Sonera, Adding Wireless Services, Shows That Small Can Be Expensive

LONDON -- In the wireless world, scale is said to be everything. Now the mobile operators chasing after Finland's Sonera (SNRA Quote) are finding that innovation counts for a lot, too.

It was just a matter of time before Sonera, which operates largely in niche markets and has only 6 million subscribers, would find itself attractive to firms like France Telecom's (FTE Quote) Orange and Telefonica (TEF Quote). Sonera itself admitted as much by announcing that it was looking at a number of alternatives, including joining with a larger competitor. TSC reported in May that traders were focusing on the possibility of a Sonera-Vodafone linkup, although both companies denied the talk.

Yet Sonera is not simply selling out, nor does it need to. Sonera is pioneering the move from being a purely wireless carrier to one that offers wireless services, something that analysts argue all operators will have to do as access rates continue to fall. As a result, Sonera, with its new service businesses, is actually in a pretty strong bargaining position.

Services From A to Zed

Its two fast-growing businesses attracting the greatest amount of attention are Zed and SmartTrust.

Zed is a mobile portal that was launched last October. It offers data on both the short message services, or SMS, and wireless application protocol, or WAP, platforms to about 15 million potential users. Zed has seven contracts with network operators, including Holland's KPN Mobile (KPN Quote), America's Powertel and Hutchison Telecom in Germany.

Zed is aiming to offer its services to 30 million potential users by the end of 2000 and, judging by first-half results released last month, it's well ahead of these expectations. The brokerage Handelsbanken expects Zed to cover a potential 60 million users by the end of 2003.

SmartTrust is involved in the potentially huge market for security systems for mobile commerce, widely known as m-commerce. As operators roll out universal mobile telecommunications services, or UMTS, users will be able to make banking transactions over mobile phones, which increases the need for security. Although companies like Baltimore Technologies (BALT Quote) and Entrust Technologies (ENTU Quote) are also working on offering wireless security systems, SmartTrust is one of the few companies devoted to wireless systems only.

Sonera is unsurprisingly very optimistic about both divisions. When the company announced first-half earnings, it said it intends to accelerate its 200 million euro ($183 million) investment plan in them. Analysts expect the two divisions to contribute almost a third of Sonera's total revenues by the end of 2003.

While the company and many analysts realize the value of the new service businesses, the market clearly doesn't. Sonera closed Monday at 41.70 euros, far short of the fair values analysts are placing on the company.

The Missing Value Investors fail to add in Sonera's new businesses.

John Karidis, an analyst at Commerzbank, puts Sonera's fair value at 58 euros, implying a potential upside of 38% from Monday's closing price. Karidis believes the domestic mobile and fixed business is worth 23 euros, holdings in foreign companies like Turkcell are worth 18 euros and the new service businesses 17 euros.

The models of the new businesses are still in the very early stages, however, making it hard to place a value on them. That is why, according to Visa Manninen, an analyst at Carnegie, Sonera plans to hold a conference on Sep. 5 to "shed more light on the NSBs [new service businesses] and their business models, and give an idea to analysts about how their current valuation is too low."

Manninen says at this meeting Sonera will also announce separate stock market listings for Zed and SmartTrust, probably by the end of next April.

Commerzbank's Karidis says these separate listings will achieve three things: Provide Sonera with stock as acquisition currency for these new businesses, allow the company to reward employees with stock options and, of course, gain a truer market value for the businesses.

Carnegie's Manninen argues Sonera is ultimately aiming to merge its mobile networks with a larger entity and continue as an independent holding company focusing on the new service businesses.

If that's the case, then Orange, one of the potential suitors, will pull out of any negotiations pretty quickly. Orange's chief executive, Hans Snook, indicated on Monday that his company is looking specifically at the areas where Sonera is "about six to eight months ahead"; in other words, the new service businesses.

If Orange's rivals for the Finnish firm feel the same way, then "whoever buys Sonera will have to buy the whole company," argues Commerzbank's Karidis.

And that's likely to be an expensive proposition, proving that in the wireless world size might not be everything after all.