When Big Brother plays the market

France Telecom's proposed bailout package could put the long term health of wireless finance in real danger

Is the European wireless market being strangled by state interference?

Chris Gent certainly seems to think so. From the fuss he's been making, you'd think operating a mobile phone

business in the EU was like being a travel agent in North Korea. Not content with re-opening the wound of extortionate 3G licences, Gent has been fulminating against the prospect of having his pricing plans capped by UK regulator Oftel, not to mention bad-mouthing the French government for a brazen bailout package to its 55 per cent state-owned national operator. Intemperate he may be, but might he also be right?

It is worth noting that state interference is not by itself a threat to the financial health of any industry. What matters is the kind of state participation. Even the most zealous worshippers of the "invisible hand" of market forces have problems explaining away the almost unparalleled financial success of the arms and military equipment industries in the US, which rely entirely on state subsidy. On the other hand, when governments do not have such a direct interest in the end-product of an industry, they can often make a real mess of things. And it is a common accusation levelled at European governments (often, somewhat hypocritically, by the US) that they are far too statist when it comes to matters economic. Are EU governments making a mess of European wireless?

Companies only complain about state interference when it suits them.

To determine the real impact of Big Brother on wireless finance it would be well to look at the specific issues closely. Of all issues, the one that has engendered the most bile by far is that of spectrum licences.

You'd think this should be water under the bridge by now but the fact that some executives, like Gent, are still smarting over the issue suggests they are still feeling the financial burden of the bids they made in 1999 and 2000.

Arguably this is because, back in 1998, Brussels strong-armed operators into WCDMA (which required new spectrum) in a bid to replicate the success of GSM. Yet there was no regulation involved in most European 3G licence auctions. The regulating factors were the need for a licence and the limited number of licences. The cost of those auctioned licences was determined entirely by the bidders, in a state of free competition, with no state interference in the bidding process. The whole point was that each firm should decide for itself what it could afford. If it later turned out they miscalculated on the cost/benefit analysis, then tough luck.

But there's no doubt that the bidding games were designed to maximise government revenue at the expense of the licence payers, which certainly did contribute to the sector's indebtedness. By May 2001, European companies had ploughed some [euro] 136bn purely into licence fees, before they'd even started to count the cash needed to build expensive 3G networks. Compare Japan, where licences were offered at no cost, precisely in order to avoid burdening the sector as it developed towards 3G. The strategy worked as Japan quickly spawned 30 million mobile internet users before 2001 was even half way over.

Even granted this blatant 3G subsidy, the dicey nature of the business meant Japanese operators were far from being assured of financial security.

When J-phone executive Takeshi Hashino remarked that, "it will take several years to cover our investment" in 3G, it must have sent chills down the spines of Europe's handicapped telecoms managers. Two years on, with colossal debts, even after several efforts at reduction, EU governments must at least accept some responsibility for the financial mess of the sector.

Two more examples of recent behaviour that has had executives fuming at Eurocrats are price caps and bailout packages. As regards the former, there's not much new in Chris Gent's pronouncements - he's been scrapping with the regulators over this one since 2000. The UK's four-strong oligopoly in the mobile market has always been suspected of being far too profitable to be considered competitive. In May 2001, Gent was incensed at Oftel for concluding that Vodafone's record [pound] 4bn profit (on an underlying turnover of [pound] 21.4bn) was the mark of an uncompetitive market. Then, at the end of the year, the UK regulator slammed UK mobile firms once again for being uncompetitive, saying it might slap on a price cap of 12 per cent minus inflation over four years.

And the row was ignited again last month with Oftel ordering wireless companies to cut the excessive cost of calls to other networks - this time saying it would take action if they did not comply. Clearly this is bad from the point of view of financial markets. Any state influence which puts pressure on companies to cut prices below what consumers are willing to pay eats into profits, which reduces shareholder returns and puts timely debt payments at risk.

So price caps are always bad from the point of view of investors. On the other hand, they can be very good for consumers if the degree of competition in a market (like that of the UK) is questionable owing to domination by a handful of companies. Here we have a case where the interests of consumers and the interests of financial markets may not be converging.

Financial markets tend to want more monopolistic industries because this boosts profit margins. But that can be costly for consumers.

Either way, a much more clear-cut statist threat to the long-term financial health of the wireless industry came at the start of 2003. This was when beleaguered France Telecom, to the horror of industry participants the continent over, was offered a juicy [euro] 9bn rescue kit from the French government.

This was part of a more general bid to raise money from other loyal shareholders, which is supposed to produce some [euro] 15bn in total. Last month France confirmed its intention to administer the aid straight away, in spite of the fact that the jury is still out on whether the package violates EC competition laws. Should the EC decide against France, FT may find itself having to pay the money back.

The row over France Telecom's bailout is a unique event in the mobile business in that just about everyone except the interested parties agrees that it is plain wrong. There is no doubt that FT needs the money. It owes staggering amounts and [euro] 15bn is due to be recalled in June 2003 (with no clear sign of where this cash is going to come from and with the financial markets already laden with FT bonds). But that's not the point. The issue is whether governments should be allowed to bail out companies that fail to manage their financial resources properly.

The answer is surely that there is no justification for this since any bailout will simply punish those companies that have been more prudent.

There is even less justification if intervention is to support a company that is an incumbent, and which has simply failed on account of being lumbering and inefficient. As a wise man once said, capitalism without bankruptcy is like Christianity without Judgement Day - it doesn't allow you to separate the good from the bad.

Not that France Telecom is about to go bankrupt. Even if the EU does reject its right to put out the begging bowl, it will manage. It has a huge customer base, billions of euros worth of assets scattered about the place and some real money-spinners like Orange. The point is that financial markets as a whole suffer when companies are rewarded for getting into trouble with debt and, ultimately, so do consumers. If the winners are the ones that managed their investments properly, that can only be a good thing for the overall health of an industry sector.

Here the EC's judgement clearly merits praise. The fact the EU was willing to stand up to the French government's naked protectionism shows that the EU does have an interest in promoting free competition in the wireless industry. Even if some of its member states do not.