Telefonos de Mexico S.A. de C.V.

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Telefonos de Mexico S.A. de C.V.

Parque Via 198
Col. Cuauhtemoc
Mexico City, DF 06599
Mexico
(5) 7033990
Fax: (5) 2545955

Public Company
Founded: 1947
Employees: 48,810
Sales: US$5.91 billion
Stock Exchanges: Mexico New York
SICs: 4810 Telephone Communications; 4822 Telegraph &
Other Communications

Telefonos de Mexico S.A. de C.V. (Telmex) is Mexico’s longdistance telephone monopoly and one of the largest companies in Mexico. It provides local and long-distance telecommunication services throughout Mexico and abroad to both residential and commercial customers. Telmex was operating as a government-owned-and-operated utility until the early 1990s, when the Mexican government began to privatize the organization. Under private ownership, Telmex was rapidly expanding and improving going into the mid-1990s.

Telefonos de Mexico was created in 1947 to purchase two telephone companies that were operating in Mexico: L.M. Ericsson, of Sweden, and the U.S.-based International Telegraph Corporation. Both companies had pioneered the telephone industry in Mexico and had succeeded in bringing basic services to larger cities in Mexico. Telmex was created to make the dominant phone service provider in Mexico a domestic company. The newly created organization acquired the Mexican division of L.M. Ericsson in 1947 before buying the Mexican subsidiary of International Telegraph in 1950. In effect, the merger gave Telmex a monopoly on the long-distance telephone industry in Mexico, although a number of smaller phone companies continued to provide local services. L.M. Ericsson and International Telephone managers continued to operate the Mexican enterprise.

From the start, the Mexican telephone service industry, like telephone industries in most other countries, was heavily influenced by the national government. That influence intensified during the 1950s and 1960s when the government decided that it needed to push the development of a national phone system that would keep Mexico from falling too far behind the United States and Europe in communications capabilities. Importantly, in the 1960s the government imposed a telephone service tax on all long-distance calls. The money was earmarked for investment in the telephone sector, namely to help supply the billions of dollars needed to add telephone lines and switching stations throughout the country. Thus, throughout the 1950s and 1960s Telmex operated as a private enterprise that cooperated with the Mexican government to deliver phone services to the nation.

The Mexican government’s role at Telmex continued to expand until 1972, when Mexico actually took control of the enterprise by purchasing 51 percent of Telmex’s voting shares; the remainder of the shares in the company were owned by Mexican citizens and institutions as well as foreigners. From that point forward, Telmex in effect operated as a government-owned utility. The government regulated the prices that the company could charge, influenced its operating budget, and made other management decisions. However, Telmex still maintained some of its private-company flavor; Government appointees shared seats on Telmex’s board with private individuals, and the government even retained most of Telmex’s management after it took control of the company.

Throughout most of the 1970s Telmex operated much as it had as a private company. The chief executive of the company, a highly respected manager, served as head of Telmex throughout the 1970s and even during most of the 1980s. For most of that time, Telmex expanded its services at a rate of approximately six percent annually. At the same time, older parts of the system were gradually modernized. By 1980, close to 100 percent of Telmex’s exchanges were automatic (not controlled by an operator), and the company was preparing to launch an ambitious plan to install only digital, rather than electro-mechanical, lines. Furthermore, Mexico’s telephone service in comparison to other developing nations at the time ranked well in categories like the average number of inoperable lines or the amount of time required to install a new line.

Telmex also performed well in comparison to other state-owned companies in Mexico during the 1970s and early 1980s, largely because it was still partly a private company. At the same time, Telmex began to suffer from many of the problems that afflicted other state enterprises; political interference, inefficiency, labor union strength, and fiscal mismanagement. Indeed, although the utility had expanded service at a rate of about six percent annually, it could have grown at a much faster clip. A prime example of the problems the company faced was the telephone service tax that had been created in the 1960s. Over the years the government had raised the long-distance tax at a dizzying pace to the point that more than 50 percent of Telmex’s revenues were eventually coming from the tax. At the same time, the government began drawing from the funds generated by the surcharge to pay for unrelated government programs. The unfortunate result was that Telmex, by the 1980s, had become a financing vehicle for the Mexican government.

The effects of bureaucratic influence at Telmex were undeniable by the mid-1980s. The company’s overpaid work force had become bloated, yet service was barely improving. Although the Mexican telephone network compared positively with phone systems in places like Venezuela, Argentina, and Indonesia, its performance was dismal when compared to the systems in the United States, the European Community, and other wealthy regions. For example, a customer that requested a telephone line from Telmex would have to wait, on average, about three years for a hook-up—that compared to eight years in Venezuela, but just a few days in the United States, Japan, and most of Europe. In addition, the hook-up fee for a single business line could cost $500 or more. Furthermore, at any one time about ten percent of all the phone lines in Mexico were out of service. To make matters worse, the government had been increasing long-distance prices (through the tax) at a rapid pace, to the point where the cost of a call had become prohibitive for many customers.

Telmex’s problems reflected lackluster national leadership. Between 1976 and 1982, for example, Mexico suffered under the inept direction of the Jose Lopez Portillo administration. Telmex remained profitable and always paid dividends because it was protected by the state, but it fell behind during the early 1980s in adopting some key technologies like 1-800 services and fiber-optics. Portillo was removed in 1982 and was followed by the Miguel de la Madrid administration. Madrid, realizing the urgency of the situation, took several drastic steps to improve the economy and decrease the nation’s debt. Among his initiatives was a program designed to privatize many of Mexico’s 1,155 state-owned enterprises, one of the largest of which was Telmex.

Both Mexico’s economy and Telmex improved under the new administration. For instance, between the early and late 1980s the percentage of phone lines that were digital increased from zero to more than 20 percent. Toll-free 800 service was added in the late 1980s and even extended to calls to and from the United States. Throughout the period, Telmex continued to post profits and to pay dividends on its stock. At the same time, however, long-distance rates continued to rise. By the late 1980s a seven-minute phone call to the United States, for example, cost about $10. By that time the telephone tax was making up 60 percent of all of Telmex’s revenues, and about half of the total tax proceeds were being consumed for other government programs. Furthermore, Telmex’s powerful labor unions remained entrenched, making for an increasingly bloated and inefficient company.

The turning point for Telmex came in the early 1990s, shortly after Carlos Salinas was elected president of Mexico. Salinas had worked for the previous administration as the secretary of budget and planning, during which time he also served as government director on the board of Telmex. Salinas had supported the privatization program that had reduced the number of state-owned companies by more than half by the time he took office in the late 1980s. However, Salinas believed that Mexico was in need of much more radical economic changes. To that end, he announced plans in 1989 to make Telmex a private company again. The plan was to get Telmex operating on its own and then gradually allow other companies to begin competing for long-distance customers.

The reasons behind Salinas’ decision to take Telmex private were multifold. Importantly, by privatizing giant Telmex soon after being elected, he would be sending a message to the global investment community that Mexico was serious about making its economy more competitive and free. A second reason for privatizing Telmex was to increase its efficiency. Indeed, having served on the company’s board, Salinas knew that Telmex’s potential for growth and profit were enormous but were being hampered by politics. By freeing the company from political strings, he hoped to markedly improve Telmex’s performance and to enhance the country’s communication infrastructure. Finally, Salinas knew that the sale of the government’s 51-percent voting share—it represented about 20 percent of the company’s total equity—could help cut Mexico’s fat pile of debt by as much as US$2 billion.

Mexico began decentralizing the bureaucratic Telmex organization in 1989, in preparation for privatization. Then, in 1990, Telmex began accepting bids from investors who wanted to purchase the 20-percent equity stake in Telmex. Easily winning the bid contest was a consortium of three companies that, by outbidding their closest rival by more than $70 million, purchased the controlling interest in Telmex for US$1.76 billion. The three partners were Southwestern Bell (of the United States), France Telecom, and Mexico’s Grupo Carso. Grupo Carso put up half of the US$1.76 billion and received a leading 10-percent equity stake in Telmex, while its partners financed the other half and shared the other 10 percent interest. The group agreed that Grupo Carso would have operating control of the company, Southwestern Bell would be responsible for improving operations and developing paging and cellular divisions, and France Telecom would concentrate on line expansion and modernization.

The head of Grupo Carso, Carlos Slim Helu, headed Telmex’s new management team. After hearing about the privatization plan in 1989, Slim had approached executives at Southwestern Bell and France Telecom about teaming up to get control of Telmex. He reasoned that those two companies had the technological and management tools necessary to whip Telmex into shape and he had the political and economic clout. Indeed, at the time of the buyout, Slim’s Grupo Carso was Mexico’s sixth largest company, with a market value of about US$2.4 billion and only US$300 million in long-term debt. Known as unassuming and publicity shy, the 50-year-old Slim had amassed a US$1.9-billion personal fortune through his varied interests in mining, manufacturing, paper products, retailing, insurance, tourism, and other businesses. Incredibly, Slim, the son of a Lebanese immigrant, had started a small construction company that he built into the Grupo Carso empire.

When Telmex went private it was generating net profits of about US$1.1 billion from sales of roughly US$3.8 billion. Despite those impressive numbers, the government-supported monopoly was in serious need of repair. There were only six lines for every 100 Mexican citizens, for example, which compared to more than 50 lines per 100 citizens in the United States. More than 1.5 million people were on a waiting list to get service, and the typical wait was at least 18 months. The company was only generating revenues of about US$400 per line (compared to nearly twice that in the United States). Furthermore, about 10 percent of Telmex’s lines were inoperable on a regular basis, despite a bloated work force by world telephone industry standards.

As part of the purchase agreement between the Grupo Carso consortium and the Mexican government, the new controllers of Telmex had to agree to rapidly increase and improve longdistance telephone service in Mexico. Specifically, the government designed a three-year plan for improvement that began in 1991 and directed Telmex to install about 8,500 miles of fiberoptic lines, replace 500,000 electro-mechanical lines with digital analog technology, bring phone service into all rural towns with a population of more than 500, and significantly reduce the waiting time to get new service installed. Furthermore, by 1996 Telmex was expected to interconnect with other carriers offering long-distance service, which would open the door for long-distance competition.

Telmex made significant progress toward its goals during the early 1990s. By late 1994, in fact, Telmex had replaced most of its obsolete lines and had converted old switching systems to 75 percent digital switching, one of the highest levels in the world. Furthermore, between 1992 and 1994 the company managed to increase the number of phone lines on its network at an average annual rate of 12.6 percent, bringing the number of phone lines per 100 citizens to 10. As a result, Telmex’s sales rose to about US$6.6 billion in 1992 before jumping to US$7.9 billion in 1993. Although revenues declined to about US$6 billion in 1994, the company netted income of about US$1.6 billion. About 45 percent of Telmex’s revenues came from local services, with the other portion attributable to domestic longdistance and international calls. Furthermore, Telmex invested about US$2.3 billion in its phone system in 1994 as part of an ongoing drive to improve service and prepare for competition in the long-distance market, which was scheduled to commence in 1997.