Business Analysis: Hutchison set for 1m UK customers - but 3G gamble still proving costly

'3' mobile phone service hits landmark figure but the economics still worry sceptics

Tomorrow should see "3", the mobile phone group, finally reach the magic number of 1 million customers in the UK and notch up a landmark in its short but troubled history.

Tomorrow should see "3", the mobile phone group, finally reach the magic number of 1 million customers in the UK and notch up a landmark in its short but troubled history.

According to analysts - both the bearish and reasonably bullish - its parent company Hutchison Whampoa, the sprawling Hong Kong conglomerate controlled by Li Ka-shing, is gearing up to announce a significant breakthrough in the UK and its other third-generation (3G) markets worldwide. The fanfare that will accompany the one-millionth UK customer will be aimed at convincing the market that "3" has broken through.

So, after a dreadful start marred by slow sales, technical cock-ups and handset delays last year, has "3" really turned the corner? From a tiny, albeit very costly, new entrant, can "3" seriously look forward to a long-term future?

"Their subscriber numbers will be stonking, absolutely no doubt," says Ben Wood, an analyst at Gartner. "They will put out some phenomenal numbers, perhaps 1 million in the UK, that has to be a milestone for them. But the question is, 'is it sustainable?'"

From the sales figures it would seem that consumers are fast cottoning on to the video calls and messaging as well as the sport, movies and music that "3" has to offer.

But what worries the market is the cost of Hutchison's investment and the price it is paying for new business.

"You can have as many subscribers as you like but can you make any money from them?" asks Mark James, a telecoms analyst at Nomura.

By indulging in a land grab at any price the economics simply don't stack up, say the critics, especially in a market as competitive as the UK mobile phone business, for instance.

It is estimated that Hutchison has sunk £11bn into its 3G operations, a decision taken by Canning Fok, the group's managing director, and the market believes it will be a long time before it sees any economic return.

Hutchison for its part believes people have failed to understand its strategy. It has long been in mobile telephony, being the original developers of the highly successful Orange business. But it sold its interest in Orange, and other so-called 2G businesses, before the bubble burst, for a $25bn profit - albeit some of that was in shares of the purchasing companies.

Even after the crash it was left with $20bn in cash from its mobile investments which it used to become the first player in 3G.

Of course Hutchison's "3" in the UK rather foolishly said at its launch in March last year that it would reach 1 million customers by December. In fact, it had reached less than a fifth of that total by the time people were opening their presents under the Christmas tree.

Things, however, have started to hot up since then. In March it revealed it had 361,000 customers in the UK and analysts believe that in recent months the performance has been nothing short of breathtaking.

"The company added 11,500 subscriptions per day globally mid-March to mid-May and that quickly ramped up to 20,000, far above expectations," says Rob Hart, a Morgan Stanley analyst.

Even Nomura, one of the biggest bears on Hutchison's 3G business, reckons the company will announce a global subscriber base for the "3" brand of 3 million, up from May's total of 1.7million. As "3" in the UK pretty consistently accounts for at least a third of "3" worldwide, the British operation should be safely into seven figures.

But will even this add up to anything more than a hill of beans? The graphic shows the UK mobile phone market shares as of the end of March.

Hutchison's efforts are squeezed into less than 1 per cent of a market dominated by T-Mobile, Vodafone, Orange and 0 ₂ - all of which are plotting rival third-generation services of their own having spent more than £20bn on 3G licences from the government at the height of the technology bubble.

But "3", led in the UK by Bob Fuller, the chief executive, reckons it has several key advantages over its rivals. It is first into the market. It has now established its brand, and crucially it has already been through the inevitable teething troubles associated with a complex new technology.

Furthermore, it has established the price for 3G services and it believes its rivals are going to struggle to match its tariffs, never mind undercut them.

Admittedly their latest tariffs are compelling, especially given the highly functional handsets that consumers are being offered from the likes of NEC and Motorola. For £25-a-month consumers get 500 voice minutes and can get extra content, including Premiership goals for instance, for just a fiver more.

The company is confident that it understands what makes people buy extra content using their mobile phones and how to nudge them into a purchase.

The problem for rivals such as Vodafone, planning to launch rival 3G services in time for Christmas, will be to match the "3" tariffs or persuade consumers that their 3G services are somehow demonstrably better and therefore worth paying more for. Hutchison reckons they will struggle to do this.

Perhaps what is really making the biggest single difference for "3" at the moment is the U8110 handset from LG, the Korean electronics manufacturer. It has helped fire sales among people who simply don't need the vast computing power and functionality of the other main "3" handsets from NEC and Motorola.

"It is the first 3G phone that has the size, weight, battery life and performance of a standard handset," says Mr Wood.

But no matter how sexy the handset, it all comes back to the dismal science. Will the economics work? As well as building new mobile phone networks to carry its 3G services, Hutchison has been busy subsidising handset sales through retailers and offering cheap tariffs. This should mean "3" hits 5.8 million subscribers globally by the end of this year, including about 1.9 million in the UK, according to Morgan Stanley estimates.

However, this could all come at a terrible cost. Mr James reckons the combination of cheap tariffs, high customer acquisition costs, falling revenues per customer and remaining capital expenditure commitments mean the cash will simply keep flowing out of Hutchison's coffers.

"We reiterate out view that we fail to see how Hutchison 3G will ever make an economic return," he said in a note last week.

The new LG handset may be proving popular with customers but it is proving a financial black hole. "Hutchison is spending, we estimate, around €500 (£337) putting this phone into a customer's hand, and getting €240 a year in return. Given that, on average, one in four customers will disappear after the first 12 months, we continue to wrestle with the economics," says Mr James.

However, Hutchison's saving grace is its enormously deep pockets. Its empire, ranging from ports to retail, as well as telecoms, provides huge amounts of cash to spend on new ventures and its outside shareholders seem comfortable letting Mr Fok get on and spend it.

A lot of people said Orange would never work but Hutchison proved them wrong. After tomorrow's figures it might just seem possible that the sceptics could be wrong again.