Hutch – O2 Ireland acquisition approval: Hutch plays it well, the “Connected Continent” loses out

The conditions attached by the Competition Commission to the clearance of the acquisition of Telefónica Ireland by Hutchison 3G shows that the Commission is still desperate to maintain network based competition. H3G offered a package facilitating the market entry of two mobile virtual network operators (MVNOs), with an option for one MVNO to morph into a mobile network operator by subsequently purchasing spectrum from the merged entity. “H3G committed to sell up to 30% of the merged company’s network capacity to two MVNOs in Ireland at fixed payments. The capacity is measured in terms of bandwidth and the MVNO entrants will obtain a dedicated “pipe” from the merged entity’s network for voice and data traffic.”

H3G probably has the first MVNO customer lined up, or else the acquisition cannot go ahead. The likely candidate is UPC. UPC is one of the few telecoms providers in Ireland with a large enough customer base to be comfortable to take on the fixed cost associated with becoming an MVNO under these terms. With that, UPC would become a quad play company. This means that at retail level competition will remain vigorous while costs are taken out of the mobile industry. So far, so good.

However, it is highly unlikely that the MVNO would want to become an MNO with all the cost implications as well as the daunting prospect of participating in future spectrum auctions to stay competitive. Therefore, just like in Austria, Hutch played it well by making a spectrum divestment offer that is unlikely to be taken up. The Commission does not get it: In mature markets new network based market entry does not make sense. Consolidation is the name of the game for the European mobile industry.

MNOs are dominated by fixed costs. Because around 75% of their costs are fixed, profitability comes through scale. In contrast MVNOs are dominated by variable costs with the proportions of fixed to variable costs roughly reversed compared to an MNO. This means an MVNO is not operationally geared, has a lower risk of not achieving break even, and can operate profitably at a lower scale. Hence an MVNO can play in niche markets. The fixed cost deal offered by Hutch Ireland is clever from Hutch’s perspective because it offsets Hutch’s fixed costs with a fixed revenue stream, and is probably betting on a limited impact because only one player in Ireland is likely to have the ability to commit to a five year fixed cost deal.

The Commission missed an opportunity. In addition to the fixed cost MVNO condition, it could have requested a similar variable wholesale price undertaking as in the approval of Hutch’s acquisition of Orange Austria. A low wholesale price (€0.002 per Mbyte for data) not only serves as an insurance against unwarranted retail price rises, but creates the opportunity for players who are not MVNOs in the traditional sense. Innovative business models would use mobile access as part of a service, such as smart metering, automotive services, home security, M-Health, etc. and might even include handset manufacturers such as Apple or Samsung as well as OTT players. If innovators could find the same wholesale price and access conditions across the EU, we would be well on the way to overcoming the disadvantages associated with the fragmentation of the EU mobile industry and truly leverage the value of LTE mobile broadband.

By adopting a country by country approach to set conditions to clear consolidation among mobile network operators, the Competition Commission might address country specific competition concerns but does nothing to advance the “Connected Continent” agenda. Next up is the proposed acquisition of E-Plus by O2 Germany. Let’s hope for a better set of conditions which signals a harmonised, fast track merger approvals mechanism with the aim of advancing mobile industry consolidation in the EU for the benefit of consumers and investors.

 

By Stefan Zehle, CEO, Coleago Consulting

Telefonica O2 and e-Plus merger: a new 4th network operator makes little sense

Today the FT reported that in order to overcome objections to the proposed take-over of E-Plus “Telefónica has offered to equip a new German mobile competitor with spectrum”.  This is similar to the offer by Hutchinson 3 in the context of its take-over of Orange Austria. In the event there was of course no new network based entrant in Austria, the aim of the Telefonica O2 and E-Plus tie up is to take costs out of the industry by reducing the number of mobile network operators. At this stage of the industry life cycle consolidation at network level is expected. This is driven by high prices paid for spectrum and continuing high LTE capex while revenues remain flat or in decline. When free cash flow declines, capital has to be taken out of the industry simply to get back to returns that are not below the cost of capital.

The FT also reports that Telefónica promised concessions for MVNOs. Competition remedies at wholesale level in the form of a reference wholesale access price offer – similar to what was agreed to by Hutchison in Austria – are a much more effective remedy. This is particularly true for Germany which already has a vibrant MVNO market. Indeed E-Plus pioneered the multi-band MVNO strategy and hence concessions at wholesale level are likely to be impactful. Given the competitive MVNO market in Germany, regulating wholesale prices provides an effective insurance against retail price increases, which might otherwise result from the tie-up.

If indeed wholesale price regulation ends up as the key remedy, and this in Europe’s largest mobile market, we are one step closer to the structural separation of the European mobile industry into NetCos and ServiceCos.

Written by Stefan Zehle, CEO, Coleago Consulting

How the Telefonica Deutschland / E-Plus merger could play out

This week it was reported that the European Commission and the German telecom regulator (Bundesnetzagentur) are applying pressure to Telefonica regarding their planned takeover of KPN’s subsidiary E-Plus in Germany.

We think on balance the deal will get approved but both parties will need to make significant concessions to get it done. This will be especially the case with regard to spectrum holdings and as we saw in Austria commitments to support virtual operators and branded resellers (i.e. wholesale access). There is always a chance that the concessions are so onerous that they may effectively destroy the deal.

The combined entity will have approximately a 39% mobile customer and 32% mobile service revenue market share in Germany, so the European competition authorities (and the German telecom regulator) will no doubt review it very carefully. Revenue market share figures would of course look much lower if the fixed and mobile markets were combined and no doubt KPN/E-Plus and Telefonica Deutschland will be arguing for this. They have a point, given the recent €7.7bn deal by Vodafone to acquire Kabel Deutschland and the fact that Deutsche Telekom sells fixed and mobile services effectively under one brand.

Regarding spectrum, the combined entity will on the face of it have a whopping 64% of the 1800MHz and 54% of the paired 2100 MHz bands, so it is likely that regulators will require a sale or handback of some of the holdings in these core bands.  In the less scarce 2600MHz band, it holds 42% of the spectrum. A similar situation was seen in the UK with regard to 1800MHz spectrum when EE was created from the merger of Orange and T-Mobile. It is possible that the other German operators will lobby to have “excess” spectrum handed back rather than sold so that the merged entity does not benefit. Some of the excess spectrum is due to for renewal in 2016 and the merger will reduce competition for these frequencies.

By contrast, in the very scarce and more valuable sub 1 GHz bands, it holds 33% of the 800MHz and 29% of the 900MHz spectrum, so there should be less of an issue here.

Clearly the deal is going to require significant concessions.  It makes sense for the competition authorities to scrutinise these deals to ensure that monopolies are not arising and customers have enough market choice.  Yet at the same time, telecom operators need to generate acceptable returns in a fiercely competitive and mature market. A difficult balancing act for the competition authorities.

By Scott McKenzie, Director, Coleago Consulting and former supervisory board member of E-Plus

Consolidation in the European mobile industry is inevitable, but what path will it take?

It has been pointed out many times that the EU with around 100 mobile operators, serving a roughly similar size population as the USA, is hugely fragmented compared to the mobile industry in the USA. The historic reason is easy to understand, but the fight put up by Directorate-General for Competition of the European Commission to halt in-country consolidation is harder to understand.

In the model used to analyse the impact of mergers on retail prices, the Competition Directorate, assumes that retail prices will always go up as a result of a merger between two MNOs in the same country. It does not assume that the efficiencies brought about by a merger would, at least in part, be passed on to consumers in form of lower prices or better service in terms of coverage or access speeds.

Network sharing is encouraged under EU rules as long as it is limited to the Node B and RNC and excludes spectrum and the core. A great deal of cost sits in the RAN, and hence RAN sharing could be termed “merger lite”. With LTE, it is efficient to deploy the technology in as wide a band as possible. Hence significant additional savings could be brought about if spectrum is shared.  This reduces competition at network level, but also delivers consumer benefits in form of higher access speeds.

The transactions now awaiting approval by the Competition Directorate are the O2 and Eplus tie-up in Germany, Hutchison’s takeover of O2 in Ireland and, if the acquisition of SFR by Altice fails, then also the Bouygues – SFR take-over in France.  The conditions the European Commission attached to the Hutchison 3 take-over of Orange Austria may serve as an indicator as to the conditions that might be imposed to allow these deals to go ahead. Among other conditions, Hutchison Austria had to publish a wholesale access price reference offer for MVNOs. By regulating wholesale prices, the Commission in effect bought insurance against sharp increases in retail prices because it would allow MVNOs to undercut these.

The conditions imposed on Hutchison Austria may be a first step towards the structural separation of the mobile industry into Netcos and Retailcos. In a world where mobile network operators share much of their network and perhaps spectrum, these mobile operators start to look more like MVNOs on a shared network. Structural separation may not be a “horror scenario” for mobile operators if returns on invested capital can increase as a result.

Looking at what business mobile operators are actually in, it seems that they are to a large extent hire purchase phone vendors. Comparing SIM only postpaid tariffs with postpaid plans that include a “free” smartphone, it appears that the price for SIM only deals is 50% below plans with a bundled handset. Therefore roughly 50% of a mobile network operator’s business is not about running a network but about selling phones on credit. Other than marketing and selling phones and SIMs, customer care and billing are a big cost bucket attributable to the retail activity of an MNO.

Retail activities are scalable, i.e. can be done profitably at different volumes. In contrast the Netco activity is not scalable because costs are fixed. Netco returns are a function of network utilisation. By structurally separating retail and wholesale activities in exchange for being allowed to merge networks including spectrum, MNOs might see lower costs and as a result higher returns, all the while prices at retail level may not move or even decline.

Barriers to entry and exit in the Mobile Netco activity are extremely high. We are now in the maturity stage of the industry life cycle, and it is normal for consolidation to take place. Furthermore, regulators have hastened the need for consolidation because they took billions of Euros out of the industry through spectrum auctions. This had the effect of dramatically reducing returns to investors. And yet, the Directorate responsible for telecoms, DG Connect, ceaselessly points out the benefit to European industry of increased investment in mobile broadband networks. How can the policy objectives of DG Connect and DG Competition be delivered simultaneously?

From the industry perspective, if structural separation allows returns to increase despite increased competition at retail level, then structural separation might be the way forward. Competition might drive down margins in the retail activity, but this is not problematic because in contrast to the Netco activity reducing capital or even exiting the retail activity is possible.

The proposed consolidation in Germany is most interesting in this regard. Eplus pioneered a multi-brand wholesale and MVNO strategy precisely because E-Plus was sub-scale. As can be seen by leafing through some older KPN investor presentations (KPN E-Plus Seminar, Delivering profitable growth, Sep 2006), this resulted in lower subscriber acquisition costs and higher EBITDA. The strategy brought about a flourishing MVNO and reseller activity, thus increasing consumer choice. This means within Eplus the set-up exists to take the concept forward to full structural separation.

From the mobile industry perspective a further benefit of consolidation at network level would be that governments can no longer pit competing operators against each other in spectrum auctions, such as the forthcoming second digital dividend. High spectrum reserve prices would finally be seen for what they are: a tax on the mobile industry that ultimately has to be paid for by the consumer. Furthermore it may be better to be in a regulated industry with reasonable returns rather than in an industry with wafer thin returns, high investment needs and continued technology risk.

Written by Stefan Zehle, CEO Coleago Consulting

The Data Tsunami is coming to East Africa

Coleago Consulting discusses regional investment, spectrum and infrastructure strategies at the TMT Finance & Investment East Africa 2013 Conference

This is a really critical time for the East Africa region. Significant decisions about the framework for investment, particularly regulation and spectrum allocation for 3G and 4G, will have a fantastic impact on regional growth.

There are a number of important spectrum auctions coming up across the region and operators are looking at how best to use spectrum, infrastructure sharing, new technologies and business models, to meet the massive demand for data services. The industry is now entering a transformational stage with unparalleled fixed-line and mobile consolidation.

Despite significant growth and achievements achieved over the past decade, major new investment, innovation and infrastructure roll out is needed for the next phase of development.

Highlighting the changing telecoms landscape in East Africa, next week (November 26^th) sees the first TMT Finance & Investment East Africa 2013 Conference arrive in Nairobi.

In my first conference presentation of my new role here at Coleago, I will be making a keynote on “The Data Tsunami: Spectrum Allocation and Infrastructure Sharing” at the event, discussing the actions that regulators and operators are taking to cope with the global “data tsunami” that started building with 3G and is now accelerating with 4G. If you’re attending the event, or considering it, and would be interested in meeting, feel free to contact me – chris.buist@coleago.com

Written by Chris Buist, Director, Coleago Consulting

European commission proposal ignores the fundamentals: We need to create an environment that attracts capital into the EU telecoms sector

The European Commission’s adoption of regulatory proposals for a Connected Continent announced by Neelie Kroes on the 11^th of September 2013 are as polemic as can be expected from a politician. The headline grabbing proposal deflects from the failings of member states to adopt sensible policies with regards to developing the telecoms sector. In its opening paragraph the proposal declares that “The overarching aim is to build a connected, competitive continent and enabling sustainable digital jobs and industries; making life better by ensuring consumers can enjoy the digital devices and services they love; and making it easier for European businesses & entrepreneurs to create the jobs of the future.”

To achieve these objectives substantial investments are required. Only 12 days prior to the Commission’s proposal, on Thursday 05 September 2013, PwC published a detailed analysis which showed that mobile operators cannot make adequate returns on capital employed. For the past three years the return on invested capital (ROIC) made by Europe’s telcos was below the cost of capital of around 8%-9%. In the mobile sector this is in part due to the high spectrum licence fees charged by national governments.

And yet with statements such as “It is also essential that citizens … are protected from unfair charges and practices such as roaming rip-offs and opaque contracts” the Commission conjures up an image of ultra-profitable telecoms operators which fleece consumers.

What the European telecoms sector needs most is a climate with the regulatory certainty which is favourable to investment. Only investment in the sector will achieve the Commission’s aim – which we all agree with – of excellent fixed and mobile internet connectivity and communication without borders within the EU.

Furthermore, the Commission proposal contains contradictions. Vice President Neelie Kroes said “The aim is to gradually make the telecoms sector a “normal” economic sector with limited ‘ex ante’ rules and responsibility shifting to ex-post regulation” and then demands that “Operators will have to charge no more than a domestic long-distance call for all fixed line calls to other EU member states. Any extra costs have to be objectively justified.”  “Normal” economic sectors do not “objectively justify” prices based on cost but charge what the market will bear. The image of the Coca Cola bottle in the proposal is a fine example. The price per litre of Coca Cola varies hugely between a discount supermarket and a beach club on the Cote d’Azur. And yet, nobody suggests regulating prices for Coca Cola.

On the positive side, the proposal highlights member states’ regulatory failings and tardiness in allocating spectrum for LTE.  This, with a call for a European authorisation for telecoms operators – and by implication European telecoms regulation – is a very positive development. This is a prerequisite for the much needed consolidation in the EU telecoms sector which will then give investors a chance to earn adequate returns.

Written by Stefan Zehle, CEO of 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

Overcoming Objections to AT&T’s Acquisition of T-Mobile USA

AT&T’s announcement last week of a $4bn charge in respect of the $39bn take-over of T-Mobile USA indicates a high likelihood that the transaction will not go ahead. This is not necessarily good news for US consumers and shareholders.

Telecoms markets in developed countries are maturing and in some markets revenues are already declining. At this stage of the industry life cycle consolidation would be expected. If there is no further revenue growth the only way in which returns can be maintained without increasing prices is by taking costs out of a business. This is likely to have been the principal driver behind the proposed acquisition.

Much of the opposition to the merger is on grounds of the negative impact on competition at retail level. A solution could be for AT&T to acquire T-Mobile’s network assets but not the rest of its operation, effectively turning T-Mobile into an MVNO. After all, much of the passive infrastructure is probably already owned by tower companies who lease tower space to several mobile operators. Traditionally a very high proportion of a mobile operator’s assets were in the non-active infrastructure – it typically accounted for two thirds of the capital cost of a cell site. The next step would be to share the active RAN and even the whole network. If T-Mobile USA continues to operate as an MVNO this would not affect competition at retail level.

In persuading the US Department of Justice and the FCC to drop their objections to the deal, AT&T might consider introducing accounting separation between its mobile network operating business and its retail business. AT&T’s retail business would buy capacity from the network operating company at the same terms as T-Mobile USA.

The net effect may be positive for all stakeholders:

• One merged network will have lower operating costs than two networks, i.e. costs are taken out of the industry. This benefit is likely to be shared between consumers in the form of lower prices and shareholders.

• Although some spectrum may have to be divested, the merging of AT&T’s and T-Mobile’s spectrum assets would make it easier to refarm spectrum to LTE and deploy wide carriers earlier. This means existing spectrum will be used more efficiently in terms of bits per Hertz. With the growth of mobile broadband this yields an economic and societal benefit, as is well documented.

• There will be a number of further spectrum auctions. With one operator less bidding for spectrum, demand at auction is reduced and prices paid for spectrum are likely to be lower. This will benefit all players in the market.

Written by Stefan Zehle, CEO, 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

Theory versus practice in the global versus local operator debate

When the Financial Times reported in January that CEO Vittorio Colao was facing pressure from some shareholders to break-up the global operator it prompted other mobile groups to re-examine the global versus local debate. Some theories suggest that value should be generated by global scale but the reality is that many of the theoretical benefits are not achieved in reality. As is so often the case, realising the benefits of global scale is down to effective execution.

In theory, operators with international scale should achieve significant purchasing economies. In practice, some national operators have managed to get more advantageous equipment pricing and terms than their parent. As a result, some local operators have opted out of the group purchasing process altogether. In the case of securing content deals content owners, in theory, are attracted by distribution partners who can provide the widest distribution or eyeballs for their content. In practice the industry has not embraced exclusive content deals and those that did, such as 3 in the UK, rapidly rejected them. There is also probably little content that is truly global in its appeal and that customers are prepared to pay for. However, global players in general probably do have a stronger bargaining position with some suppliers, particularly equipment vendors.

International operators make great play of their ability to leverage learning and experience across their operations. In practise, cumbersome group structures often fail to disseminate the learning effectively and may actually stifle local innovation and slow down decision making. For large groups with a mix of developed and developing markets the learning from developed, increasingly data centric markets is of less relevance for voice centric developing markets. Indeed operators in Africa and other developing markets are sometimes confronted with re-charges for group services that are of little relevance or benefit. Indeed local operations should have a better understanding of their customers and competitors than those sitting centrally. Whilst the benefits of technological innovation can be replicated across markets the same is not necessarily true of propositions and tariff structures.

In theory, it should not be necessary to have a large international footprint to create attractive roaming offers (e.g. in the airline industry, the Star Alliance was an early example of how marketing benefits of sharing Airmiles’ eligibility could offset the smaller scale of individual airline operators). In practice however, Vodafone was the first to launch successful ‘passport’ type products in Europe. Of course, Vodafone customers travelling to the US are unable to use Verizon’s CDMA network and so a uniform technology footprint is a prerequisite for realising global roaming benefits. A “roam like home” proposition can be very compelling and is much easier to implement with a global footprint due to billing and accounting issues. The ability to steer roaming customers onto your own network can also deliver significant commercial benefits. In practice a global footprint may well attract higher spending business customers who roam although the benefits will diminish as roaming rates are regulated downwards.

In maturing markets consolidation can often be expected as economies of scale are much easier to achieve at the local rather than global level. Prior to consolidation taking place profits and cash flow can come under significant pressure due to high levels of competition. To act as consolidator an operator will need access to cash to either make acquisitions or to ride out the storm. A global parent with a strong balance sheet can provide a major advantage in mature markets. However the sheer size of a global parent may mean that opportunities in smaller, local markets are missed if the benefits of a consolidation play represent only a rounding error in the parent’s consolidated accounts. Smaller markets may find themselves a long way down the parent’s priority list.

Global players in theory can also benefit from portfolio effects where the “cash cows” in the mature markets can finance the growth of “problem children” and maintain “stars” elsewhere in the portfolio. In theory, capital markets should be able to provide this funding, but, as recent events have shown, capital markets are often far from perfect. The strategic implications of the Boston Consulting Group Matrix for business unit portfolio management may hold true to some extent. However, operators are often reluctant or slow to ruthlessly dispose of underperforming “dogs” which weakens the benefits of a portfolio approach adopted by global players.

A global brand, in theory, should be stronger than a local one when it comes to technology based services. In practice, T-Mobile was less successful in achieving global brand equity compared to say, for example, Vodafone. However, in some markets customers have a great deal of loyalty to local brands. When Vodafone re-branded J-Phone in Japan the customer base deserted in droves. A global player can gain very significant brand synergies through successful sponsorship campaigns such as F1 motor racing or the world cup. When executed successfully a global brand can deliver global brand synergies.

In short, it all comes down to execution. Global scale is not in itself a guarantor of net synergies, however if well managed, a global company can extract significant strategic benefits. With the increasing complexity of the technological landscape in particular, having leverage with equipment and device manufacturers is key to ensuring they get what they need. Smaller operators are more likely to simply get what they are given.