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3rd December 2002 by Tony Glover of Scotsman

HUTCHISON 3G, the UK’s new entrant mobile operator, is facing growing pressure to merge with another group - possibly MmO2, formerly BT Cellnet - early next year after suggestions last week that it cannot meet its loan covenant requirements by the second half of next year.

Two years ago, Hutchison, which employs 150 staff in Glasgow but hopes to eventually have as many as 600, signed performance-related covenants when it persuaded a consortium of 16 banks, including ABN Amro, HSBC, JP Morgan, Royal Bank of Scotland and Citigroup, to lend it £3.2bn. The loan runs for three years from March 2001 with a one-year extension.

Additional financing comes from £777m equipment vendor financing and an additional £275m from parent Hutchison Whampoa, which also stumped up the £4.4bn for Hutchison’s 3G licences.

But by the second half of next year, Hutchison, led by boss Li Ka-Shing, will face a deadline to deliver on its covenants. These take the form of operational and average user targets, and the operator’s problem is that its projections for the roll-out of its network were made in a more optimistic era, when Hutchison expected it would by now have a large customer base paying more than £50 a month each for services including video and audio-messaging over 3G.

Although Hutchison has denied that it had originally told banks it would have 1.5 million customers by the end of 2002, as reported last week, it refuses to reveal what the original projections made to the banks were.

A lack of visibility regarding its covenants is making it increasingly hard for the City to monitor its performance. But telecoms analysts believe the degree of pressure on Hutchison 3G to merge with another operator largely depends on the precise terms of its covenants with its bankers.

Whatever the precise targets mentioned in the covenants are, the company so far only has a few hundred "friendly" users on a network that is not yet fully operational.

Although there is no firm date for a full commercial offering, Hutchison calculates it should be able to snare one million of the UK’s future new 3G customers. Its problem is that it does not have an existing base of customers on a second-generation network who might be tempted to trade up. Even assuming it can get its 3G network running sometime soon, Hutchison will still need to acquire a customer base quickly. Simply undercutting the competition on pricing would not work as it would mean defaulting on its average revenue per user targets.

The simplest way for Hutchison to acquire the required customer volume in time would be to merge with another operator that already has the user numbers. And, in the UK, the mobile phone operator pool is looking increasingly overcrowded. The UK has five 3G operators: Vodafone, Hutchison 3G, Orange, MmO2 and T-Mobile. These core players are starting to face stiff competition from what are called virtual mobile network operators, such as BT and Virgin, which use the power of an existing customer brand to sell mobile phone services while piggy-backing on other operators’ surplus network capacity.

Vodafone is too big a target for Hutchison, and T-Mobile and Orange both have large national incumbents, Deutsche Telekom and France Telecom, as parents. This leaves MmO2. MmO2 carries little debt since its demerger from BT came after the licence auctions in the UK and Germany. It has more than 18 million customers across Europe of which 11.4 million are in the UK and 4.29 million in Germany.

A merger with MmO2, which has a current market capitalisation of £4.5bn, would not only give Hutchison the customer base it needs in the UK, but also a considerable foothold in Germany, a current blank space in Hutchison 3G’s road map and a country where the number of 3G players is rapidly shrinking.

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