case, the present apparently high rate of growth in net new subscribers may be misleading.

To return to the specific case of Orange, the company has had to change its marketing pitch markedly to stay with the pack. Throughout 1996 into the early part of last year, Orange was showing 40 per cent-plus growth in net new subscribers, but this rate of growth then began to fall and by the final quarter of last year it was less than 18 per cent. Meanwhile the others were continuing to power ahead. Even One2One showed growth in the same quarter of nearly 30 per cent. Plainly the Sainsbury's-like approach being adopted by Orange - the belief that people are prepared to pay more for a higher quality product - wasn't working. That was the backdrop to this week's announcement by Mr Snook that he is entering the price war with a vengeance.

So even if Mr Snook is right about growth in the mobile market, the networks may have to slash their tariffs down to commodity price levels to get there. Certainly if mobile is ever going to take 90 per cent of voice traffic, it will have to be price competitive with fixed-line telephony.

Things may change, but for the time being such a pricing strategy could not be made economic. On average, each mobile subscriber is subsidised to the tune of pounds 200 for the initial cost of his handset. If this money is not clawed back through tariffs, how else are the mobile networks going to get their money back?

It seems to me that Orange, and to a more limited extent the other mobile operators as well, have created a real problem for themselves here. Rather than have the market base its judgement on what management knows to be achievable, they have allowed investors to buy into their dreams.

To base any stock market valuation on what the world might look like even five years down the line, let alone 10, is always madness. The best Mr Snook can hope for is that he will meet stock market expectations. Much more probable is that he will disappoint them.