The APT Bandwagon Reaches Cruising Speed

On the 7th of February Brazil made the decision to make available 698MHz-806MHz for mobile broadband services. The frequencies are those of the Asia Pacific Telecommunity (APT) band plan. ANATEL, Brazil’s regulator, now has the authority go ahead with clearing and the allocating this 700MHz spectrum to mobile operators for mobile broadband use. This should help Brazil to achieve the goals of the country’s national broadband plan (Plano Nacional de Banda Larga).

Of course the process will take time because the process of moving terrestrial TV from analogue to digital will be lengthy. In some parts of Brazil the spectrum could be cleared as early as 2016. Given the size of the country, a regional approach to opening the band to mobile broadband may be possible, although this potentially creates an interference problem.

Brazil’s decision means that the APT eco-system is gaining the scale which confirms it as a mainstream solution for LTE deployment. This means the 700MHz APT band plan may appear in chipsets and more devices earlier rather than later.

Many Asian countries have committed to the APT plan. However, the clearing of the band appears to be slow and countries such as India have only just launched 3G and therefore Region 2 may not be the main driver in developing the device eco-system. The confirmation of the adoption of the APT band plan in Latin America indicates that it will become well-established in Region 2. In addition some African countries have also looked at the APT band plan and the Russian 700MHz allocation is reasonably close to the APT band plan. Therefore we may see the APT band plan being adopted in also in Region 1.

Exhibit 1: 700MHz Allocation in Russia & APT Band Plan

700MHz Plans	Mobile Transmit	Centre Gap	Mobile Receive
700MHz in Russia	720 MHz to 750 MHz = 30 MHz	750 MHz to 761 MHz	761 MHz to 791 MHz = 30 MHz
APT Band Plan	703 MHz to 748 MHz = 45 MHz	748 MHz to 758 MHz	758 MHz to 803 MHz = 45 MHz

Written by Stefan Zehle, CEO, Coleago Consulting

Margin squeeze issues are attracting increased attention

With the roll-out of Next Generation Networks in the fixed telecoms world and increased network sharing in LTE mobile networks, margin squeeze is attracting increased attention. What’s at stake is to maintain competitive retail markets in a situation where multiple service providers use the network of a network operator which also competes in the retail market.

A margin squeeze may occur where a vertically integrated operator sells both the retail service and an essential wholesale input to that service. Specifically, a squeeze arises when the difference between the operator’s retail price and its wholesale price is too small for an efficient competitor to: i) purchase the wholesale input; ii) provide the remaining inputs needed to create the retail services and iii) sell the retail service on a profitable basis. In practice, there are two main scenarios in which margin squeezes may occur.

Firstly, where the price of a wholesale service is regulated on a retail-minus basis the difference between the retail and wholesale price may be too small for an efficient competitor to compete and make a profit. Secondly, where the wholesale price of the vertically integrated operator is regulated but its retail service is not, retail prices could be set at a level which does not allow competitive operators to be profitable. The intention in such a case could be for the incumbent to drive competitors out of the market so that it can put up its retail price – short term pain for possible long term gain. Looking in more detail at the two cases, retail-minus regulation is used by certain regulators for some fixed network services.

For example, the UK regulator Ofcom has argued that retail minus may be appropriate for certain innovatory services where there is considerable uncertainty about service performance and it is important to encourage new investment. For this reason Ofcom has not imposed price regulation on BT’s VULA service (next generation bitstream) although the service is subject to a number of conditions.

However, it does require that VULA prices are set at a level which ensures there is no margin squeeze. In its draft recommendation on non-discrimination obligations of 7 December the European Commission outlines an approach for NGA (but not legacy access networks) which has something in common with Ofcom’s. The recommendation proposes that NRAs should not maintain or impose cost-orientation on NGA wholesale inputs providing certain conditions are met such as equivalence of input and the satisfactory outcome of an economic replicability (margin squeeze) test. In mobile networks, national roaming charges and prices paid by MVNOs are often set on the basis of commercial negotiations although this may accompanied with the potential threat of retail minus if that does not work.

In practice, commercial negotiation often does the trick, particularly when there are a number of operators in the market, but there is always the possibility of retail minus in the background and hence, the possible need to identify what the margin actually is. As mobile telecoms moves from a voice orientated business to LTE, it becomes increasingly difficult to determine what margins are because there is no clear relationship between data volumes and revenue.

Margin squeeze tests can also be applied in situations where wholesale prices are required to be cost orientated. A potential problem arises in situations where the margin squeeze test is failed since this could result in wholesale prices being set below costs – indeed, this has happened in Austria.

Setting wholesale prices below cost is warranted in situations where the incumbent is trying to squeeze competitors out of the market but seems inappropriate where prices have been reduced to remain competitive in the market. For this reason regulators and competition authorities need to take account of the prevailing circumstances when acting on margin squeeze tests where wholesale input prices are subject to cost orientation.

In this context it is interesting to note that the European Commission Draft Recommendation on non-discrimination obligations does not propose the use of margin squeeze testing for legacy access networks, where cost orientation is required. According to a 2009 ERG survey, 12 NRAs have a procedure to carry out margin squeeze tests and, indeed, a large number of tests have been conducted.

The importance of testing is likely to increase in the future, for example in the context of NGA network rollout. Given the increasing recognition that setting wholesale inputs in NGA networks on a cost orientated basis may have a negative impact on roll-out, margin squeeze testing will inevitably become an essential part of an NRA’s regulatory toolkit. Finally it’s worth saying something about margin squeeze tests themselves. Put simply there are many types of test and the appropriate way to conduct a test will depend on the circumstances under consideration.

In many cases regulators and competition authorities may do well to test for margin squeeze using two or more different methodologies. To give some idea of the approaches/issues involved: tests can be conducted on an ex ante basis or an ex post basis;— tests can be conducted either on an Equally Efficient Operator basis (essentially the incumbent’s costs) or a Reasonably Efficient Operator basis (the costs of a potential competitor). The Commission’s recommendation has, probably sensibly, come out in favour of the former; —tests can examine either projected or realised cash flows and/or look at year by year results.

There are arguments in favour of both approaches;for bundled products tests can be carried out either on a product by product basis or at the level of the aggregate bundle; A further and crucial factor to consider is the period over which the test is to be conducted. This is particularly important for new innovative products such as Next Generation Access where it may take a number of years to achieve a positive rate of return.

Written by Jonathan Wilby, Senior Consultant, 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

Vive la différence II

The French telecoms regulator announced at the end of last week that they have finished the 2.6GHz auction process begun in June.

	FDD Allocation (MHz total)	Price (m€)	€/MHz/POP	Obligatory MVNO access
Orance	40	287	0.110	Y
SFR	30	150	0.077	N
Bouygues	30	228	0.116	Y
Free Mobile	40	271	0.104	Y
TOTAL	140	936	0.102

The format used in France was a first price single round sealed bid which meant there was no opportunity to learn and can lead to disparities in prices paid. As if to illustrate this point, one player (SFR) got the spectrum at the reserve and did not need to commit to hosting MVNOs.Although the price per MHz per pop does not look outrageous compared to some other 2.6 GHz auctions (e.g. Denmark and Sweden for example), it is 4.5x that seen in Germany in 2010 and this might be (partially) explained by the fact that the reserve price level set in France was a lot higher than that in Germany – 25x on a per MHz POP basis.

The 800MHz digital dividend spectrum is now to be launched before year end.

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

Vive la différence

The French telecoms regulator ARCEP announced the terms of the country’s 800 MHz and 2.6 GHz spectrum auction process in June. There are several noticeable features of the process: firstly the bands are being sold off sequentially with the 2.6GHz spectrum being auctioned in September and the 800MHz in December; secondly the auction is a first price sealed bid format, which is rather uncommon these days given the potential drawbacks with this format; and thirdly the reserve prices have been set at a very high level which is consistent with the worrying trend we have seen in other countries lately.

Since the auctions are sequential there is what game theorists call exposure risk which is due to the complimentary nature of 800MHz and 2.6GHz spectrum – i.e. a risk of overpaying for 2.6GHz spectrum as their bid price is based on an assumption they also win 800MHz and then fail to do so. In other words, should they bid on the 2.6GHz spectrum assuming no synergies with the 800MHz band and then risk not getting their desired allocation at 2.6GHz?

Given the fact that the format to be used in each stage is a single round first price sealed bid auction with no opportunity for price discovery, there is inherently a risk to significantly overpay – the so called “winner’s curse”. Equally there is a potential “loser’s curse” where a bidder might narrowly miss out on a spectrum block it might have been prepared to pay more for. With such a format, a bidder needs to study its own and competitors’ likely valuations as well as bidding intentions carefully to ensure successful participation and avoid embarrassing outcomes.

As we have seen in other European countries, which have announced forthcoming spectrum auctions (see our recent blog post on the Greek auction for example), the regulator is setting the reserve prices at a very high level in order to guarantee a high minimum revenue – in this case €2.5bn. If we compare the reserve prices set for the auction held in Germany in 2010 for example, it is striking that on a €/MHz/POP basis the French reserve prices have been set at 100x and 25x for the 800 MHz and 2.6 GHz bands respectively (although note the format used in Germany was multi-round). Although high reserve prices do discourage frivolous participation they also undoubtedly favour the bidders with deeper pockets and it could be argued that if the regulator really believed in market forces (since they are holding an auction) then they should set a low reserve and let the market decide.

Scott McKenzie, Director 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

Rising reserve prices in mobile spectrum auctions are a cause for concern for all

Ever since the Federal Communications Commission began auctioning spectrum rights in the mid 90s nearly all regulators around the world have relied on market mechanisms, such as auctions, to allocate and value spectrum. Regulators recognised that mobile operators themselves were best placed to value mobile spectrum and that the role of the regulator was to design an auction that encouraged operators to reveal their valuations and allocated spectrum to those that valued it most highly. Such an approach should yield a, close to, economically efficient use of spectrum which is a common objective for policy makers. Regulators would however set a reserve price which represented the minimum price they were prepared to accept for the spectrum. The conventional wisdom was to set a low but “non-trivial” reserve price in order to discourage “frivolous bidders”. During the 90s, the Dot Com era and in most recent auctions the actual prices paid have been determined after many rounds of competitive bidding and the final prices were higher than the reserves. However, there is a noticeable trend amongst regulators in auctions for new spectrum such as lots in the 2.6GHz and Digital Dividend frequency range as well as for existing spectrum such as 900MHz and 1800MHz to set a much higher level of reserves than in previous auctions. Specific examples of high reserves compared to historic levels and other auctions include the proposed auctions in Ireland and Switzerland as well as the current auctions in Spain. The trend towards higher reserve prices is a concern for all.

Regulators continue to rely on spectrum auctions to value and allocate spectrum and indeed in some countries, such as Germany, the use of auctions is written in law. However, their confidence in the effectiveness of auctions is being shaken by low levels of auction participation – especially in the case of renewal of existing spectrum

holdings. For spectrum auctions to generate economically efficient outcomes they rely upon competition amongst bidders. However, when the number of bidders matches or is less than the available spectrum such competition will be absent and the spectrum will be sold at the reserve. The absence of excess demand and competition is

increasingly likely as markets mature and potential new entrants recognise the typically higher valuations placed on spectrum by incumbents compared to Greenfield operations and may decide not to participate. This was exactly the experience of the Singaporean and Norwegian regulators in their auctions of existing 900MHz spectrum holdings in 2008 and 2004 respectively. As regulators may expect to only receive the reserve price the level of reserves is receiving a much higher level of attention.

Regulators may have amongst their objectives the goal of capturing for society part of the private value of a  natural scarce resource such as spectrum. With auction prices failing to reflect operators’ private values due to a lack of competition regulators are seeking to estimate the market value for themselves. A typical approach for regulators is to use benchmarks from previous auctions however benchmarking is generally a blunt instrument and the results are heavily influenced by whether the high 3G prices achieved during the Dot Com book are included. As a result regulators are considering developing their own bottom-up valuations to supplement any benchmarking evidence. Indeed at a recent workshop on spectrum valuation in Brussels the majority of the participants were regulators. The task of valuing spectrum is a role that regulators have historically accepted they are poorly placed to perform.

If spectrum is likely to be sold at reserve and regulators are seeking to estimate market values in order to set reserves then this should be a cause of concern for all. Spectrum valuation is a challenging exercise even for the operators who are best placed to conduct the activity. If reserve prices are set too high in error then the spectrum may be left unsold and this will lead to a significant loss of economic efficiency. High reserves may also deter participation in the auction which only serves to reinforce the lack of potential competition within the auction and in subsequent downstream markets. If spectrum prices are based on reserves and spectrum is allocated to the incumbents then the process effectively becomes an administered approach and could suffer from a lack of transparency.

Regulators should make every effort to encourage participation in an auction and if the auction is expected to be competitive they should set low but non-trivial reserves. However, if an auction is unlikely to be competitive then regulators should question the value of holding an auction at all and consider introducing other measures such as

Administered Incentive Pricing to ensure economic use of the spectrum. As with the use of AIP in markets like the UK and New Zealand, if spectrum is going to be priced based on an administered approach then the approach should be inclusive, transparent and involve those that understand the value of spectrum the best, the operators.

By Graham Friend, Managing Director Coleago Consulting

How to participate successfully in a spectrum auction

Surging mobile data growth and network congestion have created demand for additional spectrum. Governments seeking to reduce national borrowing are anxious to auction additional spectrum to raise revenue whilst also promoting access to broadband services. Mobile operators have little choice but to participate or potentially suffer a loss of competitive advantage.

The last time spectrum was at the top of the sector’s corporate agenda was 10 years ago when governments auctioned 3G spectrum. For most companies the experience and knowledge of the 3G auctions of 2001 has long since been forgotten and many companies must learn how to navigate a spectrum auction all over again. Based on our experience from over 40 spectrum awards we present the keys to successful spectrum auction participation.

Lobby, lobby, lobby: Operators should be proactive in lobbying for an auction design and associated rules, such as those relating to spectrum caps, which best serves their needs. Arguments should be presented in a language that regulators understand such as economic efficiency and promoting competition.

Valuation, valuation, valuation: Bidders must have a clear view on the value of the spectrum lots being auctioned – not only individually but also the value of any synergies arising from geographic combinations, combinations of blocks providing wider channels to benefit from technologies such as LTE or optimal combinations of low and high frequency spectrum which together offer both coverage and capacity benefits.

Clear auction objectives: Economists and auction designers assume that all mobile operators only seek to maximise shareholder value but such assumptions are seldom shared fully by boards. Auction objectives are often couched in terms of obtaining pre-defined blocks of spectrum as cheaply as possible or avoiding any adverse differentials in price for similar lots compared to other bidders. The bid team requires a clear and unambiguous statement from management as to its objectives in the auction.

Know your limits: Economists also assume that mobile operators have unlimited access to funds and are not budget constrained. Few, if any operators are in this luxurious position and management will wish to impose bid limits on the bid team. The bid team need clear guidance on bid limits and how they relate to auction objectives and interact with the valuations of spectrum lots and combinations of lots.

The devil is in the detail: Auction design has improved significantly in the last 10 years which should have made developing bidding strategy more straightforward. However, auction designers are being asked to achieve an ever broader range of auction objectives such as encouraging new market entry, increasing or maintaining competition, promoting investment in rural coverage and ensuring contiguous spectrum to promote efficiency. As a result the use of multi-stage auctions, 2^nd price rules, caps, eligibility rules and linkages to spectrum usage fees for existing spectrum holdings have made developing bidding strategy more challenging. Operators should pay close attention to the detailed auction rules especially if they do not have a pure shareholder maximisation objective and are budget constrained to ensure they have a robust bidding strategy.

Know thy enemy: In some auction formats there is scope for strategic bidding (not bidding “honestly” and “sincerely” based on your valuation) or no choice but to bid strategically (as is the case in some sequential and first price sealed bid auctions) and in such auctions estimating accurately the value of spectrum to your competitors and the their bid limits is as important as knowing your own valuation.

Practice, practice, practice: A bidding strategy is only as effective as its execution Auctions involve high stakes and can be highly pressurised occasions and bid teams need robust protocols and procedures, including disaster recovery, to ensure they can execute the bidding strategy effectively. With some auctions requiring the entry of large numbers of bids (such as the proxy stage of a combinatorial clock auction) or the constant adjustment of valuations to reflect synergies (such as in the case of regional auctions) the bid team is well advised to have developed and tested auction support tools to automate these processes prior to the live auction.

Be prepared to walk away: Successfully participating in an auction may involve walking away with nothing if prices rise above the company’s valuation. It is better to walk away and to have avoided destroying shareholder value than to pay a price above the value of the spectrum.

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.