THE ORANGE ORDER

THE pounds 3BN ORANGE FLOTATION
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The Independent Online
IT WAS the ultimate Eighties status symbol. Expensive and hi- tech. A fashion accessory for bankers and brokers. Mobile phones became such an icon of the City that former Independent cartoonists Charles Peattie and Russell Taylor used them as a running gag. Their title character, Alex, regularly arranged to have people phone him just so that he could show off his toy.

Today, if you wander through the Square Mile you are as likely to see cleaning staff and mail-room boys with cellular phones as high flyers from corporate finance departments and trading floors. Power players still have them, but prefer to keep them concealed whenever possible. The phones are now so cheap that people no longer consider them suitable as Christmas presents. The image of Alexander Graham Bell's intellectual great-great- grandchild has taken a turn downmarket.

So, too, have the fortunes of the cosy duopoly that ran the mobile phone industry in its early days. Once so powerful that they were cajoled by the Government into using a phalanx of independent retailers to market their service, Vodafone and Cellnet are now being challenged in their core business.

Last week, Orange, an upstart operator risen from the ashes of an earlier, failed, experiment, signed up its 400,000th subscriber. But what set the City's phone lines buzzing was the news that it was to be floated - possibly for as much as pounds 3bn.

The threat has unleashed a torrent of charges and counter-charges whispered discreetly into portable hand- sets. Among them is a fight over the significance of the fact that Orange has 25 per cent more capacity than either Vodafone or Cellnet.

A successful offering would be good for the whole sector, boosting the shares of Vodafone and the parent companies of Cellnet and Mercury One- 2-One.

But the danger of Orange overtaking the two market leaders could not be ignored. Industry insiders are warning of dramatically increased competition while throwing cold water on optimistic projections of the interloper's prospects. "The future is digital," said one, parodying his rival's advertising, "but it's not necessarily Orange."

Nobody argues against digital. The technology has the capacity to code signals so that private conversations - remember Squidgygate? - cannot be intercepted, or at least not without serious MI5 spy gear. It also offers more capacity - because the content can be compressed - and potentially greater clarity as microchips can be used to "clean up" the signals.

The story of Orange begins with Li Ka-Shing, a Hong Kong billionaire reputed to be one of the richest men in the world. Although he maintains that he is confident of the colony's future prosperity under the mainland communists, for several years he has been moving assets abroad in advance of 1997. By the early part of the decade, he had several telecommunications projects running in Britain, including the ill-fated Rabbit.

One of Mr Li's companies, Hutchison Whampoa, had joined forces with British Aerospace and Barclays Bank in 1992 to roll out a stripped-down digital mobile system. A similar business had proved itself in Hong Kong where 70,000 people used it. The UK system was relatively cheap and won applause from Which? magazine.

But Rabbit had more in common with pay phones than mobile phones. Customers could only make out-going calls, and only when they could see a base station less than 100 yards away. What had worked in the gadget-crazy Crown Colony a few years earlier was snubbed in the Imperial capital. After 18 months, it had just 9,000 subscribers.

Enter the backpackers. Hans Snook had left Calgary with his wife on a two-year, round-the-world trip. But when they arrived in Hong Kong, some Canadian friends he knew from home asked him to take a job running a small paging company. The 12-month job stretched to two years, and when Hutchison Whampoa took it over, he was asked to stay on.

From the opposite direction came Graham Howe, a Briton who took the Trans- Siberian railway to the East, then moved down through China. The two met up at the paging company and stayed in touch while they were at Hutchison. When Mr Snook was dispatched to London to run the telecoms businesses there, he took Mr Howe with him as his finance director.

The duo arrived in London in January 1993 and quickly concluded that Rabbit had no future. "I very much doubted that we would ever make any cash out of it," said Mr Snook. Their recommendation that the project be closed down was accepted, causing a write-off of pounds 122m, and they set about creating another mobile phone operator on Hutchison's newly won 1,800mhz band. To date, the investment has been about pounds 500m.

Launched in April 1994, Orange managed to avoid the snares that trapped Rabbit. Mr Snook concentrated on a rapid roll-out of base stations, so that within 21 months it already has more than 90 per cent of mainland Britain's population covered, although some of it is patchy. "There are still holes to be filled in," he admitted.

More importantly, the company introduced innovative pricing mechanisms. It charges by the second, rather than by the minute or half minute, and it bundles set amounts of airtime in with the basic monthly rental. The first technique ensures that customers do not feel ripped off when they make brief calls. The second - based in part on Mr Snook's experience in Canada, where local calls on conventional phones are free - encourages customers to get into the habit of using the service a lot. On average, Orange customers spend 24 per cent more time on the phone than they have paid for in their basic package.

The results were dramatic. While Cellnet and Vodafone are still pulling in more new analogue customers, Orange has led the field in signing up digital customers over the last quarter. According to Kleinwort Benson, it is likely to be running a close third to the giants with a market share of 25 per cent by 2005. And by then, the total market is expected to have grown from its current 5 million subscribers to 16 million. In an analysts' report published last week, the bank - which has been appointed joint global financial adviser to the flotation - estimated Orange will be profitable by 1998.

The ink had barely dried on the report before criticisms started to be put forward. One newspaper column compared the capital-intensive project to debt-ridden Eurotunnel. Other industry observers questioned the method Kleinwort had used to reach its conclusion that Orange was worth between pounds 2.5bn and pounds 3.7bn.

Because the company is young and still losing money, projections are based on little direct historical data and lots of educated guesswork, backed up by complex mathematics. The range of values generated gives a sense of how sensitive the results can be to the assumptions employed. Most contentious are the market-share projections, which show an increase of 4 per cent this year and next. "Their market share assumptions are quite aggressive," said one analyst. "Clearly its competitiveness is going to be eroded."

One factor that could change the projections is that Orange's price advantage of 30 per cent is about to be cut sharply to about 8 per cent. Vodafone has announced new tariffs for first-time subscribers, to include per-second billing and bund- ling. Cellnet is expected to follow suit before the float. Orange appears unfazed by its rivals' moves. "In internal meetings before we launched I was telling our people that within a year everyone would be doing per-second billing and bundling," said Mr Snook. "It's just taken them a little longer to catch up."

It is less happy about charges that the 1,800mhz band has less punch than the 900mhz portion of the radio spectrum where Vodafone and Cellnet operate. Though more desirable, the 900mhz band is surrounded by wavelengths reserved for military and police use and cannot be easily expanded, so the latest systems were awarded at the higher frequency. Critics say tests by roving teams of phone company employees phoning back to the office have discovered so-called "black holes" in Orange's coverage.

The upstart's supporters counter that the established networks have their own coverage problems. Their digital services were grafted on to existing analogue base stations, and therefore are not always ideal for the new service.

Behind the sniping, however, a real fight is under way. Orange is counting on its extra capacity to give it the flexibility to push its way ahead of the pack and stay there. Like Mercury, it was awarded 25mhz of bandwidth, almost 25 per cent more than Vodafone and Cellnet. Because of that, it is able to follow a different marketing strategy.

Orange can afford to lower its per-call rates and get its money back on sheer volume of calls. Its bigger rivals may not have that option. Although they deny that they have any capacity constraints, they have been recruiting customers who make few, short calls rather than those who are constantly on the phone. Over the past four years, the number of low-use customers signed up to the duo has caught up with and passed the level of high-use customers recruited over the past decade.

But the usual measure of capacity utilisation, subscriber numbers, can be misleading. The real comparison should be between the number of channels on offer and the number of calls being made at any given time. The most dramatic case of a misbalance came during Christmas 1994, when Mercury offered free international calls to anyone who bought a new cellular phone. So many calls were made that the system crashed, leaving a public relations nightmare. Orange now runs the risk of finding itself in a similar situation.

Pressure on the capacity of all four networks could grow even if wireless telephony starts to flag. Some industry observers predict there will be an increased use of cellular technology for transmitting data. Already some companies, such as Lerryn of Cheshire, are packaging laptop computers complete with a cellular link to the Internet. Low-resolution video transmissions are also possible, although at present the technology is less than ideal.

Ever on the cutting edge of status technology, Alex could be one of the first to buy.

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