STARTING FROM SCRATCH.

Mexico's newest phone company Pegaso races to install a national network, but will anybody call?

THERE ARE STILL MORE EMPLOYEES THAN CUSTOMERS at the sumptuous customer service center built by Mexico's newest telecommunications upstart, Pegaso, in the bustling border town of Tijuana. Surrounded by equipment displays and eye-catching ads, a dozen cashiers and sales people await the multitudes that Pegaso and countless newly licensed telephone companies hope to serve since Mexico opened the sector to competition.

Many have been slowed by funding problems or stiff competition from market incumbent Telefonos de Mexico (Telmex), the former state run monopoly turned private sector powerhouse, but Pegaso has quickly created a telephone company from scratch. Since paying $220 million for one of three nationwide wireless licenses in mid-1998 the company is working furiously to offer fixed and mobile services in Mexico's four largest cities--representing 60% of the market--by the end of the year when it hopes to have 100,000 customers.

Marketed as the country's only completely digital network, the telecom and its list of heavyweight backers are looking to carve out a niche in Mexico's underdeveloped market by offering state-of-the-art technology and customer service rarely seen in Latin America. It's a strategy many hope to duplicate, not only in Mexico but throughout the region as governments in country after country open the once-coddled telecommunications industry to unbridled competition in a bid to provide much-needed phone lines to consumers.

"Clearly the lessons learned here will go into creating the perfect launch model,' says Dan Pegg, senior vice-president of Leap Wireless, subsidiary of digital equipment manufacturer, Qualcomm, and part owner of Pegaso.

As elsewhere in the region, newcomers in Mexico are turning to wireless systems for fast and comparatively cheap installation. Already cellular penetration has grown from less than 1% of the population in 1994 to 4.5%, with subscriber growth averaging 90% last year alone. The density is still significantly below countries like Venezuela, with a comparable domestic growth and a cellular penetration of 8%, but analysts expect the number of subscribers to double to 7.8 million Mexicans by 2003.

Fast and furious in Tijuana. Similarly, the entry of many more new competitors in the next four years is expected to push the number of fixed lines per 100 inhabitants from 10 to just under 17, boosting total telecom service revenues from $6.9 billion to more than $11 billion. Of that, Pegaso figures it can cull 1.6 million fixed and mobile lines or 10% of the market by serving some 70 cities by 2005.

Given those numbers, Pegaso shareholders left nothing to chance when they launched the new service in Tijuana, Mexicos fastest growing city located just south of the border from San Diego, the so-called wireless capital of the United States. Home to several equipment suppliers including Qualcomm, the inventor of CDMA (Code Division Multiple Access) digital technology, the San Diego vendors were able to oversee the installation of more than 50 microwave base stations in and around Tijuana's rugged hills in record time. After Tijuana, Pegaso plans to move into Mexico City, Monterrey and Guadalajara.

Pegaso, like its namesake Pegasus, the winged-horse of Greek mythology, suggests, is moving quickly to position itself as more than a dozen new licensees get set to come on line. In Tijuana alone, there will eventually be five cellular companies to choose from, not to mention Telmex, which earlier this year announced a massive two-year, $4.6 billion investment plan to increase its still sketchy coverage by 48% to 20 million lines. "The idea was to launch as quickly as possible in order to establish brand awareness:' says Juan Moragas, Pegaso regional manager for Tijuana.

Financial firepower. The third player to enter the Tijuana market after Telmex's cellular phone company Telcel and its main competitor Bajacellular, Pegaso has nevertheless got an important jump-start over its two wireless rivals bogged down by financial problems. Midicel, owned by the Kanahuati family, had its license revoked earlier this year after it failed to pay its already twice deferred license fee. Mexican magnate Ricardo Salinas Pliego also delayed payment on his license for close to year, while he sold 50% of his yet-be-launched phone company, Unefon, in June to rustle up the cash. He continues to be held up by a litany of court injunctions filed by rivals arguing preferential treatment by regulatory authorities.

Like its competitors, Pegaso is the brainchild of a Mexican tycoon, Alejandro Burillo Azcarraga, but unlike some rivals, Pegaso is backed by a sturdy international ownership structure. In addition to his stake in three Mexican soccer teams, Burillo Azcarraga, the cousin of Televisa Chairman Emilio Azcarraga Jean, is best known as one of the principal heirs to Televisa, the world's largest Spanish language broadcaster. Alongside his 30 years experience at the network, Burillo Azcarraga dabbles in personal investments through his holding company, Grupo Pegaso, and after a joint venture with Qualcomm in a satellite tracking enterprise, the idea to launch a telephone company was born.

When it came time to pay the costly licensing fee, the two partners enlisted the support of financial backers, U.S. bank Citicorp, venture capital group Latin America Infrastructure Fund, and the Japanese trading company Nissho Iwai. Together the three control a 31.25% stake in the company Grupo Pegaso and Televisa own 28.75% and 15% respectively while Leap remains with a quarter of the company. "Pegaso has thought its partnerships out very well," says Leslie Arathoon, Latin American telecommunications analyst with Boston-based Pyramid Research.

So far, the five investors have committed $400 million in cash out of a total planned investment of $1.3 billion to 2005. The company is looking to take on an additional $300 million in long-term debt, says Pegaso Chief Financial Officer Juan Marco Gutierrez, but the bulk of the money is coming from vendor financing with Qualcomm and Alcatel, who together are providing $580 million to cover all equipment needs.

The deal is much like the one recently sealed by Axtel, another local service newcomer. It obtained $750 million in financing from Nortel Networks, the Canadian equipment supplier and Axtel shareholder through Bell Canada. "Most of the new players don't have capital, so the name of the game is vendor financing," says Arathoon.

With most of the money in place, what Pegaso doesn't have is a high profile operator like Axtel or long-distance providers Avantel and Alestra, both of whom partnered up with powerful U.S. telecoms, MCI Worldcom and AT&T, respectively. Instead, Pegaso counts on Leap Wireless to provide start-up support and financial planning and has contracted GTE out of the United States and British telecommunications specialist, the Red Wing Group, as consultants in the areas of billing, customer service and information technology. GTE alone has brought in 70 expatriates from Sri Lanka to Australia, while Leap personnel head up Tijuana's 60-person operation.

Not that Pegaso's Mexican counterparts are mere bystanders. Televisa's Tijuana TV station doubles as a base for switching operations. In Mexico City its strategically placed antennas provide valuable real estate in the difficult search for available rooftop relays. More importantly, as Mexico's most watched TV network, it serves as a powerful advertising vehicle and an informed source for marketing strategy--particularly when televising soccer games. Through Burillo's influential ties, the Pegaso logo has made it onto the uniform of the Mexican national soccer team as well as into the country's two largest stadiums.

"Everyone brings a different value-added to the table and Mr. Burillo has the confidence, know how and experience of launching a product in Mexico," says Pegaso's Gutierrez.

In Tijuana the results are already being felt. Despite the muted traffic at Pegaso's two shiny new service centers, the company had garnered 4,000 subscribers by mid-year, 30% more than forecasted levels, says Daniel Gomez, the company's regional sales director. New customers complain the service is still patchy but they've been won over by the company's promise to provide better voice quality as well as a new roaming agreement with U.S. telecom Sprint that will allow them to use their phones across the border in the United States.

"Phone in a Box." Much of the success, says Gomez, is owed to the company's innovative distribution strategy. Through a new product dubbed "Phone in a Box" Pegaso sells its handsets already activated with 100 pesos (about $10) of free time in supermarkets, clothing and convenience stores and several Televisa subsidiaries, including PayTV outlets and video centers.

Once hooked, the company makes it easy for customers to stay connected. "We're trying to present the telephone business as simply as possible," says CFO Gutierrez. Unlike other cellular services, which ask for innumerable references before tying subscribers into one of a dozen equally confusing and endless contracts, Pegaso offers three plans; one prepaid and two billing programs. In all cases, no contract is signed and only a credit card is needed if the client prefers a monthly payment plan. "What the country is looking for right now are new options." says Gomez.

Those new options will eventually include fixed wireless service, currently in the testing stage, and a whole spectrum of data transmission alternatives ranging from retrieving e-mail to sending short messages by mobile phone. "There is a whole new market opening up," says Ake Persson, president of Ericsson Wireless Communications Inc., a division that the Swedish telecommunications manufacturer recently acquired from Qualcomm.

The acquisition has converted Ericsson into one of Pegasa's two main suppliers and marks the first time the multinational is working with one of its chief industry rivals, Alcatel. On the strength of their experience at Pegaso, the long-time competitors plan to bid jointly on upcoming projects, says Persson, with Alcatel providing the switching and Ericsson, the radio network.

The combination is increasingly considered the option of the future in Latin America, according to those in the industry. For Ericsson's Persson, it could represent as much as "one-third of the region's future market." Adds Pegg at Leap Wireless, "There is no question wireless is the solution of choice because of the cost factor. There is no digging up of streets or laying wire, and in emerging countries where infrastructure is just beginning, you can put in so much more for the same amount of money at a much faster rate."

"CDMA magic." For Ericsson, a traditional supplier to many of the region's wireline monoliths, Pegaso also marks an important new testing ground for its newly acquired CDMA digital technology. The next generation in wireless, "CDMA magic' as it is often referred to in the industry, allows for greater spectrum efficiency, resulting in a higher volume of calls and improved voice quality thanks to the higher 1.9 MHz PCS frequency.

In Mexico, the technology is particularly attractive as government authorities aim to double the country's relatively low telephone density to 20 fixed lines per 100 inhabitants by 2005. Their efforts have been somewhat obstructed however by Mexico's dubious regulatory climate and the tenacious defence of market leader Telmex.

New entrants like Alestra and Avantel say they have lost millions to unfair practices and outrageous interconnections rates charged by Telmex for outside operators to terminate a call in its network. In the case of calling party pays, a well-known boon to mobile phone use in several Latin American countries, Telmex successfully blocked for months the introduction of the system, which charges the cost of dialing up to the caller.

When the system was finally launched earlier this year, Telmex added an interconnection fee of six cents per minute compared to a regional average of two to four cents. The high rate made the cost of calling a cellular phone comparable to a national long-distance call.

Regulatory authorities are expected to review rates for calling party pays by the end of the year and those at Pegaso are optimistic the system will eventually spark increased mobile phone use. In the meantime, the company says its strategy is not to steal customers from the competition but to sign on the millions of Mexicans still without a telephone. "Once Telmex realizes there's more business than all of us can say grace over they will be easier to deal with:' says Pegg at Leap Wireless. "Nobody in all honesty can tell you how big this market really is."