Bullish On Iridium

Last November, amid considerable fanfare, the Iridium satellite communications system achieved its long-awaited commercial launch. The milestone event represented the culmination of years of technological development, including the design and deployment of a constellation of 66 low-earth-orbit satellites to create the world's first wireless global phone and paging service. Along the way, a dozen "gateway" companies were established to serve as regional connecting points between the satellite network developed by Motorola Inc. and various ground-based communications systems, including existing cellular systems. In addition to Iridium's many technical achievements -- such as developing a way to "cross-link" the satellites in order to relay communications signals around the globe -- the massive undertaking required negotiating regulatory approvals with countries around the world and lining up several hundred service providers to partner with the gateway companies in making Iridium service available in the marketplace. Since the commercial start-up, however, Iridium LLC -- the Washington-based international consortium created to oversee the development of the $5 billion telecommunications system -- has rediscovered an old business truism: that achieving a historic technological feat is no guarantee of immediate business success. Indeed, quite a bit of hand-wringing must have taken place as the company prepared to announce its first-quarter financial results -- a net loss of $505 million on just $1.45 million in revenues. As of the end of the quarter, Iridium had signed up 10,294 customers -- far fewer than the 57,000 customers required under a financial covenant in its $800 million secured credit facility. (The shortfall required the company to obtain waivers from its lenders and renegotiate the terms of its financing.) The commercial phase of the venture -- initially proposed in 1987 by engineers at Motorola, which owns a 25% stake in Iridium LLC -- has been hampered by delays in getting handsets distributed to customers around the globe. In addition, its service-provider partners have been slow in establishing fully trained sales staffs. The early setbacks have been compounded by negative news reports citing difficulties in using the $2,300 portable phones, which can communicate directly with the satellite network. The upshot is that strategists at Iridium LLC were forced to return to the drawing board to rethink their business plan -- and they've had to do it amid a climate of executive turmoil at the top. On Apr. 22 Vice Chairman and CEO Edward F. Staiano resigned -- just three weeks after the resignation of CFO Roy T. Grant. After the Iridium board of directors named John A. Richardson as interim CEO, one of Richardson's first acts was to oust Mauro Sentinelli as senior vice president for marketing and distribution. But however disappointing the early stages of commercial operation may have seemed at the firm's Washington headquarters, there is little evidence of dismay in Tempe, Ariz., which is home base for Iridium North America, one of the key gateway companies in Iridium's global business alliance. "We're tracking to our plan. We're very bullish on the business," asserts James M. Walz, president of Iridium North America, which is jointly owned by Motorola, Sprint Corp., and Iridium Canada Inc. As a gateway company, Iridium North America focuses on lining up service partners, providing connectivity to the Iridium satellite constellation, and reselling air time on the Iridium network. "Iridium worldwide has the [satellite] constellation, and, basically, we procure wholesale minutes from them and decide how to distribute them to service providers, how to market it, and how to support it," Walz explains. "Some of the gateways have lagged behind in getting the product out to the market, and I think that has contributed to some of the problems encountered by Iridium LLC worldwide," he says. "But our investors are more than pleased with our operation down here, and we think we have a solid business plan. "Iridium is a global constellation, but running the business is a backyard concern," Walz asserts. "You can't run a company out of Washington, D.C., for the entire world. You run the company by decentralizing -- and investing resources in the backyards." Iridium North America, he says, was "very aggressive" in establishing an infrastructure that would enable it to bill and support customers "right from the get-go. But other [gateway firms] were less fortunate for a variety of reasons." As a private company, Iridium North America doesn't report financial data -- nor does it reveal information on the number of subscribers that have signed up with its affiliated service providers. But Walz does emphasize: "Whatever numbers you've been hearing about the total [worldwide] subscribers to Iridium, you can bet that a majority of them are coming from our gateway. We represent a big chunk of [Iridium] LLC's initial revenues -- and their load. We have some very strong distribution partners, and they are ramping up their businesses to incorporate Iridium." The firm has service-provider agreements in place with Motorola Cellular Service Inc. (to handle a full range of equipment and service offerings), PageNet (for satellite-based paging service), and Sprint PCS (for digital wireless service). It also has lined up a number of partners to serve vertical niche markets -- providing global communications solutions for broadcasting firms, maritime operators, and companies in the oil, gas, and construction markets with worldwide operations. Often these are in remote areas that lack terrestrial phone or wireless communications service. For Sprint PCS, a primary benefit of the Iridium connection is that it will be able to offer worldwide coverage to subscribers in its 260-plus U.S. markets -- taking advantage of "roaming" agreements that Iridium has negotiated with terrestrial networks around the world. Moreover, by using Motorola Satellite Series phones, Sprint customers also will be able to communicate via satellite in regions lacking cellular coverage. Even within the U.S., many non-urban areas are beyond the reach of terrestrial wireless communications, Walz points out. "Today, about 35% of the U.S. geographically is not covered by cellular communications," he says. "If you have a cabin in a remote area or you're on vacation somewhere that doesn't have cellular coverage and you need to make a phone call, you might have to get into your car and drive for an hour to get to a phone." Outside the U.S., the geographical reach of terrestrial cellular systems is even smaller, the Iridium North America president adds. About 70% of Canada -- and 90% of the world in total -- lacks cellular coverage. "Our belief," Walz says, "has always been that any wireless carrier that wants to offer a global solution to its business customers really needs to pair up with a satellite provider like Iridium. . . . Sprint now can tell its customers, 'We can cover every single square inch of the planet with your PCS number.' That's a pretty powerful statement." Through its service providers, Iridium North America offers four different phone rates -- international satellite service, domestic satellite service, international water service (a single rate anywhere on the water), and international world roaming (via terrestrial wireless). With the roaming service, subscribers can place calls from any city in the world that has terrestrial cellular coverage -- even if they don't buy the satellite phone. "You don't need the Iridium phone to use Iridium worldwide roaming," Walz notes. Although Sprint customers who travel abroad aren't able to use their Sprint PCS phones overseas, they will be able to take advantage of Iridium's worldwide roaming agreements by inserting a Sprint "smart card" into either an Iridium handset or a GSM phone to connect to the Iridium backbone. (GSM -- for global system for mobiles -- is a technical standard widely used in Europe and other areas of the world.) Sprint was expected to set its rates for Iridium-based service at $1.49 a minute for worldwide roaming, $1.99 a minute for domestic satellite calls, and $3.99 a minute for international satellite service. Iridium handsets being produced by Motorola and Japan's Kyocera Corp. include a dual-mode version that can operate either as a terrestrial cellular phone or communicate directly with one of the satellites circling 420 miles above the earth. The phone searches for the local wireless network, if one is available. If not, it switches into the satellite mode. In the cellular mode, customers can move between local terrestrial networks by inserting a different radio cassette -- each one compatible with a local wireless standard. Most of the early usage of the Iridium system has been for satellite communications -- especially to remote areas. One reason is that the cassettes, which slide into the handsets to permit cellular connections, weren't available until April. "The phones available earlier were satellite-only versions," Walz notes. "But as Sprint brings up its program, I expect the mix to change, and we should see more dual-mode usage." With the Motorola-built phones, insertion of a CDMA 1900 cassette enables connections to the Sprint PCS system in all major U.S. cities. Business travelers who take their phones overseas can use a GSM cassette to tie into cellular networks in Europe and other areas where the GSM standard has been adopted. Among the early complaints about Iridium's satellite phones is that they don't work well -- or at all -- inside buildings. Because the satellite signals are relatively weak, users have had to step outdoors or at least stand near a window to make calls. But it was never Iridium's intent to encourage indoor use of the handsets for satellite communications. "We don't sell these phones to be used in urban areas," Walz asserts. "That's why we have a terrestrial wireless partner like Sprint." When used in the cellular mode, the Iridium handset operates like a cellular phone and generally can be used inside buildings because cellular signals are stronger, Walz points out. Walz reports that early feedback from Iridium North America subscribers has been positive. "We're gathering customer testimonials showing that the phones have proven valuable in improving productivity and efficiency. People are finding that they work and sound great in very remote locations. "Right now our focus is on trying to load the proper types of subscribers, and to learn from subscribers how to grow the usage and what other value-added services they might be willing to pay for. . . . We're very happy with the trend in our business, and very bullish on it." That should be encouraging news to the folks at Iridium LLC. But it is likely to be some time before the financial picture acquires the kind of rosy glow that impresses Wall Street. A Merrill Lynch & Co. Inc. analyst's report in late April projected that Iridium LLC will be reporting net losses through the year 2006 -- largely because of depreciation and financing costs -- and that its EBITDA numbers (earnings before interest, taxes, depreciation, and amortization) will be written in red ink until the year 2002. However, the longer-term view gets brighter. Merrill Lynch analyst Thomas W. Watts projects that the total number of Iridium subscribers could top 1 million in 2002 and reach nearly 4.5 million in 2006. "With [Iridium's] increasing focus on vertical markets, the key to sales growth lies in trained salespeople," Watts asserts. "Iridium and its service providers are mounting a campaign to expand sales forces and improve training, but we do not expect fully functioning channels until the third quarter of this year." By then, however, Iridium may no longer be the only player in the global wireless-communications market with a commercially viable system. In late April Globalstar, a competing satellite service spearheaded by Loral Space & Communications, announced an accelerated launch schedule that was expected to have 32 satellites in orbit -- enough to support start-up of commercial service -- sometime during the third quarter. The Globalstar consortium eventually plans to have a constellation of 64 low-earth-orbit satellites. Yet a third entrant -- ICO Global Communications -- is expected to enter the market sometime in the summer of 2000. Its medium-earth-orbit system will require only 10 satellites for full global coverage.