MARKET COMMENT
mm02's Days Are Numbered

By David Kuo (TMFDragon)
November 19, 2002

The interim results from mmO2 (LSE: OOM) were, as the company itself pointed out, encouraging. Both revenues and underlying profitability continued to grow. In the six months to 30 September, group revenues improved to £2.3b from £2.1b, a rise of 11%. The much abused profitability measure of EBITDA (earnings before interest, tax, depreciation and amortisation) came in at £378m compared to £135m last time. At the bottom line, though, mmO2 is still loss making. The mobile phone operator posted a pre-tax loss of £259m but this was much better than the deficit of £368m it made last year. Today's results, which came in at the top end of expectations, were given a gentle ripple of applause with the shares moving some 3% higher.

Given the high level of competition within the marketplace for cellular phone services, the results from mmO2 showed that the industry is still growing. That is a poke in the eye for those who were forecasting doom and gloom for the mobile phone operators. mmO2 has positioned itself largely as the operator for business customers and high value customers. The improvement in Average Revenue Per User (APRU) is a measure of the success of that strategy. It has also reduced the churn, a measure of customers who have defected to rival operators. Although a churn of 29% appears high, it is no worse than churn figures for its rivals.

mmO2 has also stepped up its data services, which include games and picture messaging. This will help drive revenue growth and also provide new avenues of opportunities for the company. It has kept a tight control of capital expenditure with spending down from £623m last year to just £354m. This two-pronged approach has allowed mmO2 to generate cash. Rising revenues and reduced expenditure has also allowed the company to turn around its loss-making German unit, ahead of time.

Despite the much-improved performance of mmO2, it is difficult to see the company continuing to exist as a stand-alone business. Mobile operators require high levels of investment to keep the business moving forward. Huge investments will be need in the next few years as the market move towards 3G services. When that happens mmO2 will not be able to skimp on capital expenditure, as it will need to make sure its services remain competitive. As it is yet to move into profit it remains a difficult company to value. Continuing bid interest may help the shares but this is rarely a good reason for long-term investors to part with their cash.