THEY DREAMT IT UP: a satellite network that would work anywhere on Earth. They designed it. They built it. And got everyone else to help pay for it. Now that Iridium has sunk to bankruptcy, Motorola may yet emerge on top.
NEW YORK - "Hello," says the cover of Iridium World Communications' second - and probably last - annual report. The satellite telecommunications company, which debuted on the stock market just 28 months ago, may soon be saying "Goodbye."
While Iridium's constellation of 66 satellites hovers in the sky, the company itself has come clunking down to Earth. Iridium, backed by 19 telecommunications and electronics companies, filed for bankruptcy protection in August. It's now trying to restart itself as a smaller business and appease its creditors. With just $200 million in cash and virtually no income, Iridium faces $1 million a day in expenses and owes $3 billion.
Iridium owes the most, $2.9 billion, to Motorola, the Schaumburg, Ill., electronics company that invented, designed, financed, built, supplied, operated and maintained much of Iridium's system of satellites, ground stations and telephones.
There are many reasons Iridium went bust. The company had bulky telephones that weighed as much as 1 pound, cost as much as $3,000 and didn't work well in buildings or cars. What really doomed Iridium, however, may have been the multiple, and often conflicting, roles played by Motorola. Some investors say that as the prime contractor on the project, Motorola milked Iridium and used the partners' money to finance its own foray into satellite communications technology.
"Motorola used Iridium as a vehicle to amass a presence in the global satellite industry," alleges a shareholder suit filed in June against Iridium and Motorola by Berger & Montague, a Philadelphia law firm. "By using Iridium, Motorola ensured that its reputation would not be tarnished if the project failed.
Motorola, which owns 18 percent of Iridium's stock, hasn't escaped from this fiasco unscarred. The world's No. 2 maker of cellular phones has written down the value of its Iridium shares to zero. It expects to lose $2 billion on Iridium - serious money at a company that had revenue of $29.4 billion and a net loss of $962 million last year. On Oct. 12, Motorola took a $994 million pretax charge for its Iridium losses.
But these numbers don't tell the full story.
So far, Motorola has collected $3.65 billion on its $6.6 billion in Iridium contracts. SG Cowen analyst Wojtek Uzdelewicz estimates that Motorola, after covering expenses and paying its suppliers, has pulled in $750 million in profit from the contracts, bringing down the company's net loss on Iridium to $1.25 billion.
Motorola also will emerge from the wreckage of this project with new expertise - and more than 1,000 patents - in building satellite communications systems.
In July, Bellevue-based Teledesic signed up Motorola as prime contractor to build its 288-satellite "Internet in the Sky" to compete with terrestrial fiber-optic networks. Backers of the Teledesic project, which will cost as much as $15 billion and transmit data, video and voice, include Boeing, Microsoft Chairman Bill Gates and cellular magnate Craig McCaw.
At least 20 groups of investors have sued Iridium and Motorola, charging that the companies, their executives and their underwriters knowingly issued false and misleading statements about Iridium's condition and prospects.
Motorola denied those allegations. "The claims we've seen against Motorola are groundless," said Motorola spokesman Scott Wyman. "We plan to defend them vigorously and we expect to prevail."
Iridium was born in 1985, after Karen Bertiger, a real estate broker vacationing in the Bahamas, complained to her husband, Bary, that she couldn't get her cellular phone to connect to a client back in the U.S.
After the trip, Bary Bertiger, a Motorola engineer, brainstormed with his colleagues and came up with the notion of a constellation of low-Earth-orbit communications satellites that would enable anyone to call anyone from anywhere. They named the project Iridium after the element with 77 electrons, the number of satellites they originally envisioned.
Some big telecommunications companies spurned early appeals for investment from Motorola, then led by Chairman Robert Galvin, father of the current CEO.
Herschel Shosteck, head of his own wireless telecommunications consulting firm in Wheaton, Md., was author of one research report that AT&T executives read. In January 1993, he said Iridium was likely to flop because its technology was ununproved. "We place the chance of its economic success at one in 10 or less," he wrote.
Shosteck says Motorola predicted in 1990 that it would have 6.76 million subscribers by 2001.
"It was clear the demand forecast was developed by Motorola engineers to show a `good market' for the end of building the satellites," Shosteck says. "It had nothing to do with a rational business analysis."
By 1994, Motorola had rounded up a hodgepodge of 18 "strategic partners," including Sprint, the third-largest long-distance phone company in the U.S., and two large U.S. defense companies, Raytheon and Lockheed Martin. Other strategic partners consisted of a consortium of companies in China, the Middle East, Africa, India and Russia.
In exchange for a total investment of $3.7 billion, the partners got equity and board seats. They agreed to buy additional Iridium equity and debt, if necessary, and to become gateway investors, financing and operating Iridium's ground stations, known as gateways.
Motorola ponied up $400 million, giving it 25 percent of the equity, the largest stake by far. The company held six seats, the biggest bloc, on Iridium's board.
While spreading the risk, Motorola retained the most power. Like Tom Sawyer, who talked his friends into paying him for the privilege of painting his back-yard fence, Motorola persuaded its partners to finance its development of space-age communications technology.
Iridium itself was a sort of toothless tiger from the outset. It didn't have the authority to sell or service any phones anywhere. The partners controlled marketing, pricing and distribution. Iridium set the wholesale rates of its phone service and signed major contracts with Motorola, which then farmed out some of the work to subcontractors.
Motorola drew cash from Iridium's till in many ways. The $6.6 billion in contracts that Iridium awarded Motorola included $3.45 billion, payable from 1996 to 1999, for designing and launching satellites and $2.9 billion for operations and maintenance.
In 1994, Motorola landed a $356 million contract for supplying hardware and software to Iridium's 12 ground stations. Motorola even wrote Iridium's payroll checks. For this and other administrative services, the company rang up $3.8 million in 1994, $604,000 in 1995 and $563,000 in 1996.
Motorola also collected fees for guaranteeing some of Iridium's debt, a necessary step after Iridium's hapless effort to tap the bond market.
In June 1997, just a month after Iridium finally had overcome a series of technical problems and had launched its first five satellites, the company did an initial public offering.
By now, Wall Street was full of believers. Five out of the six equity analysts covering the fledgling company rated it a buy; the other one rated it a hold.
"The target market was virtually the entire world," said William Kidd of C.E. Unterberg, Tobin. He noted that cellular phones, the ones that relied on towers rather than satellites to relay their signals, worked on only 15 percent of the Earth's surface.
The IPO was a success - 12 million shares priced at $20 each, which rose to 54 four months later.
Iridium used most of the $225 million from the IPO to pau Motorola for designing most of the satellite and ground-station software and hardware.
In July 1997, Iridium sold $1.45 billion in bonds with interest rates ranging from 10.875 percent to 14 percent. Iridium used the proceeds mainly to pay Motorola for the satellites.
Iridium's stock soared to $68.875 in May 1998, but by later that year things were looking dicey. Iridium began service on Nov. 1, 1998, with just 3,000 customers, a fraction of the 500,000 subscribers that analysts thought the company needed to break even.
Nobody was happy. Iridium blamed the gateway partners, including Motorola, for not marketing the service zealously enough. "The gateways were very often huge telecoms," said Stephane Chard, chief analyst at Euroconsult, a Paris-based research firm. "To them, Iridium was a tiny thing."
The gateways said Iridium's suppliers were late delivering its phones and pagers. J.P. Morgan analyst Marc Crossman says he ordered his Iridium phone from Motorola in September 1998 and didn't receive it until mid-January. Then, he says, he couldn't use the phone for three weeks because of a delay in setting up his account.
Customers complained that the phones didn't work inside buildings. Whatever market there was for Iridium phones shrank even further with the continuing Asian financial crisis, which had begun during the summer of 1997.
Iridium now has about 20,000 customers worldwide. Since April, almost all of its top executives have quit or been fired, including Chief Executive Edward Staiano, a 23-year veteran of Motorola.
Today, Motorola holds 27.3 million shares, or 18 percent, of Iridium. Those shares were worth $83.6 million when Iridium stopped trading in August.
There clearly is a market for Iridium phones among at least one class of customers - chief executives negotiating multibillion-dollar deals in remote locales. Sprint CEO William Esrey says he worked out the details of his company's proposed merger with MCI WorldCom on an Iridium phone while riding his horse in Colorado. On the other end of the line was MCI WorldCom boss Bernard Ebbers, the architect of the record-breaking $129 billion deal, which was announced in October.
Motorola, meanwhile, using technology developed largely on Iridium's nickel, is getting ready for its next life as a telecommunications satellite contractor.
Of course, Teledesic may be no more successful than Iridium. Hundreds of small and large competitors have filed for U.S. Federal Communications Commission licenses for similar systems. Shosteck, the Iridium Cassandra, is equally bearish on Teledesic, giving it only a one in 10 chance of "having a viable market" - the same odds he gave Iridium.
Still, as Standard & Poor's analyst Bruce Hyman points out, "Motorola has gained substantial experience in commercializing the technology of manufacturing communications satellites in high volume."
Tom Sawyer might have approved. Motorola gets the fence and the paint job. The other Iridium partners are still hoping for some kind of return.