By staff reporter He Yuxin

Many acquisitions and mergers end in failure, but the eight-month-old mobile phone joint venture between TCLCorporationand Alcatel draws particular attention. TCL, a major Chinese conglomerate, acquired a 55 percent share inmultinational Alcatel’s mobile phone manufacturing enterprise to produce TCL & Alcatel Mobile Phone Limited (T&A), which wasworth 1 billion yuan (US＄ 120.77 million)in assets. By the end of the first quarter of 2005, T&A had lost over 660 million yuan,(US＄ 79.71 million) greater than TCL’s original investment of 55 million euro (US＄ 68.15 million).

On May 28, TCL Communication Technology Holdings Limited, (HK:2618) the telecommunications branch of TCL Corporation, announced that it would acquire Alcatel’s 45 percent share in T&A to take full control of the venture. According to the announcement, the transaction will occur as a stock exchange, with Alcatel transferring its T&A shares to TCL Comm in exchange for a 5 percent share of TCL Comm, with a market value of about US＄ 8.10 million. Alcatel also plans to pay 20 million euros (US＄ 24.78 million) compensation for the withdrawal of intellectual property rights that it provided to T&A.

T&A’s difficulties stem from many internal and external problems that existed before its creation. These include Chinese-manufactured mobile phones’ lack of competitiveness with their international counterparts and the poorly anticipated costs of integrating business internationally. These factors contributed to the failure of the joint venture more than problems with communication and cooperation between TCL and Alcatel.

Original Motivation

Several companies, including China Telecom and Shanghai Fosun High-Tech (Group) Co., Ltd., also showed interest in purchasing Alcatel’s mobile phone division when it revealed the intention to sell. Both Fosun and TCL entered negotiations.

Li Dongsheng, chairman of TCL Corporation, explained that TCL was most attracted to the venture by the prospect of acquiring and using Alcatel’s technology. Partnering with Alcatel meant that Alcatel would provide some of its technologies and patents to the joint venture, including the resources from its two research and development centers.

TCL and other potential investors were motivated by more than the enhancement of R&D resources. According to Li Dongsheng, Chinese enterprises often suffer from a lack of intellectual property rights when they expand into overseas markets. Many Chinese mobile phone manufacturers do not develop their own technology and must pay for the use of patents, which are generally owned by large multinational companies, driving up production costs. The use of Alcatel’s patents provides a significant advantage to the Chinese investor in the joint venture, facilitating movement into international markets that require compliance with intellectual property laws.

Fosun, the other bidder, told Caijing that the purchase would be profitable if Alcatel provided bargain fees for the use of patent rights, contributed R&D resources, and transferred labor costs to China. However, Alcatel’s mobile phone operation has been in the red since 2001, making it more difficult to produce a profitable venture out of its purchase. Ernst & Young’s report shows that in 2001, 2002 and 2003, the operation’s net losses were 400 million euro (US＄ 495.94 million), 19.72 million euro (US＄ 24.45 million) and 74.4 million euro (US＄ 92.28 million).

The benefit to Alcatel of the deal was that it could unload the bulk of ownership of an unprofitable asset onto another company. Alcatel’s CEO Serge Tchuruk said that his two primary goals are increasing stock prices and increasing profits, both of which are directly linked to the disposal of poorly performing assets.

China Telecom, the Chinese shareholder in Alcatel’s subsidiary Shanghai ASB, also expressed interest in the purchase. This interest matched an international trend among large telecommunications service providers. They seek to develop a comprehensive brand and stable customer base by using their own manufacturers to produce customized mobile phones that are incompatible with rivals’ networks.

Roots of Failure

The low cost of labor in China combined with the advanced technology of Alcatel should have produced a successful enterprise, but they were not enough to ensure success. Experts said that Chinese bidders face two challenges when considering the Alcatel acquisition. First, they would have to deal the high production costs of an international enterprise. Second, since Alcatel’s mobile phone operation suffered losses for several years, it likely had marketing or strategic flaws that the new partner would need to address. Both the global and Chinese domestic mobile phone markets are still dominated by multinational giants, making participation the industry even more difficult for an already weak enterprise.

Fosun began negotiations first and demonstrated clear objectives and requirements for a deal. TCL ultimately achieved the acquisition, primarily because it made a number of major concessions. The resulting T&A only obtained a limited portion of Alcatel’s patent rights. Third Generation (3G) telecommunications technologies, which are used in Europe but have not yet arrived in China, were not incorporated into the T&A deal, crippling the enterprise in the long-run. Alcatel never specified how much it would invest in the venture alongside TCL’s planned 55 million euro (US＄68.2 million) investment. In addition, TCL agreed to retain approximately 700 of Alcatel’s mobile phone employees in the new company.

Despite the transfer of manufacturing to China, TCL faced high employment costs from these international employees. Many of the retained Alcatel employees live in France, where laying off even a few workers is treated with greater negative attention than in China. These employees continued to be provided with extensive benefits, costing around 10,000 euro (US＄ 12,400) per person per month. This was higher than TCL had anticipated, and became a large financial burden to TCL as the primary shareholder in the enterprise.

More broadly, mobile phone sales by all of the top Chinese manufacturers have been declining since the second half of 2004, due to increased competition from major foreign manufacturers in the Chinese market. These multinational companies not only enjoy economies of scale and advantages in technology and intellectual property rights, they also have greater control over the components of their mobile phones. TCL’s mobile phone production shares weaknesses with the broader domestic electronics industry. Production in China of telephones, televisions, MP3 players and other personal electronics largely consists of the final assembly of imported parts. Because of this, Chinese manufacturers lack complete control over the technology used and the costs of production, limiting their ability to compete especially in the low and high-end extremes of the market.

TCL depends on sales in the domestic market to provide stable revenue while it invests in more risky overseas expansion. Attempting to balance the challenges of an increasingly competitive domestic market and costly integration of an international joint venture proved damaging to TCL’s formerly stable domestic sales. According to data from DBS Vickers, a Hong Kong investment bank, TCL’s mobile phone sales decreased in 2004 at a higher rate than its major domestic competitors, including Bird and ZTE. All of these factors contributed to T&A’s high costs and losses, which TCL Comm blamed for its 2004 reported loss of US＄ 28.79 million, and which led to the failure of the partnership between TCL and Alcatel.

(1 Euro = US＄ 1.24)

English version by Zhu Hongbin