Taking Stock / We're Not Scared

"As far as we care, let them declare us a de facto monopoly and regulate our prices. Bezeq's prices are regulated but it's assured of a minimum return on equity. We'd like a minimum like that, too. Let the government set prices and put an end to the competition." (A cellular executive, in an interview last week.)

The cellular community is rustling again. Three months after Communications Minister Ehud Olmert broke under the pressure of the heart-stopping nightmare scenarios painted by the cellular chieftains and slashed the planned cut in interconnection fees, the cellular trio announced a price hike in outgoing call charges.

The fiasco Olmert cooked up attracted the attention of the antitrust commissioner, Dror Strum, who happens to be Olmert's subordinate. In his report to the Knesset Economics Committee, Strum declared what we have said in this column time and again: The much-vaunted competition in the cellular arena is pure fiction, especially when it comes to household clients.

As is de rigueur for a cash-bloated monopoly, the cellular carriers devote enormous resources to influencing the powers that be. Each of the trio - PelePhone Communications, Cellcom and Partner Communications - employs whole divisions devoted to swaying the regulators.

They have hordes of lawyers and economists on the payroll, topped off with lobbyists and public relations masters whose job is to maintain the monopolistic structure of the industry and to terrify any politician or bureaucrat who might dare to consider leaving tracks on their turf.

Oh dear, don't they earn enough?

The cellular executive quoted above suggesting that regulation would be welcome because it would assure minimum returns, is worthy of more attention.

First of all, allow us to remind the nameless executive that assured returns are an outmoded method long relegated to mothballs.

The arrival of competition in the mid-1990s, mainly insofar as it reached communications, blew that method out of the water, together with the Bolshevik pretension that the government should set prices for services from monopolies. After Bezeq "persuaded" the Knesset Finance Committee about its tariffs, and "was forced" to bow to the "efficiency coefficient" imposed by the heartless treasury, it transpired that the phone company actually could lower its tariffs by dozens of percent (for instance, on long-distance calls) without submerging in red ink. Mere mention of that outdated, discredited method of government regulation of prices shows the person has a problem with his memory, or assumes we do.

Second of all, it is interesting to see what import the market ascribes to the financial results of the monopolies. The only one of the three cellular companies listed on a stock market, or several of them in fact - Nasdaq, London and Tel Aviv - is Partner. It's also the best of the trio; it's growing faster and despite being only six years old, it's producing cash flow at the same pace as its 11-year old rival, Cellcom.

At the end of 2004, Partner's shareholders' equity totaled NIS 1.6 billion, all resulting from profit over three years. In 2004 it netted NIS 471 million, averaging 35 percent return on equity in the year.

The best company in Israel is unarguably Teva Pharmaceuticals and its return on equity is about 30 percent. Bank Hapoalim's was 16 percent at its highest.

When the furor erupted about their interconnect fees, we asked Partner CEO Amikam Cohen whether the company's return on equity didn't show that the company was phenomenally profitable, to a degree that could only be explained by a monopolistic market structure. Cohen smiled.

On the one hand, he's proud to hear that his profits are phenomenal. On the other, he knows that phenomenal profits could signal the public and the regulator not only that the management is brilliant, but that the market structure allows them to be.

It's just a baby

Finally, after much hemming and hawing, Cohen answered that Partner is a young company that began to post earnings only a year ago, so its equity structure is lean, but it's growing all the time and that's why its return on equity will be dropping from this point on.

Boy, did he get that one wrong. We're willing to bet that in 2005, the "annus horribilis" that the cellular czars have been wailing about, Partner will double the return on equity it presented for 2004.

How? Simple. A month ago Partner said it would buy back a billion shekels worth of stock from its Israeli shareholders. Where can Partner get a billion shekels? By taking new loans and from disposable income made in 2004, which amounted to NIS 700 million.

What does the stock repurchase do to the company's shareholders' equity? Reduces it by a billion shekels, of course. It will go back two years in time to half a billion shekels, and in 2005, Partner's return on equity will rise to around 70 percent, which is three times the return achieved by the best companies in Israel.

How could a huge company its size, with its vast capital investments in equipment and networks, manage to achieve 70 percent return on equity? Good management and a strong brand can explain a third of that, but the answer to the other two-thirds has to lie in market structure. Or, in other words, in the absence of competition, which results in tremendous value creation for the company.

What "minimum returns" are the cellular chiefs prattling about? In communications, for instance, the norm is 10 percent to 15 percent, in special cases maybe as much as 20 percent. But Partner is already at 70 percent. The cellular trio had better come up with a new way to frighten us.