Demand moderation in German spectrum auction

As predicted by Coleago, the three bidders Telefónica, Deutsche Telekom, and Vodafone from the start limited their bids in the 700MHz band to two blocks each, so that after 34 rounds at the end of day 3 the standing highest bids are still at the reserve price. Bids for the 900MHz blocks have also not increased since round 29. There is still activity on the 1800MHz blocks with the three bidders compete for 10 blocks. In round 34, Vodafone was the standing highest bidder on 5 of the 10 blocks. The 1800MHz band is important because in accommodates GSM and LTE traffic. The 1500MHz is only contested between Deutsche Telekom and Vodafone and prices are ticking up slowly. The auction is likely to end next week with auction receipts in the €2 to €2.5 billion range. This would be low compared to recent prices paid and is consistent with the German policy objective of not maximising auction receipts. The key policy objectives are to a) deliver wide area mobile broadband coverage, b) provide incumbent operators with planning certainty and c) maintain network based competition.

Bidders in spectrum auction attach a high value to 1800MHz spectrum

The multi-band combinatorial spectrum auction (CCA) in Austria ended on the 21^st of October, with bidders paying €2,014 million for 2x30MHz of 800MHz, 2x35MHz of 900MHz and 2x75MHz of 1800MHz spectrum. The 800MHz spectrum was new spectrum whereas the two other bands were renewals. The only bidders were the three incumbent operators Austria Telekom, T-Mobile, Hutchison.

The overall price paid for sub-1GHz spectrum and the 1800MHz spectrum amounted to €0.85/MHz/pop. This is only slightly less than the implied price for the sub-1GHz spectrum of €0.96/MHz/pop.

The price for sub-1 GHz spectrum is roughly in line with prices paid for 800MHz spectrum in recent European auctions.  The price paid for 800MHz spectrum in Germany was €0.73/MHz/pop (May 2010) and the average in Europe during 2010 to 2013 was €0.52/MHz/pop. So the price paid in Austria for 800MHz spectrum is relatively high. Benchmark prices paid to renew 900MHz spectrum are in the €0.19-0.53 range whereas the implied price paid in Austria amounts to €0.96/MHz/pop.

Exhibit 1: Austrian Spectrum Auction Results

 

However, since the overall price per MHz per pop paid is only slightly lower than the implied price for sub-1GHz spectrum, this means that operators valued the 1800Mhz spectrum very highly at €0.76/MHz pop.  This is significantly above prices paid for 1800MHz spectrum in recent auctions, and certainly massively more than prices paid for 2.6GHz spectrum. Benchmark prices paid to renew 1800MHz spectrum are in the €0.10 – 0.21 range.  In this context the comments by Telekom Austria’s CEO Hannes Ametsreiter, referring to a “bitter pill to swallow,” are quite appropriate.

The auction outcome highlights that in the context of the rapid growth of data traffic, spectrum is becoming an ever more valuable resource. The re-farming of 1800MHz from GSM to LTE requires more spectrum in the short term because spectrum resources cannot be used efficiently. In that sense governments can hold a gun to operators’ heads and demand almost any price.

1800MHz spectrum is the spectrum of choice for LTE in Europe. Most operators have built a grid based on 1800MHz and hence the 1800MHz band provides both an LTE capacity and an LTE coverage layer. In contrast 2.6GHz is “only” a capacity band. I placed quotation marks around the word “only” because LTE capacity is of course very important in urban areas and here cell sizes are quite small. Nevertheless, the in-building propagation characteristics of 1800MHz spectrum are significantly better than for 2.6GHz spectrum and in-building capacity matters for mobile broadband.

The auction outcome, with A1 Telekom (Telekom Austria) acquiring 2/3^rds of the 800MHz band means that the company now holds 53.8% of sub-1 GHz spectrum compared to a subscriber market share of around 39%. As the operator with the weakest cash flow it is likely that Hutchison faced budget constraints. The result is that the market leader managed has managed to acquire a disproportionate share of spectrum.

The design of the Austrian auction and the absence of effective caps on sub 1GHz spectrum holdings suggest that the Austrian government is not particularly concerned about the effects of spectrum concentration on competition. On the other hand, the spectrum divesture conditions imposed on Hutchison (European Commission, DG Competition, CASE M.6497) to clear its acquisition of One Austria, suggests a very different view of spectrum concentration is applied when it comes to approving in-market consolidation.  The only saving grace for Hutchison is that there was no new entrant and so the requirement to divest 2x10MHz the 2.6GHz frequency band lapses; however the MVNO access requirement remains.

While Hutchison managed to increase its sub-1 GHz spectrum holding from 1.6MHz to 2x5MHz, the cost per eNodeB of deploying LTE is 2x5MHz is roughly the same as for Telekom Austria deploying LTE in 2x15MHz in the same band. Furthermore, there are already many smartphones with 800MHz LTE, where Telekom Austria acquired 2x20MHz, but as yet, none with 900MHz LTE.

In the light of this the comments by Trionow, CEO of H3G, describing the auction as a “disaster for the industry” are understandable. Certainly it is a disaster for Hutchison and for a competitive mobile broadband market in Austria.

 

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

The new iPad illustrates the importance of mobile broadband spectrum and the device eco-system

The New iPad was launched early March 2012 in many markets world-wide. It appears to be a highly desirable device.  Among its many features Apple touts 4G connectivity. However, a closer look reveals that only the American region 4G bands, namely 700MHz and 2100MHz have been included in the radio chip set.  Of course the device also includes 3G connectivity and here it is compatible with European 3G/HSPA in the 2100MHz band and also in the 900MHz band.

It is likely that  Apple will launch a European iPad version with LTE at 800MHz and 2.6GHz, but in the meantime there is a problem. In Europe, not many operators have refarmed the 900MHz spectrum to 3G HSPA and some operators do not hold any 900MHz spectrum.  This means in Europe mobile broadband access for the iPad is restricted to more densely populated areas where 3G is available in the 2.1GHz band.

This gives T-Mobile and Vodafone in Germany a marketing advantage. The most ardent iPad fans are probably also high voice spenders and can be locked in with a 24 months contract. Even if a European device becomes available in 6 or 12 months, in the meantime O2 and E-Plus are disadvantaged.  For O2 this is all the more annoying because they spend €1.15 billion to acquire 800MHz spectrum in May 2010.  Of course E-Plus who does not have any 800MHz spectrum will remain disadvantaged for the foreseeable future.This matters, because the new iPad is a desirable device and customers making device choices will also have to make mobile operator choices.  Take Germany as an example.  Vodafone, T-Mobile and O2 each purchased 2x10MHz of the digital dividend 800MHz spectrum in the May 2012 auction and deployed LTE and, under the terms of the licence, rolled out the network first in rural areas.  Vodafone and T-Mobile hold 2×12.5MHz of 900MHz spectrum whereas E-Plus and O2 only hold 2x5MHz.  This means Vodafone and T-Mobile are in a position to refarm 2×5 MHz of the 900MHz spectrum to WCDMA whereas the two other operators will find it near impossible.

The lesson here is that spectrum matters, as device manufacturers have to make chipset choice.  The multiplication of bands and technologies introduces technology barriers to competition and switching. This is a very different situation compared to the relatively harmonised GSM world of the past.

From an operator’s perspective, spectrum diversity provides the best device eco-system insurance. However, in Europe where only 2x30MHz of 800MHz spectrum is available, markets with more than three network operators are facing a problem if regulators are keen on packaging the spectrum in a minimum block size of 2×10 MHz.  There are of course benefits of deploying LTE in a channel wider than 10MHz, but the benefits are overstated. Spectral efficiency in terms of bits per MHz only increases marginally when moving for 5 to 10 or even 20 MHz wide channels.  While headline speeds are higher, the user experience is governed by other factors such as the number of concurrent users in a cell, distance to the cell edge, or the position within a building. In contrast the negative impact on competition resulting from different spectrum allocations, particularly in the lower band is very real.

One disturbing aspect about the European iPad launch is that even in Europe, Apple highlights the 4G capability, yet it is not compatible with the European 4G bands. Could Apple not have waited a couple more months and introduced also a European version with LTE 800, LTE 2600 and possible also LTE1800? Of course there is a little asterisk and a footnote “4G coverage is not available in all areas and varies by carrier”. Not all areas? That’s putting it mildly. Not anywhere in Europe would be a more appropriate statement.  Some disappointed buyers will take a dim view of Apple’s marketing tactics.

Written by Stefan Zehle, CEO, Coleago Consulting

Spectrum sparks interest of mass media

With many countries worldwide moving from analogue terrestrial TV to digital terrestrial TV, the conversation has turned to what the defunct spectrum from the analogue terrestrial TV will be used for. TV is of course the mass media par excellence and hence the mass media are starting to speak about spectrum related issues, notably the digital dividend spectrum (700-800MHz) and mobile broadband.

Whilst this is something the industry has been working on for a number of years, it is now becoming of interest at a consumer level as individuals want to know how the digital switchover may affect the mobile services they receive. We spoke with the BBC Click team last week. To see their take on the digital switchover and spectrum please click here. This interest at consumer level is an excellent opportunity for mobile operators, device manufacturers, cloud service providers, software firms and other industry players to position themselves in the public imagination.

Written by Stefan Zehle, CEO, Coleago Consulting

Google to buy Motorola

Today’s announcement that Google is to buy Motorola Mobility is an interesting development in the Smartphone operating system fight for market share. Earlier this year we had the announcement of the alliance between Nokia and Microsoft. Will the next step be the acquisition of Nokia by Microsoft? This is no longer a fanciful idea.

Stefan Zehle, CEO Coleago Consulting

The World will eventually go Dutch

According to a recent report from Telecompaper.com, MVNO subscribers represent almost one third of the Netherlands’ mobile market. This is clear proof that multi-branding and mobile wholesale are a good antidote to a saturated competitive market. By comparison, we estimate that even in other advanced European markets such as Germany and the UK, the percentage is probably less than 20 %, so the Netherlands is a world leader at trying out new mobile business models with some 56 MVNOs operating in a country of 17m people. The main segments targeted are the Youth, Low Cost and Immigrant segments and the incumbent KPN has traditionally been a strong proponent of wholesale business models. The idea that a big mobile operator can target an entire country with one single monolithic brand has never made sense to Coleago and the operators in the Dutch market including KPN, Vodafone, T-Mobile are living proof that a wholesale strategy can drive market development even in difficult times.

By Scott McKenzie, Director Coleago Consulting

The $8.5 bn paid by Microsoft for Skype may not be silly money

The $8.5 bn paid by Microsoft for Skype may seem extravagant when looking at Skype as a stand-alone business. However, as anyone involved in valuing M&A deals knows, what matters is the value to the acquirer of the combined business.  Microsoft has a market capitalisation of around $ 211 bn. Microsoft’s business planners will have carefully analysed the deal. A small tweak in one of the drivers of future cash flow will result in a substantial swing in the valuation of Microsoft and the deal could easily be justified on this basis. What immediately springs to mind is the potential of deep integration of Skype with Windows Mobile, potentially lifting Microsoft’s market share in the smart phone operating systems market from its current low level.  Microsoft’s recent tie-up with Nokia provides further leverage in this context. While in the PC operating system market, Microsoft’s dominance lead to regulation limiting bundling (e.g. the EU regulation concerning the bundling of MS Internet Explorer with the operating system), given Microsoft’s small market share no such limitation exists in the mobile operating system market. There is huge scope to integrate Skype in simpler phones aimed at highly price sensitive emerging markets where saving pennies on domestic and international calls matters a lot. Mobile operators are probably watching the acquisition with some trepidation.

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.

Hong Kong 850MHz spectrum auction prices reflect the advantages of in-building coverage of low frequency spectrum

By Graham Friend

The Hong Kong auction of spectrum in the 850MHz band concluded today with
operators Hutchison and SmarTone securing 10MHz each of paired spectrum for $250
million. The auction, which concluded after 4 days and 41 rounds, saw the winners
outbid China Mobile Hong Kong, CSL and PCCW as well as local fibre network
operator Hong Kong Broadband Network. The 15 year licence includes a 50%
coverage requirement and will allow the winners to deploy 4G technologies such as
LTE in the band.

The price paid generates a benchmark of US$/MHz/Pop 1.78 (the standard measure
for spectrum valuation.) There are relatively few recent benchmarks for sub 1GHz with
which to compare, however two of the most relevant recent examples are Germany
and the USA. The average in Germany was US$/MHz/Pop 0.92 and in the US the
figure was 1.18. The winning bids in Hong Kong look expensive when compared to
Germany however Germany’s auction included reverse roll-out requirements requiring
the operators to cover rural (and therefore less commercially viable regions) first which
would have depressed the price and weakens the value of Germany as a benchmark.
Hong Kong also looks expensive when compared to the US average but Hong Kong is
one of the most densely populated countries in the world. With a population of 7 million
people and a population density of 6,571 people per square kilometre Hong Kong
ranks as the third most densely populated country in the world and sits 165 places
above the US in the world rankings. Many parts of the country are also characterised
by tightly packed sky scrapers providing a topography which can be described as
super dense urban. It is the topography that gives some clue to the value attached to
the spectrum. Sub 1 GHz spectrum has superior in-building coverage characteristics
and in the case of Hong Kong this will have contributed significantly to spectrum
values. Indeed, SmarTone, commenting on the auction result said “at the 850 MHz
frequency band, the lowest frequencies available to mobile operators in Hong Kong,
SmarTone-Vodafone will be able to provide even better in-building radio coverage to its
customers.” Whilst determining the level of in-building coverage from a radio planning
perspective is relatively straightforward and objective, determining the marketing
advantage and how this translates into spectrum value is highly subjective.

Few countries have the same topography as Hong Kong and so those contemplating a
future auction for sub 1 GHz spectrum will be able to draw little insight from the auction
results. If Germany provides a lower boundary of 0.92 and the top 20 cities of the US
(with greater population density) provide an upper boundary of say 4.17 this represents
a wide range of potential outcomes. The Hong Kong benchmark of US$/MHz/Pop 1.78
does not appear completely out of line with the limited benchmarks that already exist
but the prices paid will reflect a much higher degree of subjectivity over valuation and
further variation can be expected when in-building coverage is sighted as a key driver
for spectrum values.