Hard cell: BellSouth looks to the Internet to win Latin America's high-stakes wireless showdown. (Telecom).

Digging into a credenza in BellSouth Latin America's Atlanta offices, Roberto Peon--the man who oversaw the U.S. regional phone company's galloping wireless growth in Latin America--yanks out his secret weapon in Venezuela: an unassuming gray desk phone.

Or is it? Crack the phone open, and it's nearly empty. Strapped inside, hidden from view, is a wireless telephone handset. Designed to compete with Venezuela's dominant telecom Cantv, the phone makes calls without external wires, a blessing in disconnected Venezuelan neighborhoods.

"They actually want a phone that looks like a fixed phone. That's what they told us," says Peon, the company's chief marketing officer and former Brazil president for the company. "The truth is, when they look at this, and they look at a Cantv phone, they say to themselves, "This is very good-looking, too, and I don't have to have a line coming to me." Peon won't reveal numbers, but he says they're selling well so far.

Peon and his company need more of these marketing miracles. Wireless customer growth has hit the brakes in Latin America. For BellSouth and its major competitors in the region, Spain's Telefonica, Telefonos de Mexico (Telmex) and Telecom Italia, the days of relatively easy growth are over.

During the late 1990s, the Big Four grew enormously by satisfying pent-up urban demand for phone service or by acquiring smaller start-ups. But compound annual growth is predicted to slow from 71% in the late '90s to 16% through 2006, says Pyramid Research.

Stodgy telcos now face the ultimate "what have you done for me lately" market. Callers use fewer minutes and drift from provider to provider with little loyally. A US$20 billion-plus business hangs in the balance, and consolidation is nearly unavoidable. Like its competitors, BellSouth is heading down-market, looking for any upside it can get before the crunch comes.

"Nobody has really figured out how to crack the code on that lower revenue customer, how to do it well and how to do it profitably," says Ralph de la Vega, president of BellSouth Latin America. "And we're going after that with every ounce of effort that we can muster."

Competitors are turning up the heat. Spanish behemoth Telefonica, the second-largest player in Latin America, has agreed to buy Mexican wireless provider Pegaso to become the No. 2 player in that market. The Spanish telephone giant also signed with Microsoft to deliver e-mail to 24 million of Microsoft's Hotmail e-mail customers via their Telefonica Moviles phones. In 2002, Telefonica says it expects to finish its merger with Portugal Telecom, more than doubling the Spanish company's cellular operations in Brazil.

Telecom Americas, a joint venture of Telmex's America Movil, Bell Canada International and SBC Communications, is arming for a battle in Brazil, too. By far the leading wireless company in the region thanks to its enormous Mexican presence, Telecom Americas is raising cash--possibly in preparation for a merger with BellSouth in Brazil. BellSouth declines to comment on merger rumors, although plans for a Latin America tracking stock remain on tap, something which executives have often said would give them a "new currency" to do deals in the region. A new stock would make a merger or acquisition much easier.

Just as the market cools in Latin America, BellSouth is switching gears in management: De la Vega, formerly head of its broadband Internet unit, has taken the reins of the Latin America group. It is also converting from a holding company of 11 separate carriers to an operating company, a move execs hope will squeeze out costs. Led by Paulino Barros, a Brazilian and a former Motorola exec in Latin America, the company hopes streamlining will help push out products faster, since telecom services quickly become commodities. Increasing margins is not enough; costs must be controlled, too. "You need to go on a diet before you have a heart attack," says Barros.

Attack plan. To hear it from regional head de la Vega, though, his company's growth is just getting started. Its 10.8 million customers are just a slice, he says, of a potential 224 million customers in the 11 countries it serves. De la Vega predicts wireless will continue to grow, noting that 16% total cellular penetration in Latin America pales in comparison to the 46% penetration in the United States and the 66% enjoyed by Europe.

"If you look at where the wireless growth is going to be, it's going to be in Latin America," says de la Vega, in a hybrid accent that hints of both Georgia and Cuba, his native country. "I am not sure it's going to be 66%, but I am saying it's going to be a lot higher than 16%."

The short answer is pre-paid cards. De la Vega says nearly all of his business is pre-paid. But making the cards profitable is hard. Pre-paid users sign no contracts, so they are more likely to drop one company for another, a phenomenon called "churn." On the other hand, pre-paid users always pay up--or their phones go dead. And there's never any reason to chase after bad debt. All the money comes in up front.

Marketing plays a big role in pumping up the numbers. In Venezuela, for example, BellSouth has 25,000 distribution points for its pre-paid phone cards--nearly every corner newsstand, bakery, shopping mall and kiosk. In a stab at the gabby youth market, the company has been burning compact disc singles by a variety of Sony musical artists onto the backs of higher-denomination pre-paid phone cards, now sold in Venezuela, Colombia and Ecuador. Plop the card into any CD player and the latest hit from Enrique Iglesias or Christina Aguilera comes flooding out of the speakers in full digital quality.

Naturally, tucked into the back of the high-end card's plastic sleeve is a discount coupon for 15% off the next card. "They significantly increased the sale rate. It varies by country, but some by as much as 30%' says de la Vega, who admits to having developed a fondness for the voice of Andrea Echeverri, of Colombian rock band Aterciopelados, by listening to pre-paid cards in his office.

The other strategy for wireless companies has to be beefing up the number of minutes people use their cellular phones. BellSouth recently rolled out audio chat, a kind of party line on Chilean cellular phones where callers can latch onto floating conversations-- generally of the teenage gossip variety-- at any moment.

BellSouth is also attempting to marry Internet information and phones using off-the-shelf technology like voice portals, the voice-driven menus that allow phone users to shop, get information or hear their e-mall. Key to the success of that gambit is Web portal StarMedia. The company paid an estimated $25 million in May 2001 for 11% of StarMedia, precisely to take advantage of its millions of users in Latin America in a wireless-plus-Internet expansion strategy. The star-crossed portal now is under investigation by the U.S. stock market regulator, the Securities and Exchange Commission (SEC), over earnings statements.

StarMedia says it cannot talk about its accounting issues while the SEC investigates. But StarMedia CEO and President Enrique Narciso agreed to speak about how the company plans to expand its services to fit the demand of the region's wireless carriers.

The idea is pretty simple. Before cellular customers can really enjoy the promised services of so-called third-generation technologies--fast information services via cellular phone or wireless devices like handheld computers--they will he most likely using a simpler, cheaper technology called short messaging service, or SMS, says Narciso.

The rage in Europe, SMS requires the wireless device user to request information from the Internet, usually using a simple key command, like 99 for weather. The key commands send a request to a Web site where the users have preset certain types of information they want often and quickly: weather forecasts, stock prices, or tailored news updates. In Europe last year, cellular users sent hundreds of billions of short messages to each other at a cost of about 10 cents each, putting billions into carriers' pockets.

For Narciso, it's all about keeping cellular customers loyal to the carrier, regardless of how they connect to the information--via cellular phones or wireless handheld computers.

Secondly, developing an Internet base for users of their cellular phones is a gold mine of information. Pre-paid card users are essentially anonymous. But if they start pre-loading Internet data to feed into the phones, they become chatterboxes for marketing purposes. Suddenly it becomes clear what cities they care about, where they like to shop or eat, what stocks or news they follow.

Big Leap. "One of the problems has been always waiting for the next big thing," a process which has carriers doubtful about how to proceed into the promising data market, says Narciso. Doling out $450 handhelds to every employee in a Latin American company is not going to happen soon, either, he says, but most workers have cellular phones now, and many are already capable of dealing with SMS services. "You have to go with a low-cost solution that's ready to go," he says.

Of course, widespread adoption of messaging by Latin Americans assumes a cultural leap that isn't assured, says Rene Pimentel, an analyst at Deutsche Banc Alex. Brown. If messaging does take off in Latin America, it could cannibalize higher-revenue voice minutes since people might simply message instead of calling.

Also, in Brazil, a key growth market, government telecom regulator Anatel wants companies to migrate to a new regulatory regime, Pimentel says, a potential disaster for wireless outfits dependent on pre-paid customers.

Currently, Anatel sets the rates that big, traditional fixed-line incumbents like Telesp, Telerj and Embratel must pay wireless outfits for calls originating on fixed lines but ending on cellular phones. Since pre-paid phone users tend to take calls rather than make them--free calls for them--cellular companies count heavily on these revenues in countries with "calling party pays" schemes. Under the new rules, however, wireless companies must accept whatever fixed-line incumbents will pay for interconnection. That could mean a revenue decline for smaller firms with large pre-paid bases, Pimentel says. Interconnection fees account for up to 40% of revenues for some small operators.

Companies are not required to follow the new rules unless they change owners, then the regime kicks in. "The regulatory side is crucial," Pimentel says. Put another way, consolidation means ownership of major fixed-line assets could be the difference between buying and being bought in Brazilian wireless--the single most important market in Latin America.

BellSouth has faced similar predictions of fixed-line dominance in the past. When the company entered the region, many thought cell phones would never take off. Peon, the marketing chief, hammers home a simple message: Keep costs down, grow with the demand that's out there. "Years ago, people said, 'Why do you even think you're going to get 5% penetration [of wireless service] in Latin America?' They couldn't predict the growth rates we actually experienced."

Peon and de la Vega could prove them all wrong again, but this time they will have to stave off bigger fish than ever to succeed.

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FUELING MERGER TALK

Latin America Market Share of Wireless Operators


Telefonica Moviles/Portugal Telecom  (22%)
BellSouth                            (12%)
Telecom Italia                       (12%)
America Movil                        (29%)
Others                               (24%)

NOTE: Based on 2001 gross subscribers

SOURCE: Pyramid Research

Note: Table made from pie chart