A close call for Orange

The mobile boom is slowing - with dramatic effects for one of last year's wonder stocks

Those who missed the flotation in March of Orange, the mobile phone operator, may be forgiven a certain smugness.

From an issue price of 205p, the shares hit 253p a couple of months later, only to suffer a similarly meteoric decline thereafter, to a current level of 184p. Stuck around 175p to 190p, the shares look set for a more torpid period. Orange's outlook may not be entirely dark, but neither is there any guarantee the future is bright - or even orange (to quote from the company's advertising slogan).

The reason for the brief honeymoon lay in the track record the firm had built in the first two heady years of operation. It had already notched up sales of pounds 228m in 1995, with subscriber numbers growing at almost 50 per cent a year.

Since Orange's stock market debut, however, just as everyone was expecting the upwards march to continue apace, mobile phone companies have started reporting a fall in the rate of growth of new subscribers. That, in turn, has meant analysts have had to revise forecasts of when they expect the company to post its first profit figures.

In the last six months, growth rates have fallen quite sharply. The latest subscription figures, this month, showed that market leader Vodafone gained a net 95,000 new subscribers for the third quarter of this year. Cellnet, Vodafone's main rival, saw new connections grow by 84,100 - up 20 per cent. Orange, despite being a tiddler compared to the country's top two, added 86,000 in the quarter, up 20 per cent on the same period last year.

Still remarkable, admittedly, but way off last year's overall performance. Why this should be so is still something of a mystery. Various theories have been proffered: from consumer confusion at the plethora of special offers flooding the market, to disappointment at raw deals from service providers. More than a million customers have tried mobile phones, only to switch off their connections for good.

Investors have also been turned off by Vodafone's recent news that it had cut back its subscriber forecasts for the total UK market to 8 to 10 million by 2000, from the 10 to 14 million it had originally predicted.

Orange offers customers two big attractions: it uses new digital technology and it bills clients by the second. Without getting bogged down in technical details, digital technology was seen as the medium of the future. TV will be digital; computers are digital; telephony too will become digital. The benefit to the subscriber is that a digital signal gives clearer, more secure reception.

Anecdotal evidence now, however, suggests reception is really little different from analogue, digital's predecessor, which is still used by most of Cellnet and Vodafone's subscribers. And in any event, the battle will be fought on price: Orange will not get rich just because of its leading-edge technology.

Mobile digital telephony does have other advantages though: carriers have more capacity, so they can handle more calls; and customers have better access to overseas networks, including continental Europe. But while business users may need a connection with Europe, it might not be uppermost for others.

Nevertheless, Orange's achievement has been remarkable. Since 1994, when its licence was granted, the company has built from scratch a business with almost 700,000 subscribers. The total market is about 6.35 million, with Cellnet and Vodafone grabbing the lion's share, having 2.54 million and 2.65 million each. Mercury's One-2-One has 460,000 customers.

Many believed the British consumer's love affair with electronic gadgetry indicated that mobile phones would be the next big thing. Such prognoses have proved true, but only in part.

Early forecasts put the UK on a par with growth on the continent, especially Scandinavia, where market penetration is as high as 24 per cent. Although that now seems unlikely, an impressive 10.18 per cent of people over here owned mobile phones last year.

The market, however, is already in the grips of a bitter price war. Take handset costs. Special offers can put the price of a digital handset at less than pounds 50, half the previous level - but the cost to Orange of a Nokia phone is believed to be pounds 230. The difference is a marketing expense Orange has to absorb if it is to stay in the game. In other words, the company is subsidising the consumer.

The frantic scramble for new business will heat up even further. Vodafone and Cellnet have caught up with Orange's innovations, such as per-second billing and simpler invoicing.

Most believe Orange can fulfil its potential. But a continued price war could put the company's hopes of profitability on hold for another year or two.

At present, Orange is on course to return its first profits in 1998. That can still be achieved: the recent interim results showed the first positive cashflow - of pounds 6.1m.

But with heavy marketing costs expected to be a recurring item for the foreseeable future, there are probably too many risks in the business for the long-term investor at present. Orange may not be another Eurotunnel in waiting, but nor is it the next pot of gold.

Orange

Share price 184p

Prospective p/e n/a

Gross dividend yield n/a

Year to 31 Dec 1993 1994 1995 1996* 1997*

Turnover (pounds m) 123.4 143.4 228.7 276 462

Pre-tax profits(pounds m) (230.9) (119) (140) (250) (180)

Earnings p/s (p) (30) (16) (18) 21 15

Dividend p/s (p) n/a n/a n/a n/a n/a

*ABN-Amro Hoare Govett forecasts