Hutchison's Rabbit, Orange and a great big lemon

Back in the early 1990s someone over at Hutchison Whampoa had a brilliant idea.

At the time the cash-rich company was keen to diversify its earnings away from Hong Kong, where in addition to its ports, property and retail businesses, Hutchison had recently rolled out a new mobile-telephone service.

In those days mobile telephones were a niche market. The handsets were the size and weight of a brick, connections were patchy and coverage scant. Worst of all, the charges were crippling, which restricted the customer base to a handful of investment bankers and their drug dealers.

But the mobile market was evolving rapidly and costs were falling fast as the technology was becoming increasingly commoditised.

I know, reasoned Hutchison's bright spark, let's make the most of our balance sheet strength to build mobile networks in Europe. That way we can kill two birds with one stone, both diversifying our earnings and making a tonne of money as we bring mobile phones to the European masses.

The first attempt was a disaster. In an effort to make mobile phones affordable, Hutchison tried to replicate its reasonably successful Hong Kong mobile business in Britain, launching a service called Rabbit (rabbit, Hutch - get it?) in 1992.

It's performance was as lame as the joke. To keep customers' bills down Hutchison opted for a cut-price service with handsets that were unable to receive incoming calls and could make outgoing calls only within 100 metres of a base station.

The idea may have worked in Hong Kong, but it never caught on in Britain. Base stations were too few and far between and customers, who had long regarded mobile phones as a status symbol, were reluctant to be seen toting a cheaper version. With only a few thousand subscribers, Rabbit closed down at the end of 1993 having sustained losses of hundreds of millions of pounds.

Hutchison seemed to learn from its failure. The next year it launched a fully featured mobile phone service called Orange. The marketing was slick, the handsets were state of the art and the coverage was extensive. Best of all, the service was affordable. Customers loved it.

By early 1996, when Orange was floated at a capitalisation of GBP2.5 billion, it had signed up 400,000 subscribers. By the time Hutchison cashed out in 1999 with a GBP20 billion sale to Mannesman it had millions. Hutchison chairman Li Ka-shing's reputation as the consummate asset trader was firmly established. Rabbit was forgotten.

Then in 2003 Hutchison tried to repeat its Orange success, launching 3, a third generation mobile service, in Europe.

The formula proved difficult to replicate, however. The investment costs were punitive. And customers were reluctant to ditch their existing phones for a more expensive version with the dubious added benefit of being able to make video calls or receive live football scores.

Five years on, Hutchison's 3 Group has yet to turn a profit although, as the first chart below shows, its losses are at least getting smaller. In the first half of this year, the unit made a loss before interest costs and tax of HK$3.2 billion, a marked improvement over last year's first-half loss of HK$11.3 billion. The company hopes to make a monthly operating profit (before interest costs) by the end of this year and a whole year operating profit (again before interest) in 2009, some three years later than its original target.

At that point Hutchison is likely to try and recoup some of its vast investment either through a trade sale or with an initial public offering, probably of 3 Group's Italian arm. Whether buyers will step up is uncertain. Hutchison tried to float its Italian service in 2006 but abandoned the deal after it failed to get the price it sought.

True, the unit is losing less money now, but with European economies contracting, investors are bound to be wary and it looks like Hutchison's venture into 3G telecommunications may continue to weigh on the group's stock price for a considerable time to come (see the second chart).

Unfortunately, it seems Hutchison has not fully taken to heart the lesson of Rabbit, and Orange's successor has turned out to be a lemon.