Slow go at DoCoMo

March 1 should have heralded a brave new era for NTT DoCoMo. That day, as president and CEO Keiji Tachikawa rang the opening bell at the New York Stock Exchange, company shares were listed simultaneously on the Big Board and the London Stock Exchange, ceremoniously marking the Japanese company's emergence as the world's leading provider of mobile data services.

At once, the dual listing promised DoCoMo brighter financing prospects , it would gain additional access to major investors in the two biggest capital markets on earth , and underscored a slew of recent achievements. Its innovative wireless data technology, known as I-mode, was a runaway hit in Japan, and only five months before, it had launched the world's first third-generation, or 3G, service, which allows users to access a much broader array of Internet services using a cellular phone. What's more, DoCoMo's balance sheet carried little of the massive debt load that hobbles rivals like Deutsche Telekom and France Télécom and bankrupted NextWave Telecom.

Prospects seemed so bright, in fact, for DoCoMo, a unit of Japan's all-powerful Nippon Telegraph & Telephone Corp., that securities analysts and other commentators envisioned the company emerging as a Japanese brand with the global appeal of a Sony Corp. or Honda Motor Co. Its continued growth might even help reestablish its beleaguered country as a technology powerhouse.

Alas, DoCoMo's bright future hasn't lasted very long. Since that chilly day in March, DoCoMo has been bedeviled by the financial equivalent of static, crosstalk and dropouts.

Just weeks after the NYSE ceremony, DoCoMo was forced to write off ¥813 billion ($6.5 billion) in overseas investments in four major wireless telecom partners, a devastating blow to its international strategy. Other, less noticeable cracks have begun to appear at home. Thanks to expensive sales incentives, DoCoMo's domestic market share has mostly held stable at about 59 percent, but rivals have taken the lead with snazzy new features that DoCoMo hasn't matched. And its ambitious plan for domestic 3G services is falling short of expectations; in the six months after it inaugurated service, the company was signing up Japanese subscribers at only about 60 percent of its projected rate. The problems are big enough to prompt many analysts to question whether DoCoMo's vaunted technology , responsible for the innovative I-mode and the advanced 3G system , now lags behind competitors' at home and abroad. All in all, it's a turn of events that has stunned many market observers.

"They have been historically held up as the shining light of future wireless services," says Andrew Cole, senior wireless analyst at Adventis, a Boston consulting firm. "But the shine has gone off the DoCoMo name."

No one is suggesting that DoCoMo's situation is as dire as that of many in the depressed telecommunications sector. It remains financially strong; its market capitalization of $136.5 billion is the biggest of any telecom company in the world. Over the five fiscal years ended March 31, DoCoMo's revenues doubled, to ¥5.17 trillion, while its net income tripled, peaking at ¥365.5 billion in fiscal 2001. Despite the write-downs on its foreign stakes, DoCoMo still managed to eke out a tiny profit of ¥862 million in fiscal 2002. Like all telecoms its share price has been hammered, falling from a February 2000 high of ¥914,000 to ¥344,000 recently, but even at the reduced level, it still carries a price-earnings multiple of 34 times DoCoMo's projection of fiscal 2003 earnings. Unlike its European and U.S. compatriots, it has relatively little debt , $10.5 billion. Other major companies owe far more: Deutsche Telekom carries a debt load of $55.3 billion, France Télécom, $54 billion, and Spain's Telefónica, $25.8 billion.

DoCoMo's readily apparent strengths, however, only make its recent missteps more glaring. The company , which aspires to a role in wireless data analogous to Microsoft Corp.'s in software , has been forced to reassess its expansion strategy. Global dominance is now a more distant prospect. "Two years ago they were to be the next Sony, the next national champion," says a telecommunications consultant. "But two multi-billion-dollar bets , one on their international strategy, the other on going early on 3G , are both now hitting them."

What went wrong?

With the exception of a handful of consumer electronics manufacturers and automobile companies, Japanese forays into the West have often been expensive mistakes. DoCoMo is no exception. Tachikawa and his execs believed they could use I-mode as a stepping stone to dominance in 3G networks. They invested billions in cash for minority stakes in wireless operators around the world, convinced that I-mode's technology was so compelling that DoCoMo would be able to dictate its affiliates' strategies. "The race to fulfill their global aspirations seems to have resulted in a set of investments more focused on the number of flags on a boardroom map rather than the basic economics driving superior profitability," wrote Michael Garstka, the Tokyo-based leader of Bain & Co.'s telecommunications and technology practice in Asia, in a recent article comparing DoCoMo with now-bankrupt Swissair Group. (DoCoMo's senior management declined Institutional Investor's repeated requests for interviews.)

But with 3G technology and customer demand lagging, overseas wireless firms, weakened by massive debt and excess competition, delayed their 3G deployments. They also refrained for the most part from incorporating I-mode technology into their current wireless data networks. Without controlling stakes, DoCoMo was stuck. Worse, distracted by its overseas dreams, it lost the technology edge to rivals in its domestic market.

Until recently, DoCoMo didn't seem capable of mistakes. When the company's I-mode technology was introduced in 1999, it became a cultural phenomenon reminiscent of Sony's Walkman. I-Mode is a transitional system , also known as 2.5G , between existing second-generation wireless networks and superfast 3G networks. It allows users to send e-mail from their handsets and download other online content.

The service found an unprecedented reception in Japan, where consumers rely upon the mobile Internet more extensively than anyplace in the world. In Japan more e-mails are sent using cell phones than PCs. I-mode quickly became the way consumers accessed the Internet. To date, DoCoMo has signed up more than 32.6 million I-mode subscribers, making it the world's biggest wireless Internet service provider. The Telecommunications Carriers Association of Japan reports that three quarters of the 70 million Japanese who have cell phones have I-mode or similar services offered by DoCoMo's domestic rivals, KDDI Corp. and Vodafone Group, controlled Japan Telecom Co.'s J-Phone.

As popular as the technology is, I-mode's business model is better. By design I-mode has multiple revenue streams. Customers pay for the phone, the connection, for each feature (like ring tones and screen savers), for content and even for bits of data sent and received. "There's not any one value chain, but more a value constellation," says Shiv Putcha, an analyst at the Yankee Group in Boston. "Across the spectrum all the pieces fit together."

Sending a short e-mail, for instance, costs about ¥1, an airline reservation can be made for ¥40 and downloading games, stock charts, maps and other applications costs about ¥25. Each content provider charges for services, but the amounts per customer are too small to bill in a cost-efficient way. For a 9 percent fee from content providers, DoCoMo combines all the charges into one monthly bill and distributes the proceeds. "DoCoMo is the only wireless company that has leveraged its technological base to deliver a host of services that people absolutely use and pay for," says Nandu Narayanan, lead portfolio manager at New York,based Trident Investment Management, which has $425 million under management and holds DoCoMo shares in two of its global funds. "Every telecom company in the world is trying to emulate them in their own markets."

To take advantage of its substantial technological edge and its strong domestic market acceptance, DoCoMo set out to make I-mode's technology dominant in the new 3G networks being created around the world. Both I-mode and 3G networks send information the way it traverses the Internet , in packets, rather than bits, of data. So I-mode technology, services and content can easily transfer to 3G networks. Once operational, 3G networks will work the same way I-mode does, but fast enough to handle streaming video and videoconferencing and to permit users to download music, data and images at broadband speeds. With its systems at the heart of cell phones and Internet services worldwide, DoCoMo would be , like Microsoft , in a pivotal position to negotiate still more alliances and to help set crucial industry technical standards.

As the recent write-offs suggest, however, it hasn't worked out as planned. Part of the problem has been DoCoMo's failure to leverage its investments overseas. At a time when other companies were using their high-priced stock to make acquisitions, NTT, which still owns 64.1 percent of DoCoMo, its onetime mobile division, would not let DoCoMo dilute the telephone giant's ownership to do the same. So DoCoMo used cash , more than $14 billion of it , to buy positions in its telecom partners.

But instead of accumulating a controlling stake in one company, Tachikawa scattered his chips across the world. In a series of deals between December 1999 and January 2001, DoCoMo bought a 16.1 percent share in AT&T Wireless Services in the U.S., 20 percent of Hutchison 3G UK Holdings, 25.4 percent of Hutchison Telephone Co. in Hong Kong, 21.4 percent of KG Telecommunications in Taiwan and 15 percent of KPN Mobile in the Netherlands , which, in turn, owns Germany's E-Plus. DoCoMo seemed to fear a nationalistic backlash in the U.S. and was unsure of its skill in managing foreign companies.

Although DoCoMo claimed that the strategy would seed overseas networks with its I-mode, and later, 3G technology, it got no guarantees. In fact, its investments simply left the company with a large financial exposure to , but little influence on , its partners' deteriorating performance. Their embrace of I-mode has been underwhelming thus far, and DoCoMo doesn't have the financial clout to force them to use it. The value of the company's investments has plunged with the collapse of the telecom industry, so it has gained neither global acceptance for I-mode nor a return on its investment.

In just one example, AT&T Wireless began an I-mode-like service in April, dubbed MMode, but uses no proprietary DoCoMo technology in its handsets, according to Philip Osman, an executive vice president in charge of mobile multimedia services at AT&T Wireless. Instead, like most of DoCoMo's foreign affiliates, AT&T Wireless does little more than borrow features of I-mode's external design and its billing system. "We're not going to be identical, but the way we target customers and even some underlying technology will be very similar and have the same look and feel," notes Andre Dahan, president and CEO of AT&T Wireless' mobile multimedia subsidiary. "Is it really I-mode? I don't know, but I doubt it," says David Farber, a former chief technologist at the Federal Communications Commission who serves as a member of DoCoMo's U.S. advisory board, of the AT&T product.

"The story was that I-mode would be imported with specific technologies," says Tero Kuittinen, a technology adviser to Opstock Investment Banking in Helsinki. "Now all that's left is, We can learn some pretty neat ideas from these guys."

DoCoMo has had better results in Europe, but even there questions about its strategy , and its products , persist. Using DoCoMo's technology, NEC Corp. and, later this year, Toshiba Corp., will manufacture I-mode phones to be introduced in limited numbers , perhaps 50,000 to 100,000 units , by KPN Mobile's affiliates in Belgium, Germany and the Netherlands. These handsets, however, are two-year-old DoCoMo technology; compared with Europe's newest models, they are heavier, lack built-in cameras and display fewer colors.

Worse, Nokia Corp., the world's biggest handset maker, and other European manufacturers are introducing a rival wireless data architecture called MMS, for multimedia messaging service. Built for messaging, the most in-demand feature, MMS has a major advantage because it will work on Europe's 2G, 2.5G and 3G networks. Tech adviser Kuittinen reckons that 15 million MMS phones could be sold this year. "Rolling out I-mode just before MMS is being launched in Europe is either very brave or astonishingly dumb , possibly a mixture of both," he says. "By autumn I-mode could be dead and done."

DoCoMo's vulnerability in some of these markets contrasts with that of Vodafone and Deutsche Telekom. Vodafone, the world's largest wireless operator, owns two thirds of Japan Telecom and 45 percent of Verizon Wireless in the U.S. , just part of its interests in mobile networks in 28 countries that serve more than 95 million subscribers. Deutsche Telekom paid $26 billion in cash and stock last year to acquire VoiceStream Wireless Corp. in the U.S. Its T-Mobile International wireless operation serves 77.6 million customers in eight countries. In a capital-intensive industry, such control and a broad customer base give carriers leverage to drive down equipment costs, acquire content and develop new services. "DoCoMo's international strategy has been a disaster," says Adventis's Cole. "The minority investment approach does not work. Vodafone's strategy has been correct. Only with majority stakes can you influence operators and derive scale advantages, which are fundamental in this business."

Adds Bruce Kirk, a telecom analyst at Commerzbank Securities (Japan) Co.: "With a 20 percent stake, you can't control the destiny of a company , its purchasing, strategy and product rollout. That's what has happened. It would have been far better to turn I-mode into McDonald's and franchise it around the world. Their strategy has been flawed from the start."

The ambitious overseas strategy may also have diverted management attention and resources from issues that have been gradually undermining DoCoMo's powerful grip on Japan. The launch of 3G came four months late, in October. Unusual for DoCoMo, the new service has lacked appeal because of technical glitches , dropped calls, limited battery life and coverage that extends only to major cities.

The setbacks have contributed to disappointing sales. DoCoMo had only 89,400 3G subscribers at the end of March, well short of its goal of 150,000. It says it expects to have 1.38 million subscribers by next March. By then, KDDI, which in April introduced a slower but less expensive version of 3G based on Qualcomm's technology, expects to have sold some 7 million handsets. Worse, the revenues per 3G subscriber are barely 5 percent higher than the revenues per I-mode subscriber. To get these revenues, DoCoMo must spend another ¥1 trillion to build out the network on top of its huge investments to date.

While developing new 3G applications , such as a video clipping service and a new portal for wireless personal digital assistants , DoCoMo has lost the edge to domestic rivals in the transitional 2.5G services. Japan Telecom's J-Phone, for instance, introduced the first handsets with built-in digital cameras and a photo-mail service; DoCoMo has yet to offer them in I-mode. KDDI's service introduced the first phone with a global positioning satellite function.

"DoCoMo's success in the past has always been that they had superior products," says Commerzbank Securities' Kirk. "But over the past year they've gone from being market leaders to being market followers."

DoCoMo's market position, like its technology, is showing signs of wear and tear. Its market share has stagnated, while J-Phone is gaining ground. And the Japanese market is getting saturated. DoCoMo predicts I-mode subscriptions will increase only 14 percent in 2003 as a shrinking number of regular cellular subscribers switch to I-mode.

Introducing a new technology always invites problems. But DoCoMo's creation of an insular network and its failure to develop new services raise doubts about its ability to spur the deployment of 3G even if it does gain traction overseas. Moreover, European carriers , who paid some $100 billion in the auction for 3G spectrum licenses and will need another $100 billion to deploy 3G networks , are likely to wait to see the demand for the intermediate 2.5G services before investing.

Skeptics have even begun to doubt whether any investment in 3G is prudent. "There's absolutely no rational business case for 3G business services outside of Japan, nor is one even clear in Japan," says Tim Clark, Tokyo-based strategy director for consulting firm Ion Global Japan, pointing to the tiny increase in average revenue per customer.

Despite its growing list of troubles, some fund managers see DoCoMo as a bargain. "That DoCoMo's share price could rise 30 to 50 percent is almost a no-brainer for us," says Trident Investment's Narayanan. Analysts see an opportunity to improve operating margins from 32.6 percent last year to the 40 percent range common among European wireless operators. "The main reason I like DoCoMo is because of the operating margin expansion story," says Michael Brell, a buy-side telecom analyst at USAA Investment Management in Houston, which has about $1 billion invested in overseas securities. "I'm not factoring in anything from their overseas investments."

Narayanan believes that the wretched market favors a deep-pocketed company like DoCoMo. As the global wireless industry consolidates, its ability "to borrow as much money as it wants at near-zero interest rates" will make it a welcome partner to cash-strapped telecoms. "It makes sense now for DoCoMo to just wait for one or two carriers to go bankrupt and then buy their assets for 10 cents on the dollar," says Narayanan.

But deep pockets are no substitute for a well-defined plan. Some think that DoCoMo's attempt to provide such a wide array of services, not to mention the handsets, may eventually prove to be its undoing. "You have to ask what are the core competencies of DoCoMo," says Adventis's Cole. "Is it a wireless carrier or a software player or a handset maker? If you're a carrier, all these things, while nice, don't seem to fit."

In that confusion lies DoCoMo's dilemma. As the opening bell on the NYSE clanged on March 1, nobody could doubt that DoCoMo has been a resounding success in Japan. But until Tachikawa and his management team develop a more realistic, forceful and focused international plan, overseas achievements are going to be few and far between. And the costs to its home market position may be too high.