Carburton Street, London -- It might be bright and it might be orange, but the future of the mobile communications industry is anything but clear. It wasn't clear when Orange floated for the first time in 1996 and, if anything, it's even less clear now. In that original flotation, investors were sceptical that mobile penetration rates in the UK could increase beyond the lofty heights of 50%. According to experiences in more developed Scandinavian markets, the "s-curve" would lead to a slowdown in growth and a levelling off at around the 40% to 50% level. Despite this, many investors (myself, unfortunately, not included) made the leap of faith and have been repaid handsomely for their troubles. Orange shares soared, but even since its takeover in 1999, the market has gone from strength to strength. Penetration rates in the UK have passed even the most bullish projections and now stand at over 60%, after an astonishing rise from about 41% at the end of 1999.
Now we're being asked to believe in penetration of more than 100%. Not only will we carry a device around with us, but many of our electronic toys and tools will soon be able to talk to us and to each other. This new world of "human to machine", "machine to human" and "machine to machine" communications is where Orange wants us to believe the future lies. Do we believe them? Should investors again take a big gulp and put their money behind this hazy Orange view of the future?
It is going to happen
What we've seen from mobile communications so far merely represents a short taxi over to the runway. Don't ask me exactly where we're flying to but, over the next few years, I'm confident that the mobile market is due to take off. Why? Simply because there is no reason why it shouldn't. There's just too much scope for it to add value to our lives.
People might say that that they don't need automatic directions and traffic information in their cars, and they'd be right. But not needing something does not mean to say that it wouldn't be useful. The technology is there (or very nearly) and it won't be prohibitively expensive, so why not have it? People will say that they don't need to watch the highlights of last night's game on their handheld device on the train to work. Again they'd be right, but it would be quite nice, wouldn't it? How about an alert that automatically leaves a message on your phone if your normal train route to or from work is disrupted? It's not vital for a full and meaningful life, but quite handy nonetheless. None of these things are essential, but then neither is a television and nor is a can of Coke.
Orange will deliver
Despite its already enormous scale, mobile communications is a market in its infancy. You have to have quite an imagination to have any idea of where the market is likely to be in even a few years' time (as demonstrated by my rather brief list of possible uses above). It's a market that favours companies with a vision and the courage to back it. If you take the slowly, slowly catchy monkey approach, you'll wake up to find that the monkey has suddenly disappeared to another part of the jungle
Orange has shown already that it has all the elements to thrive in this environment. From a standing start in 1994, it has taken a market share in the UK of 24%, almost catching number 2 Cellnet's 25% (Vodafone (LSE: VOD) leads with 30%). More importantly, though, with innovative services such as Wildfire (a voice-activated personal assistant) and Orange internet, the company has demonstrated that it has the vision and adaptability to take advantage of a rapidly developing market.
It is true that its visionary leader, Hans Snook, has reduced himself to a consultancy role, but new CEO Jean-François Pontal has made it clear that he aims to keep Snook incentivised and closely involved. In any event, despite appearances, Orange is far from being a one-man band. Other senior management, including deputy CEO and finance director Graham Howe, has remained or been strengthened. Just beneath that, an already strong layer of managers will, if anything, be more motivated to carry on their good work as an independent company, after the ownership uncertainties of the last few years have been removed.
Valuation
Mobile communications are set for take-off and Orange is in as good a position as any network operator to benefit. Current plans are to price the shares at between €11.5 and €13.5 (725p to 851p). A price tag in the middle of this range, €12.5, implies a market value for the whole group of €60.6 billion, or £38.2 billion.
Based on forecasts for the year to December 2000, this represents a multiple of 5 times sales and 35 times EBITDA. Based on yesterday's close and forecasts for March 2001, equivalent multiples for Vodafone are 7 times sales and 22 times EBITDA.
The other obvious comparison is "proportionate subscribers" (that is, the total number of users of each network times the company's proportionate shareholding in each network). Vodafone has about 70 million of these, giving everyone a value of £2,460 (based on an enterprise value of £172b). Orange, on the other hand, has around 28 million, making each subscriber worth just £1,490.
These comparisons show that Orange is on a discount to Vodafone on sales-related measures, but a premium on profit-related measures. This reflects the lower margins but higher growth of Orange's younger and less developed networks. For example, Orange took 35% of the new market in the UK in the first 9 months of 2000.
Orange's lower valuation per user also reflects the fact that it has a higher proportion of less valuable pre-paid customers. The UK network, for example, generates annual average revenue per user (ARPU) of around £260. This breaks down into 36% contract customers, which generate a healthy £494 in ARPU, and 64% pre-paid customers producing just £129. Vodafone, on the other hand, has only 62% pre-paid customers at £165 each, with 38% contract at £557 for a much better average of £314 per user. I can see no real reason, though, why Vodafone should be able to maintain its advantage in this area. After all, anything that Vodafone does for its contract customers, Orange can do too. Most likely, in fact, it will do it that little bit better.
One final little titbit for private investors is that Orange is planning to give them a discount of €0.5 (or 4%) off their shares, compared to what the institutions pay. At the Motley Fool, we'd say that private investors don't need too much help to beat the pros, but we also wouldn't look a gift horse in the mouth. To be given a 4% head start in the battle for performance is rare indeed and sweetens an already attractive offer.
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