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

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

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

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

UK to open extra mobile spectrum

The UK used to be at the forefront of mobile communications deployment. The announcement by Chancellor George Osborne that 2.6 GHz spectrum and digital dividend spectrum will be auctioned in 2011 or 2012, now puts the UK well behind Scandinavia, Germany, Austria and other European countries in terms of mobile technology deployment. UK mobile users will have to wait for LTE for another 2 years whereas commercial services are already in operation elsewhere.

However, from the operators’ perspective this is not bad news. Capital expenditure for the acquisition of spectrum at auction and the subsequent deployment is also delayed. It is likely that mobile broadband demand will remain strong and existing capacity would not be sufficient. Operators may be able to increase mobile broadband prices which would help to improve not only UK mobile industry EBITDA margins – which are among the lowest in Europe – but also increase free cash flow. This should delight shareholders.

As regards auction design, the fact that the announcement was made by the Chancellor who is primarily concerned with raising revenue for the government, must be worrying for operators. It is likely that the auction will be designed to maximise revenue.

Turkcell launches German MVNO

News that the number one Turkish mobile operator Turkcell (home market share 56%) is launching an MVNO on Deutsche Telekom’s mobile network in Germany is not entirely a surprise given its desire to expand outside Turkey and the success that Dutch operator KPN had with its wholly owned Turkish proposition Ay Yildiz in both the German and Belgian markets over the past five years. No figures are available but it is rumoured that the A Yildiz subsidiary of KPN’s German operation E-Plus numbers circa seven hundred thousand mobile customers (>20% market share) in the 3.5m strong Turkish community in Germany. E-Plus’s real market share amongst the German Turks is therefore a lot higher as this does not include other brands that it markets (E-Plus, BASE, SIMYO, Ortel etc.). Turkcell may also have felt compelled to act given the competition it is seeing from Vodafone which entered the Turkish market via the acquisition of Telsim in 2005 (and now has a 25% market share) and which has started offering roaming deals between Germany and Turkey. The question is whether they can successfully market and distribute the right product for the Turkish German community given the headstart that E-Plus/Ay Yildiz enjoys in the crowded segment.

German Spectrum Auctions Results

The mobile telecoms spectrum auction in Germany ended on the 20th of May 2010. On offer were a total of 358.8 MHz of paired and unpaired spectrum in the 800 MHz, 1.8 GHz, 2 GHz, 2.6 GHz bands. The auction was a combinatorial simultaneous multi-round auction. That is to say all blocks were auctioned simultaneously and bidders could place a single bid for packages of spectrum blocks rather than bidding individually on separate blocks. The overall result was an average price of US$ 0.19 (€0.15) per MHz per head of German population ($/MHz/pop is the most common measure of price for spectrum). However, there were significant variations in price across the different bands but overall the prices are reasonable.

The key determinant driving these reasonable spectrum prices were firstly the frequency bands that were available and second the number of bidders. For example, the high prices paid in the Indian 3G auction, which closed only 1 day earlier on the 19th of May, where bidders paid up to US$4/MHz/pop, are mainly a reflection of the fact that there were many more bidders than available spectrum and only 3 out of 7 or 8 bidders ended up with spectrum. The number of bidders vs. available spectrum also resulted in the high prices paid in the auctions in the USA in 2007 and in Canada in 2008. It’s down to economics class 101, supply and demand.

All eyes were on the “digital dividend” 800 MHz band. The propagation characteristics of this sub 1 GHz band produce wider geographic coverage outside urban areas and better in-building penetration is dense urban areas. Prices paid for the 800 MHz spectrum were relatively low, amounting to an average of US$ 0.91 / €0.73 per MHz per head of German population. By comparison prices in the US 700 MHz auction in the top 20 areas, namely cities, reached $4.17/MHz/pop. The US average at the time was US$ 1.18, which is only 30% higher than prices paid in Germany. However, the US has a much lower population density than Germany, and generally the higher the population density the higher the prices paid.

The reasonable prices paid for the 800MHz spectrum in the German auction are due to three factors:

• Only the four incumbent operators (Vodafone, Deutsche Telekom, Telefonica O2, E-Plus) bid for the spectrum, there were no new entrants.
• The unusual aspect of the German auction was that the 800MHz spectrum band had been designated to provide mobile broadband coverage in rural areas. Operators must first build coverage for 90% of the population in villages with a population of not more than 5,000 inhabitants, in phase 2 towns from 5,000 to 20,000, in phase 3 towns 20,000 to 50,000 and only in phase 4 can the spectrum be deployed in larger cities. Mobile operators usually roll-out networks first where there is the greatest density of population in order to maximise the return on their investment – i.e. in urban areas. The value of the spectrum to an operator will be lower if they have to invest in what they would normally regard as marginal or even uneconomic areas first.
• Vodafone and Deutsche Telekom were restricted to a maximum of 20 MHz each out of 60 MHz on offer. This meant the fight over the remaining 20 MHz was between Telefonica O2 and E-Plus. In the event Telefonica O2 placed a higher value on the spectrum and outbid E-Plus, obtaining 20 MHz and E-Plus had to content itself with spectrum in the 1.8, 2.0, and 2.6 GHz bands.

Prices paid for the higher bands were only a fraction of the 800 MHz band. Since E-Plus did not buy any 800 spectrum, the operator ended up paying only US$ 0.06/MHz/pop (€0.05/MHz/pop) compared to the three others paying an average of US$ 0.22/MHz/pop (€0.17/MHz/pop). Yet E-Plus gained two 10 MHz blocks in the 2.0 GHz band which was the next most valuable band.

Prices paid for the 2.6 GHz band with an average of US$0.03/MHz/pop (€0.02/MHz/pop) were low, but in line or even slightly above other recent 2.6 GHz auction in Europe, some of which only achieved the reserve price of less than $0.01/GHz/pop. The 2.6 GHz band is the primary band for the deployment of LTE (4G) and is ideal to provide capacity for mobile broadband in densely populated areas. The coverage roll-out conditions do not apply to the 2.6 GHz band and Germany has many cities with high concentrations of populations which makes this spectrum potentially more valuable in Germany than in many other countries.

Making sense of recent European spectrum auctions

Regulators across Europe are busy this year auctioning spectrum in the 2.6GHz spectrum frequency range as well as other frequencies including the 800MHz Digital Dividend. 800MHz spectrum is clearly of great value to operators as the equivalent US auction demonstrated. The low frequency allows the radio signal to propagate further which means that fewer base stations and hence capital expenditure is required to provide coverage compared to higher frequencies such as 2.6GHz. This makes the spectrum ideal for supporting mobile broadband services at manageable levels of cost. The lower frequency range also provides better in-building penetration and as mobile broadband usage seems to be predominantly in-doors, this further increases its attractiveness. The first significant auction of spectrum in the 800MHz band is currently taking place in Germany and bidding levels have already reached 0.67 $/MHz/Pop. At this level the price paid is greater than the prices paid in the heady days of the Dot Com book for 3G spectrum in Denmark and Austria but it is still considerably lower than the US 700MHz auction average of 1.18 $/MHz/Pop. If German prices reached this level it would also put them on a par with the auctions of 3G spectrum in the Netherlands and Italy at the start of the new millennium. Prices would then have to increase by more than three fold to reach the German 3G auction price levels. Prices may well continue to move higher but with few other benchmarks available it is too early to draw any significant conclusions regarding this spectrum band but at present the bidding levels look reasonable.

In contrast to 800MHz there has been much greater activity in relation to 2.6GHz spectrum. Norway, Finland and Sweden auctioned their spectrum in 2007, 2008 and 2009 respectively. This year the Netherlands and Denmark have already concluded their 2.6GHz auctions, the auction in Germany is on-going and at least a further six 2.6GHz auctions are expected at some point during 2010 (France, Spain, Poland, Portugal, Switzerland and Belgium are all expected to hold auctions this year). Mobile operators will be busy preparing their 2.6GHz business cases in preparation for the auctions and in doing so they will be attempting to make sense of the results of the spectrum auctions that have already taken place. This is no easy task when the highest price paid so far in Europe (Sweden, May 2008) is almost 135 times greater than the lowest (the Netherlands, April 2010). Analysis is further complicated by the fact that in most auctions the paired spectrum (FDD) has commanded a premium to un-paired (TDD) spectrum which in some cases attracted no bids at all (Netherlands). However, in the case of Finland the result was reversed with the TDD spectrum priced at a premium to FDD.

Attempting to make sense of these results requires the consideration of a great many factors. The timing of the auctions is important as some occurred before the start of the on-going financial crisis. The licence conditions attached to the spectrum, such as coverage requirement, should also be considered. These vary from regulator to regulator and the more onerous the coverage requirements, for example, the less valuable the spectrum. However, in the end, the final price paid in an efficient auction will determined by relative levels of spectrum supply and demand. The regulators have taken different approaches when it comes to supply and have auctioned blocks ranging from 2x5MHz to 2x20MHz and everything in between. Caps on total spectrum holdings have also been imposed in some cases. The fewer unique blocks that are offered the greater is the potential for demand to outstrip supply. On the demand side the most significant factor is the number of incumbent operators and in Europe this varies from 2 in Norway to 4 in markets like Denmark and Sweden. There has also been demand from new entrants usually arising from the existing cable operators such was the case in the Netherlands. In addition to the number of potential bidders demand will also be influenced by operators’ expectations of future mobile data traffic. Mobile data traffic is growing exponentially and no one has a clear view of where demand levels will be in 15 or 20 years time which is the typical term for the new spectrum licences. Not only must operators contend with uncertainty over traffic levels there also remains uncertainty over what levels of data throughput can actually be achieved when technologies such as LTE and MIMO are implemented in this frequency range and have matured. On the issue of TDD versus FDD it would seem that there is a reasonably clear trend that the FDD spectrum is more valuable than the TDD spectrum however this is not always the case and the relative valuations can vary significantly.

Despite a reasonable number of 2.6GHz auctions having taken place it is almost impossible to draw any firm conclusions especially as the design of each auction is also subtly different which can have a major impact on participant’s bidding strategies and ultimately the price paid. As a result, for any operator facing a 2.6GHz auction little conclusive insight can be drawn from the results of the 2.6GHz spectrum auctions to date. Therefore in order to prepare for an auction a country, operator and auction specific business case will be required to value the spectrum and to allow the operator to bid with confidence.