Australian spectrum auction failure

The Australian 700MHz and 2.6GHz spectrum auction results were announced on the 7th of May. The most striking result is that 2x15MHz of the 700MHz spectrum remained unsold because VHA (Vodafone) decided not bid and Optus acquired only 2x10MHz. This poor result is due to the extremely high reserve prices. The reserve price for the 700MHz digital dividend spectrum was set at 1.36 $/MHz/pop. This is 186 per cent of the average price paid in other auctions for digital dividend spectrum as shown in the chart below. Furthermore, by comparison the reserve price for digital dividend spectrum in the recent auction in the UK was only 0.30 $/MHz/pop and in Germany the reserve price amounted to less than one cent / MHz / pop.

Digital Dividend Spectrum Price Paid vs. Australian Reserve

The rationale for freeing up spectrum from analogue TV for use by mobile broadband services is the benefit this brings to the economy.  At the start of the process of the digital switchover, the Australian Mobile Telecommunication Association (AMTA) engaged Spectrum Value Partners and Venture Consulting to determine the net economic benefit generated by redeploying the 700MHz spectrum freed up by the switch-off of analogue television, i.e. digital dividend.  They reported that:  “Allocating the optimal mix of UHF spectrum to mobile operators is forecast to generate a net benefit to the economy of between $7bn and $10bn, depending on which overall market scenario is realised. “ (Getting the most out of the digital dividend in Australia, Spectrum Value Partners and Venture Consulting, April 2009).

This estimate assumed that all of the digital dividend spectrum will be allocated to mobile.  In the event one third of the APT band plan 700MHz spectrum remains unsold whereas 100 per cent of the cost of freeing up the spectrum has been incurred. Therefore potentially several billion dollars of benefit to the economy has been lost as a result of setting reserve prices above the level where weaker operators can earn a normal return of capital employed.

The damage that has been inflicted on the Australian economy does not end there.  Since VHA ended up without spectrum it will further weaken their relevance in the market. Since competition is likely to have been weakened this will reduce the “consumer surplus” from the digital dividend i.e. the benefit consumers would gain in the form of lower prices.

Of course the most direct impact is the lower auction revenue for the Government. The Australian government budgeted in revenue from the auction at least equal to the total reserve, i.e. AS$ 2,894 million. In the event the auction raised only AS$ 1,964 million, i.e. 32 per cent below the target.

The auction failure could hardly be more complete.  Yet, it was widely predicted that with these high reserve prices spectrum would remain unsold, in fact Vodafone said it would not bid unless the reserve prices are lowered.  The outcome says a lot about politician’s lack of understanding of how investment decisions are made and also demonstrates an unwillingness to listen to the industry.

The blame for the ACMA’s auction fiasco lies mostly with the government since the reserve prices were set by Communications Minister Stephen Conroy who set out his stall in his now infamous declaration of “unfettered legal power” over telecommunications “The regulation of telecommunications powers in Australia is exclusively federal. That means I am in charge of spectrum auctions, and if I say to everyone in this room ‘if you want to bid in our spectrum auction you’d better wear red underpants on your head’, I’ve got some news for you. You’ll be wearing them on your head … I have unfettered legal power.”

Conroy clearly told everyone that he had no intention of listening to the industry. The reserve prices were set to plug the Government’s budget deficit. This is the worst way to set reserve prices for spectrum. It is devoid of any rationale and is in effect a hidden tax to be paid for by consumers in form of higher prices.

Although Australians are always good for a bit of fun, I very much doubt that bidders in the Australian spectrum auction wore red underpants on their heads. However, in the light of the spectrum auction fiasco, it is plausible that the Minister now wears a red face.

Written by Stefan Zehle, CEO Coleago Consulting

Towards a single EU telecoms market

In a speech delivered at Mobile World Congress 2013, Neelie Kroes, European Commissioner for Digital Agenda, called for the creation of a single telecoms market in the EU. Kroes iterated that it would be of great benefit to the European telecoms industry as well as consumers. There are numerous aspects to this, but mobile telecoms and notably spectrum allocation is most notably one of the focal points.

In recent times, common EU policy has led to the harmonisation of mobile spectrum and technology in the form of GSM at 900MHz and 1800MHz. One could argue that it is this which kicked off the global boom in mobile communications as a result of delivering low equipment prices (terminals and network) as well as international roaming. The benefits to both the European industry and users are undeniable. Mobile communications is now a global business and with the inclusion of multiple LTE bands on chipsets, harmonisation is perhaps a little less important from the technology perspective, but it still matters from a business perspective.

Spectrum allocation mechanisms and prices paid by operators are driven by national policy objectives. Some governments (e.g. Finland) rightly think that spectrum should be made available to operators as cheaply as possible since ultimately this generates the greatest benefit to society. Others (e.g. Ireland and Greece) focus on immediate cash generation. Views on competition may also differ. The 800MHz auction rules in France are a good illustration of a government ensuring the survival of the 4th entrant, whereas in the highly competitive UK market, competition does has not been a big issue in the recent spectrum auction.

These policy differences result in very different costs for mobile operators and yet there is an assumption that prices, notably wholesale prices should be standardised across the EU. Clearly there is a contradiction.

Another key point in pushing for an EU wide approach to telecoms regulation is that cross-border mergers should be made easier in the EU. The fragmentation of telecoms services provision within the EU is a barrier to the single market. An innocent bystander might ask a whole series of questions which demonstrate that the current EU mobile and fixed regulatory environment is unsatisfactory, for example:

—Why is it that a call on a mobile network within a country tends to be included in the bundle whereas a call to a neighbouring country is usually priced at a premium?

—Austria has a smaller population than Bavaria, so why does T-Mobile run Austria as a separate business from its German operation?

—Why are mobile numbers portable within a country but not within the EU?

The current structure of the EU telecoms industry and markets are an artefact of national telecoms regulation. Faced with competition from global OTT players who are not bound by national regulatory regimes, it is the European telecoms companies who suffer. Both industry and end-users would greatly benefit from a truly EU wide approach to telecoms policy and regulation.

Written by Stefan Zehle, CEO, Coleago Consulting

The end of geography and roaming in telecoms

Today most people are familiar with services such as Skype. Effectively a location independent mobile service, with Skype it does not matter where people call from nor does it matter where the called party is located. Geography has become irrelevant. By the end of Q4 2012, it was anticipated that roughly 50 per cent of international call traffic is likely to have taken place via Skype and similar services rather than traditional carrier traffic.

More and more people are installing Skype on their handsets or using Facetime on their iPhone, and they are getting used to the fact that calling from their mobile phones doesn’t necessarily have to involve the mobile operator. What’s more they also get video telephony. Increasingly people use WiFi on their smartphones, both at home, at work and in public places. The introduction of WPA2 as well as SIM based authentication which allows automatic connection to a WiFi network without signing in makes it easy for users to route their traffic via WiFi and opt out of traditional telephony.  Operators such as Rebtel in Sweden and Republic Wireless in the USA focus on this opportunity – these mobile operators that use WiFi offload “push” their customers to make calls using Skype like services.

The trend away from making standard mobile voice calls is accelerating with the adoption of LTE. For example, in contrast to older versions of the iPhone, the new iPhone with Apple’s iOS 6 upgraded FaceTime from a WiFi only feature to a cellular feature. AT&T Wireless was the first to allow customers to use FaceTime over LTE if they signed up to their new shared data tariff plan.

During 2013 we will see the start of a fundamental reshaping of mobile telecoms service offerings driven by new services based on the IP Multimedia Subsystem (IMS), the evolution of mobile wholesale as well as regulatory trends. Some operators may go all the way and break the link between the mobile telephone numbers and geography. After all it seems somewhat archaic that in a world where distance does not matter, mobile operator tariffs are still based on location and distance. Location is not an issue with Skype or FaceTime and this is one of the reasons for the success of these OTT operators.

Some operators have already introduced services based on IMS, for example in Canada the Rogers One Number service allows the seamless switching between a smartphone and computer. It allows mobile operators to leverage the proliferation of free WiFi connectivity to in effect extend their network coverage world-wide.  This allows mobile operators to fight back against OTT services such as Skype, WhatsApp and FaceTime by in effect becoming themselves an “OTT over WiFi” player.

There are also traditional mobile services that allow users to avoid roaming charges and thus take at least one aspect of geography out of equation that already exists for voice (Truphone, WoldSIM and other) and data (roamline.com, in collaboration with KPN). The business model is built on exploiting the difference between lower wholesale prices paid by MVNOs versus high inter-operator roaming tariffs by offering customer SIMs with multiple numbers in different countries.

The opportunity to take geography out of mobile pricing is not limited to roaming. For example, Turk Telecom launched a service in Germany and Belgium aimed at the Turkish ethnic segment in these countries. Customers are charged exactly the same amount to call numbers in Belgium or Turkey. Turkcell could add the ability to recharge linked accounts (a Turkish person working in Belgium can recharge the prepaid SIM of relatives in Turkey) and make small mobile payments across borders. Smart, of the Philippines is already going down this route, targeting the Filipino diaspora segment around the world.

As a result of these trends in international call pricing as well as roaming, Geography may soon become irrelevant.

Written by Stefan Zehle, CEO, Coleago Consulting

Is time running out for the Combinatorial Clock Auction format?

Earlier this month, I attended the Spectrum Management Forum 2012 in Munich and was interested to hear several presenters criticise the Combinatorial Clock Auction (CCA) format. The CCA format which has clock and supplementary rounds where bidders bid on indivisible packages of spectrum and where prices paid are determined by a second price rule has in the last few years found increasing favour by many governments for spectrum auctions. Under the second price rule, the price a winner of a particular package pays for its spectrum is determined entirely by competitors’ bids.

Supporters of the CCA format, claim that it results in more economically efficient outcomes and reduces aggregation risk where there may be complementarities between lots e.g. between high and low band spectrum.

Most of the criticisms of the CCA format relate to the fact that it is incredibly complex to prepare for, that the outcome is not very transparent and it can lead to perverse results. But there are other issues that for instance competitors can “game” the system and drive up prices paid by other bidders by bidding on larger packages that they do not sincerely want to win. In addition it represents a difficult issue for companies to deal with from a corporate governance point of view in terms of establishing bid limits and deciding whether to bid sincerely.

We can confirm that complexity is a serious issue as one CCA auction that we have been involved in required our client to value more than one hundred thousand different spectrum packages to prepare for the supplementary round. In terms of strange results there have been several auctions where there have been very large disparities in prices paid e.g. the 2012 Swiss multi-band auction and the 2010 Danish 2.6GHz auction.

We have worked with most major auction formats and while CCA was introduced with good intentions we are starting to doubt that the benefits outweigh the disadvantages.

Written by Scott McKenzie, director, Coleago Consulting

From One to 3 in Austria: Will Hutchison be a consolidator in Europe?

Rumours that Hutchison Whampoa’s 3 Austria is close to sealing a deal to acquire Orange Austria (previously One before being rebranded) for €1.4bn may be good news for the Austrian mobile sector which has seen fierce competition as four operators battled it out in a country of eight million people. It is estimated that in service revenue terms Hutchison has about 6% of the Austrian mobile market while Orange has about 19%. By comparison, Telekom Austria has 44% and T-Mobile has 31 % so the merged entity will still be smaller than its larger competitors.  Although the price seems quite steep at circa 7x EBITDA it may well be justified if 3 Austria can extract hundreds of millions of synergies from the deal by rationalising the networks and avoiding damaging price and subscriber acquisition wars. Post-merger execution will needless to say be critical.

The two other operators in the market (Telekom Austria and T-Mobile) will also benefit and no doubt they will be hoping that the deal is approved by the competition authorities. This might explain, if the press reports are true, why Telekom Austria is so keen to help 3 Austria do the deal by, for example, buying Orange’s discount mobile brand Yesss! as well as some 2.1GHz spectrum and 3,000 redundant base stations. Press reports suggest that 3 Austria will raise up to €300m from these divestments which will lower the overall transaction risk.

In the coming years we expect further mobile network operator consolidation in developed markets as the industry becomes increasingly mature and margins come under further pressure. For Hutchison Whampoa, this represents a new wave of investment in Austria and its 3G business and we wonder if it is not a template to be used in other markets where it is finding the going tough.

Written by Scott McKenzie, Director, Coleago Consulting

Wireless Industry Consolidation in the USA: AT&T’s blocked acquisition of T-Mobile

The troubles of T-Mobile go back many years and are related to inferior spectrum holdings: “We were late with 3G”, said Neville Ray, SVP, engineering and operations T-Mobile USA, in March 2009. Since then T-Mobile acquired spectrum in several auctions and launched 3G, but it still has an inferior spectrum position. Spectrum auctions, beloved by the FCC, often cause reduced competition in wireless markets because the business case for spectrum auctions always looks better for larger operators. One of the largest components in deciding how much to bid for spectrum is the value arising from denying spectrum to rivals. If the US government had wanted more competition at network level it could have chosen a method of spectrum allocation other than unfettered auctions.

However, developments in the wireless industry have moved the goalposts and sooner or later the Justice Department will have to relent on its opposition to the proposed acquisition.  In developed wireless markets there is now very little growth in the wireless industry revenue, i.e. the industry is mature.  At this point of the industry life cycle management focus shifts from seeking revenue growth to taking out costs, for example through consolidation.

The physical network is increasingly a commodity, whereas there is increasingly fierce competition at retail level. In many markets consolidation at network level went hand in hand with increased competition at retail level with the launch of multiple Mobile Virtual Network Operators (MVNOs) and branded resellers. If the Justice Department and the FCC are concerned with competition they could make approval conditional on incorporating provisions into the acquisition that make it easier for MVNOs to enter the US market. Having said that, T-Mobile’s case is not helped by the smoking gun in T-Mobile’s past: In October 2009 Deutsche Telekom’s CFO Timotheus Hoettges insisted there was no need for further consolidation of the US wireless market: “There are four national players in the US market for 300 million households, while in Europe, where we have 350 million households, there are 50-70 operators.”

Written by Stefan Zehle, CEO, Coleago Consulting

Should Mobile Networks Evolve into an Access Utility?

The licensing of multiple mobile networks within the same market really took hold with the advent of GSM. Often licences were awarded based on beauty contests and later through auctions.  Coverage was of the main evaluation criteria and also a source of competitive advantage for mobile operators.  In the early days of GSM coverage maps featured prominently in advertising and for customers geographic coverage was the main factor in choosing one mobile operator over another. Licence obligations and competitive pressures ensured that operators build coverage rapidly, even in areas with low revenue potential. This development was of course very much to the benefit of the rapid growth of the mobile communications market. In other words, licensing and building several mobile networks in parallel proved to be a tremendous success.

In 2011 few operators in developed markets talk about geographic coverage, i.e. geographic coverage is no longer a differentiator between networks and hence does not confer competitive advantage. Competition tends to be around bundled offers, handsets, price plans, rewards, content, and occasionally mobile broadband quality gets a mention. The implication is that at this stage of the mobile industry life cycle, network ownership appears to matter less and less. Indeed many operators share sites and in some cases even share the Radio Access Network (RAN).

However, the exponential growth in mobile broadband traffic means that capacity started to matter. New spectrum is being auctioned and in some cases prices paid, particularly for digital dividend 700MHz or 800MHz spectrum, are quite high – €0.70 per MHz per pop in Germany for example. Prices paid for 2.6 GHz are much lower, in the region of €0.02/MHz/pop, but still represent a substantial cost to mobile operators. Governments are keen to extract significant amounts of cash from mobile operators and design spectrum auctions to achieve this. From an operator’s perspective the question arises, how can we avoid bidding up prices for the new spectrum?

Given that most regulators have already accepted RAN sharing, perhaps the best course of action for competing operators in a particular market is to form a Network Company which will bid for spectrum jointly on behalf of operators, deploy an LTE network in the new spectrum and then lease capacity to each mobile operator. Indeed, following the conclusion of the 800 MHz and 2.6 GHz auction in May 2010 in which ePlus failed to obtain 800 MHz spectrum, the winning operators immediately announced that there would be a deal to give ePlus access to the sub 1 GHz spectrum. This begs the question whether such a deal could have been struck prior to the auction?

In the run-up to a spectrum auction collusion rules are often not clear. For example, in the forthcoming Swiss auction there are rules against collusion but also any company is allowed to bid. Could two operators form a bidding vehicle? If yes, network consolidation would take a step forward. Site sharing is already standard operating procedure and RAN sharing is becoming more widespread. Sharing spectrum would take this evolution a step further. Sharing brings of course the greatest capex and future opex benefits in a new build situation. The forthcoming digital dividend and 2.6GHz auctions and roll-out of LTE therefore present an ideal opportunity for mobile operators to increase return on capital employed by co-operating at network level while preserving competition at retail level.

There are likely to be regulatory concerns in respect of competition. These concerns can be alleviated if there is already enhanced competition at retail level through MVNOs and if operators are mindful of other competition related aspects, committing to net neutrality for example.

Moving towards a net-utility and fostering competition at retail level may seem counter intuitive. However combining careful analysis of the industry evolution as it moves into the mature phase of the industry life cycle with an analysis of capital expenditure and the return of capital employed along different parts of the mobile operator value chain may produce new insights. After all, all investors should be interested in is return on capital employed.

By Stefan Zehle, CEO Coleago Consulting

Swedish spectrum prices provide a new lower benchmark for Europe

By Graham Friend

The auction for 800MHz spectrum concluded today in Sweden and provides Europe with a new and lower benchmark for this key spectrum band. Spectrum in the 800MHz band, sometimes referred to as the Digital Dividend, is attractive to mobile operators due to its superior propagation characteristics which makes it ideally suited for providing 4G services such as LTE in rural areas and greater in-building coverage in urban areas.

The winners of the spectrum were the four incumbents HI3G, TeliaSonera and Net4Mobility, a joint venture between Telenor and Tele2. The formation of the joint venture may well have reduced competitive pressures in the auction as bidders were capped at a maximum of 2x10MHz allowing for the three blocks to be shared equally amongst the three bidders representing the four incumbents. Two other bidders participated in the auction, Com Hem and Netett Sverige, but as new entrants their business cases would have been weak by comparison with incumbents and very unlikely to exceed the blocking value that the incumbents would have included in the their valuations for keeping out a new entrant.

The result of the auction was a benchmark of US$/MHz/Pop 0.58 which is 63% of the value achieved in Germany and only 32% of the value achieved in the Hong Kong auction which also concluded today. Both the German and Hong Kong auctions faced much higher levels of competitive tension.

There were also interesting results at the operator level in Sweden. HI3G secured its spectrum at roughly 50% of the prices paid by Net4Mobility and TeliaSonera. This outcome is particularly interesting as HI3G may well have had one of the highest valuations for the spectrum as HI3G, prior to the auction, did not hold any sub 1GHz spectrum. This represents another good result for HI3G as the company secured 2x10MHz of 2.6GHz spectrum in the Danish auction at a fraction of the prices paid by other bidders on a per MHz, per Pop basis.

Why mobile data should be more like mustard

Industry analysts and commentators continue to marvel at the “growth in demand” for mobile data and indeed some mobile networks are groaning under the strain. It appears however that the meaning of the word demand has been forgotten. Demand, in an economic sense, relates to the willingness to pay. One could say that there is a “high demand” for Ferraris as who would not want one, but few can afford them which is why they are not clogging up the motorways.

The prevalence of unlimited or “all you can eat” data offerings has resulted in significant growth in traffic but not revenue as the link between demand and the willingness to pay has been broken. Unlimited offers made some economic sense two years ago when adoption of mobile broadband was low and networks had unutilised capacity. Two years ago incremental traffic did not necessarily result in incremental capital expenditure. Networks are now congested and increasing traffic is resulting in increasing capex without increasing revenues which can only depresses returns to shareholders.

Pricing structures need to change if the economics of mobile data are to improve. Within a mobile operators’ customer base there are usually a relatively small proportion of customers who use a very high proportion of network resources. These “bandwidth hogs” should be charged for the data that they use or their usage should be constrained. In fact mobile operators should start to look at mobile data a little more like mustard.

Since 1814 Jeremiah Colman of Colman’s English mustard has been making his money not by how much mustard people eat but how much they left on the side of the plate. If you are going to charge somebody £15 a month for 2GB the customers you actually want are those who use only a quarter of their allowance. Studies show the average smartphone user is using a lot less than 2 GB a month, and perhaps a tenth of what the average dongle user gets through. If operators started to think about mobile data a bit more like mustard we might see an improvement in industry returns.