Dividing a Firm in Order to Conquer

By MICHAEL A. HILTZIK

July 29, 1996 12 AM PT

TIMES STAFF WRITER

In 1984, around the time of the Los Angeles Olympics, a group of Pacific Telesis executives met around a conference table in recognition that they had a tiger by the tail.

The tiger was cellular telephone service, which the California phone company had introduced to coincide with the widely promoted games. And it was roaring far louder than anyone had anticipated.

“We weren’t prepared for the explosion of orders,” said Sam Ginn, then the group president for diversified business at Pacific Telesis. “We sat around the table saying: ‘Is this for real?’ ”

Cellular was, indeed, for real: Customer growth in wireless communications, of which cellular is the largest component, has outstripped that of conventional phone lines by 50% in recent years.

But the irony of that meeting was that Pacific Telesis could only foster the growth of cellular in California by cutting it loose. In 1994, fully a decade after that meeting at Olympics time, Ginn, by then PacTel’s chairman and chief executive, spun off the company’s cellular operations as an independent company, shortly renamed AirTouch Communications. He also left PacTel to head the new company.

PacTel’s struggles to exploit the potential of cellular within its own stodgy culture--and its ultimate surrender to what seemed implacable regulatory and financial obstacles--illustrate what happens when a highly regulated corporation confronts the finances and management needs of an innovative, technology-driven business.

It also shows what happens when a chief executive is willing to break out of the corporate mold to accommodate new realities. The spinoff of AirTouch has become a case study of how to exploit opportunities in the new economy--which often requires a radical rethinking of old models.

The highly controversial spinoff, many observers say, has benefited not only the shareholders of both firms but arguably wireless customers in California and elsewhere.

“Sam did something very unnatural,” said an investment banker close to Ginn. “He split up his empire. People don’t understand how radical that is, but without it the cellular company would be 50% the size of what it is today.”

AirTouch posted profits of $132 million last year, up nearly 35%, on a 30% increase in revenues to $1.6 billion. Although its stock price has recently lagged the market, falling to near its 52-week low of $25.625, many on Wall Street regard the company as well positioned to take advantage of a global surge in the wireless communications business.

Meanwhile, by most measures, the owners of its old parent company have not done badly.

Stockholders of PacTel who kept the AirTouch shares they received from the spinoff had gained about the average earned by holders of the other six “Baby Bells” created in the 1984 AT&T; breakup. Then, on April 1, the announcement of PacTel’s pending takeover by SBC Communications gave shareholders another 30% in gains.

The company, energized by the addition of a cadre of new executives from such competitive companies as Sprint, AT&T; and Mattel, is preparing to reenter the wireless business, albeit at great expense.

PacTel bid $796 million this year for federal licenses to operate personal communications services, or PCS, covering much of California. The service will eventually compete directly with cellular.

For all that, most observers say the story of the AirTouch spinoff is the story of one man: Sam Ginn. Now 61, Ginn, an outwardly courtly and affable Georgia native, pursued the spinoff with single-minded determination.

“Sam is probably one of the most entrepreneurially minded people I’ve ever met in a big company environment,” said one observer. “He just powered this through. At management meetings where everyone would have 87 reasons why it couldn’t be done he’d say: ‘Folks, this is the right thing to do and we’re going to get it done, period.’ ”

Ginn stands by that assessment today. In the late 1980s and early ‘90s, PacTel’s wireless operations seemed doomed to be poor relations forever. The company’s top priority was modernizing the Pacific Bell land-line network, a task projected to cost billions. That in itself would leave precious little with which to finance the equivalent costs of developing cellular.

“I always understood that whatever free cash Pacific Telesis had, Pacific Bell had first call on it,” Ginn said. “That was a franchise operation and you had to meet its needs first.”

Compounding the problem was the California Public Utilities Commission, which was intent on keeping local phone rates low and introducing vigorous competition to the California market.

Meanwhile, the nimble maneuvering necessary to grow in the lightly regulated wireless industry was foreign to many at PacTel who had come up through the ranks of a regulated monopoly.

“We had constraints that entrepreneurs didn’t,” said Philip Quigley, who succeeded Ginn as chairman and chief executive officer of PacTel. “We had a control mentality.”

At one point, he said, PacTel turned down a deal for licenses covering 25% of Hawaii at a cheap price because it was structured as a partnership.

“Opportunities were rampant but . . . partnerships are fragile,” he said. “Our mind-set was control.”

By contrast, AirTouch has grown largely through partnerships and joint ventures, especially abroad. In most of these cases it is a minority partner, albeit with the authority to install its own technical staff, a strong voice in the venture’s business plan, and right of first refusal when its partners seek to sell their shares.

For all that, Ginn and Quigley do acknowledge today that the telecommunications marketplace has changed faster and more radically than either expected in 1992 when the AirTouch spinoff was announced. (It was finally completed in April 1994.)

One difference is the revival of the California market. In 1992, says Mark Lowenstein, vice president for wireless research at the Yankee Group, a Boston research firm, “California was in recession, no telecommunications reform was in sight, and growth in [telephone] lines was down. The market didn’t look as bullish for traditional telephony as it does today.”

Another unforeseen change was the passage of federal telecommunications reform in 1995, years ahead of expectations. The federal telecommunications act vastly expanded the potential of competition at all levels of the business. The number of competitors in the cellular business in any given market will go from two to as many as eight.

A key battlefield is technology. Over the next several years the PCS digital technology PacTel will employ in its markets will compete for wireless customers with competing digital systems being developed by AirTouch and other cellular carriers.

The changing competitive landscape may revive the debate over whether the AirTouch spinoff was the right move.

Even Edward Whitacre, chairman and CEO of SBC, expressed skepticism about the spinoff’s rationale and ramifications.

“As a practical matter it left PacTel with no cellular business,” he said in a recent meeting with Times editors. “It’s now spending billions to get back into that business.”

Quigley insists that competition would have driven PacTel to seek a merger partner even if it had never divested its cellular business. But he acknowledged in an interview that retaining cellular might have meant being able to merge with SBC on more favorable terms.

“It might have been more a merger of equals,” he said.

Still, even in hindsight, few believe that Pacific Telesis would have been able to exploit the market potential of wireless communications, here and overseas, as well as AirTouch has.

“The spinoff was quite radical, but I don’t think anyone would say it was an error,” said Lowenstein of the Yankee Group. “In many ways it’s proven to be a very smart move, especially from AirTouch’s perspective.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

AirTouch at a Glance

Since AirTouch floated its initial public offering in Dec. 1993,*

...its customers worldwide have more than doubled...

(please see newspaper for full chart)

...its profit has nearly quadrupled...

(Income, in millions)

12/92: $10.2

12/93: $34.5

12/94: $98.1

12/95: $131.9

...but its stock price has languished, generally trading between $25 and $30 share.