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

The risks with Google Wallet

Interest in the industry regarding NFC and mobile payments is continuing to grow following the joint venture by Orange, Vodafone, O2 and T-Mobile, with the Google Wallet emerging as the latest major breakthrough. It will aide NFC to continue to take off (albeit slowly at first) and it is our expectation that we will see NFC technology be built into a growing number of new mobiles, including the iPhone 5. But uptake will still be slow over the next 18 months to two years. However, NFC chip makers are forecasting that 40 to 50 million NFC-enabled phones will be in circulation by the end of 2011, so early adopters are likely to be investing in a new handset pretty soon.

Making money out of mobile payments was one of the drivers that drove the share prices of telecoms companies to stratospheric levels during the Dot Com boom. Ten years on and the Google Wallet is the only real  progress that has been made in relation to m-payments outside of some mobile banking applications for developing markets and the UK operator joint venture earlier this year, of which we’re still waiting to see the results. One of the reasons for the lack of progress is that m-payment is a classic example of network economics. The more customers and the more sellers who adopt an m-payment platform, the more valuable that platform becomes. The GSM mobile standard was a perfect example of network effects in action and the lack of global or even national coordination for an m-payment standard is a contributing factor to the lack of success to date.

Google seeking to establish a dominant standard is a risky business. If it gets it right, like Microsoft, it can look forward to significant returns. If it gets it wrong, like Betamax video and more recently HD DVD, it can expect some difficult questions from shareholders. A number of players in the last 10 years have sought to establish a payment standard but none have been successful and their attempts have been somewhat half hearted.

Written by Graham Friend, Managing 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

The Network Sharing Conundrum

By Sharad Sharma, Senior Consultant, Coleago Consulting Ltd

Network sharing is gaining momentum

Mobile operators worldwide are struggling to increase the ARPU where voice, the main source of revenue source is commoditised and the data is yet to carve its way to be a high revenue generator. However, in order to maintain the technological leadership in the market, high investments are still needed in the networks whether it is a developed economy or a developing economy. The operators are facing a big challenge to justify the investments in the network. As a result operators look to identify cost cutting opportunities. Some of the costs saving initiatives are easy to tackle but the others like network sharing and network outsourcing involve business transformation of high degree.

Network sharing as a cost saving initiative has been gaining momentum in the different countries but also to improve performance. Tower sharing and national roaming has been around for quite a while now with operators across the globe are sharing towers for speedy network deployment. Originally Network Sharing was looked at in the light of revenue generation for incumbents and a more favourable to greenfield operators, helping the latter to increase roll out coverage faster. However, today network sharing is viewed from the angle of cost reduction.

Forming separate entities to pool tower assets or an entity to manage a consolidated network in the case of RAN sharing are of interests to many operators. However, there may be trouble ahead if such agreements are not thought through correctly: A cookie will always taste different when two different people make it even if it is the same recipe. These initiatives are now a trend and the decision to implement is taken without a detailed assessment of the opportunity. It is very important to assess the market dynamics and company’s own capability before actually going ahead with the network sharing. Many questions need to be answered before making a decision as to the network sharing model, the partner, the scope and the structure of the agreement. Two of the major questions that arise are the risk of losing the network related competitive advantage and the risk of degraded quality.

Network as a competitive advantage

The increasing number of smart phones is making the customers now much more aware of network quality / capacity / congestion as variations in service quality for data services are much more apparent and much more frustrating. Operators have pursued different strategies in terms of network investment for data capacity and as a result there are greater variations in network performance and customers are more aware of the differences. As a result network once again has become a source of competitive advantage. This may well lead operators to turn away from network sharing deals as they would not want to neutralise their advantageous position.

But are these strategies giving an operator a sustainable competitive advantage or is it just a short lived like any other voice quality improvement that the customers forget after all operators achieved equality. On the other hand, is it possible to gain this competitive advantage by a cost saving initiative like network sharing? The answer depends on the case.

For example, in the UK, most operators in UK claim 99 per cent geographical coverage. Now boasting of superior network quality with a combined network can be seen in the advertising campaigns. The operators like ‘3’ and T-mobile after implementing RAN sharing are claiming a better network coverage and quality while T-Mobile now ringing bells of combined Orange and T-Mobile network. Vodafone and O2 in turn moved into a tower sharing model. However, in developing countries where the networks are less mature, the implications are different because geographic coverage roll-out continues to be an issue.

Network capacity and congestion

An issue with network sharing arises in the context of capacity upgrades. Particularly in respect to mobile broadband the challenge is forecasting the capacity requirements not the network sharing or technology. If the forecasting is smartly managed for both the radio access and transmission backhaul, capacity issues could be overcome easily. However it does raise issues with regards to sharing sensitive commercial information between competitors.

Should we share now or wait?

When competition is based largely on price, the competitive advantage resides with the lowest cost operator. The lowest cost operator is probably an operator with a network sharing deal in place. An operator who currently enjoys a leading market share position and therefore decides to delay sharing may well find that when their advantage is neutralised, there are no network sharing deals to be done as all competing operators have entered into agreements. In the long run this market leader may well suffer because he no longer has the lowest cost operation and therefore would be unable to compete on price. Resolving the conundrum requires careful consideration and a valuation of the relative benefits of network superiority versus cost sharing. As with any strategic decision, timing is everything.

Austrian 2.6GHz spectrum auction results show some consistency with previous auctions but the picture is still confusing

The Austrian regulator RTR concluded the auction of 140MHz of paired spectrum and 50MHz of unpaired spectrum raising proceeds of €39.5 million from the four incumbent operators Telkom, Hutchison, T-Mobile and Orange. The benchmark for the paired spectrum of approximately €0.04 is at a similar level to the results from the German auction which also saw the 4 incumbents secure spectrum but 4 times lower than the Danish auction, another market with 4 existing operators. Whilst relative levels of spectrum supply relative to operator demand is often a significant determinant of spectrum prices achieved at auction it is clearly not the full story.

Austria has one of the most competitive and developed mobile broadband markets in Europe and the need for capacity should have pushed prices higher. However, unusually the RTR attached roll-out requirements to the 2.6GHz band requiring 25% of the population to be provided with coverage with a downlink of 1 MBit/s and 256 KBit/s on the uplink by no later than December 2013. This represents an onerous requirement for operators as it will require them to deploy LTE sooner than perhaps they might have preferred. The coverage requirements will have depressed auction prices. Attaching coverage requirements to the 2.6GHz spectrum is unusual as coverage is usually addressed through lower frequency spectrum bands such as 900MHz and 800MHz as the propagation characteristics of the lower bands are more suited to providing coverage. The mix of strong demand and onerous roll-out conditions mean that the auction results provide little additional insight for regulators and operators who have yet to auction the spectrum.

The relative prices for paired and unpaired spectrum also remains confusing as Hutchison paid less in total for its paired and unpaired spectrum (a total of 65MHz) compared to T-Mobile which only acquired 40MHz of paired spectrum. This outcome is however more likely to be due to the algorithm (effectively a second price rule) used by the regulator to determine the final prices.
The use of second price rules, where the highest bidder wins but only has to pay the amount of the 2nd highest bidder, tends to result in more economically efficient allocations of spectrum but it can lead to interesting variations in price for similar lots. For example Telkom paid 20% more for the same amount of spectrum as Hutchison and T-Mobile paid 40% more on a €/MHz/Pop for its 40MHz of paired spectrum than Orange paid for its 20MHz and the difference is unlikely to be explained in full by differences in spectral efficiencies of LTE in wider bands
As countries such as Switzerland, Spain and the UK prepare to auction spectrum in the 2.6GHz band the Austrian auction provide some insight into the potential value of the spectrum but considerable uncertainty remains.

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.