Deutsche Telekom fights back on all fronts

News Analysis: Europe's largest telecoms group has had a rough ride this year, but aggressive expansion could restore credibility

A FEW MONTHS ago, Deutsche Telekom and its chief executive, Ron Sommer, were the laughing stock of the European telecommunications industry. Ambitious plans to merge with Telecom Italia had been robustly rejected by investors and politicians alike, and its global alliance with France Telecom lay in tatters. Many doubted that Mr Sommer would still be in a job by the end of the summer.

But now Deutsche is attempting to bounce back, embarking on a root-and- branch corporate restructuring that is sending shock waves through the industry. Can Mr Sommer hope to save his job and his company from the competitive forces gathering at his door?

Just three weeks after snapping up One2One for pounds 8.4bn, Deutsche Telekom is conducting an auction of its nine regional cable networks. The sale, which could raise upwards of pounds 6bn, has drawn interest from more than 20 bidders, from venture capital partnerships to Microsoft, News Corp, and the new telecoms startups like Mannesmann and Viag Interkom.

If that weren't enough to digest for Deutsche Telekom, Europe's largest telecommunications group, and NM Rothschild, its advisors on the sale, last week the group outlined ambitious plans to expand further beyond Germany and hinted at setting up separately listed holding companies on the stock market for its mobile phone and on-line assets.

"I am convinced that this is the only way in which we can further enhance our strong position in rapidly changing markets," said Mr Sommer. He added that setting up separately listed companies could prove the best way to finance a new round of mergers and acquisitions.

This burst of activity follows the telecoms giant's aborted, and poorly organised, last-minute attempt to be a white knight to Telecom Italia as it unsuccessfully tried to escape Olivetti's hostile pounds 40bn takeover bid. Deutsche Telekom isn't the first national telecoms carrier to struggle with privatisation and a tidal wave of new, fleet, cost efficient competitors spawned by telecoms market liberalisation.

In some ways, however, the German company is being forced to adjust far faster than other national carriers. British Telecom, for example, began its adjustment to competition and life in the private sector in the mid- 1980s, but only had to face off against Cable & Wireless, formerly state- owned itself. Nippon Telephone and Telegraph on the other hand has faced the new telecoms environment through the protective embrace of the Japanese government, which until recently has aimed to slow the onslaught of competition.

Mr Sommer's determination to advance on a number of fronts has coincided with a fall in sales and profits from Deutsche's traditional business. The company unveiled a 4 per cent fall in first-half sales to 16.8bn euros, while interim net earnings slid 4.5 per cent to 951m euros. However, the company's stock has rebounded as investors draw encouragement from the Deutsche's new-found determination to change.

The spur to change has been an explosion of competition in Germany since deregulation belatedly began 20 months ago. Liberalisation has resulted in heavy price cuts in domestic and long distance fixed line charges.

A closer look at the first-half figures shows that fixed-line network sales plunged 19 per cent to 8.5bn euros. That contrasted with a 21 per cent rise in mobile sales to 1.7bn euros. Revenue from other services, including the company's T-Online Internet arm, soared 47 per cent to 471m euros.

Price cuts, said Joachim Kroeske, chief finance officer, are expected to stabilise at between 5-0 per cent per year from 2000. "Combined with continued double-digit growth in the number of call minutes and smaller declines in market share, this will mean that our fixed-network call revenues will at least remain stable," he added.

But some analysts disagree. They argue that the company will still have to face steep price cuts in fixed-to-mobile and international call prices. "I expect prices to drop off the cliff," said Joeri Sels, an analyst with Bank Julius Baer. Such forecasts are the stuff of nightmare for any firm, but are more acutely felt by executives at formerly state-owned telecoms carriers. With workforces numbering in the tens of thousands and decades- old infrastructures, their fixed costs far exceed the costs of new entrants, who, more often than not, target only the most lucrative, fast-growing, market niches.

That's one reason why Mr Sommer, acting on a European Commission missive forcing the company to sell its cable assets, is seeking to retain 25 per cent stakes in each of the regional networks even though they require upgrading that will cost pounds 2bn or more.

The network, which with 17 million homes connected is the world's second largest, promises to be the conduit early next century for delivering high speed Internet service, pay-TV and e-commerce products. Of course, these aren't traditional telecoms products, but they do offer Deutsche an opportunity to offset the ongoing decline in its existing businesses.

Along with that focus on new business models, Mr Sommer also plans to expand the company abroad.

Global One, Deutsche Telekom's existing joint venture with France Telecom and Sprint of the US, appears on the verge of splitting up after enduring hundreds of millions of pounds in losses, and making a decidedly minor impact on the market for delivering telecoms services to multi-national corporations.

Compared with BT, Europe's second-biggest telecoms player, Deutsche is at least two years behind in building stakes abroad in high growth data and mobile telecoms operators. Last week's admission that a flotation of the Net and mobile units is being considered could provide Mr Sommer's team with the high-rated stock needed to fund expansion beyond its German heartland into other European markets, Asia and North America.