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Challenging the Spectrum Auction Orthodoxy May 2014


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Should auctions always be considered as the right approach for spectrum allocations?

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Challenging the Spectrum Auction Orthodoxy May 2014

  1. 1. Should auctions always be considered as the right approach for spectrum allocation? Latin America Spectrum Management Conference, Rio de Janeiro, May 2014 Stefan Zehle, CEO, Coleago Consulting Ltd Tel: +44 7974 356 258
  2. 2. A specialist telecoms management consulting firm About Coleago Consulting © Copyright Coleago 2014 1
  3. 3. Since 2001, Coleago has offered a wide range of advisory services to the telecom industry 2 © Copyright Coleago 2014 Strategy & Business Planning  Strategy Development, Marketing Strategy  MVNO and Multi-Brand Wholesale Strategy  Business Planning and Business Modelling Telecoms Regulation & Interconnect  Accounting Separation, Regulatory Price Control  Interconnect Cost Modelling, RIO  Regulatory Consultations Business Transformation & Cost Reduction  Cost Reduction  Mobile Network Sharing  Restructuring and Turnaround Transaction Services  Commercial Due Diligence  Tower Due Diligence  Preparation of Information Memorandum Spectrum Valuations and Auctions  Spectrum Strategy  Spectrum Valuation for Auctions  Spectrum Auction Bid Strategy and Execution  Beauty Contest Bid Books Mobile Network Sharing  Mobile Network Sharing  Managed Services and Outsourcing  Tower Due Diligence  Network Audit
  4. 4. Coleago has carried out over 60 spectrum consultation, valuation, auction and beauty contest licence projects Completed in 2013/4  Canada – 700MHz  Paraguay - multi-band  Oman - 800MHz & 2.6GHz  Belgium – 800MHz  New Zealand - 700MHz  Myanmar – greenfield  Australia – 700MHz & 2.6GHz  UK – 800MHz & 2.6GHz  Sri-Lanka – 1800MHz Completed in 2012  Belgium – 2.6GHz  Netherlands – multi-band  New Zealand –1800MHz spectrum trading  Switzerland – multi-band  Russia – 700MHz & 2.6GHz  Pakistan – 2.1GHz valuation  Bangladesh - 2.1GHz valuation © Copyright Coleago 2014 3
  5. 5. Should auctions always be considered as the right approach for spectrum allocation in Latin America? Challenging the auction orthodoxy © Copyright Coleago 2014 4
  6. 6. Auctions are the default mechanism for spectrum allocations Beauty contests were used at the start of the mobile industry growth  Difficult to administer, bureaucratic  Open to dispute and vulnerable to corruption Since 2000 auctions are the norm in spectrum allocations  Transparent process (no subjectivity)  Policy objective: maximise economic efficiency  In theory, whoever values spectrum the most will produce the greatest social good © Copyright Coleago 2014 5
  7. 7. Implicitly, auctions focus on maximising revenue from whatever is sold © Copyright Coleago 2014 6
  8. 8. Policy objectives for the allocation of mobile spectrum are wider than revenue generation  Promote the highest value use of spectrum  Promote investment and innovation  Promote rural broadband access  Increase digital participation rates  Promote competition  Promote customer convenience  Provide an appropriate rate of return to the community  Immediate revenue generation © Copyright Coleago 2014 7
  9. 9. Allocating spectrum on the basis of private valuations may be at odds with the public good © Copyright Coleago 2014 8 “The key goal of any auction is to guide goods to those who value them the most. Spectrum auctions help identify the highest value use and users.” New Zealand Ministry of Business, Innovation and Enterprise - May 2013 “The private value for incumbents includes benefits gained by preventing rivals from improving their services. The value of keeping spectrum out of competitors’ hands could be very high. However, this ‘foreclosure value’ does not reflect consumer value.” US Department of Justice, Ex Parte Submission before the FCC - April 2013
  10. 10. © Copyright Coleago 2014 9 Spectrum auctions worked fine in past, so what’s different now?
  11. 11. We need to rethink the method of allocating spectrum in the light of maturing mobile markets © Copyright Coleago 2014 10 Mobile markets have reached the maturity phase of the industry life cycle  Many markets show flat, at least in real terms) or declining revenues and EBITDA  This maturity industry life cycle stage suggest that that policy goals should be revised: – Encouraging new network based competition is not be appropriate – Taking cash out of the industry is not sustainable
  12. 12. Maturing markets are characterised by consolidation, not new market entry Mobile industry consolidation is in full swing  The pace and size of cross-border M&A has been breath-taking, with five mega-deals announced or completed during the past three months.  Markets with consolidation potential include India, Indonesia, Canada, Italy, Germany and Brazil - although regulation is likely to be a constraint in most of these.  Not surprisingly, we are seeing numerous infrastructure sharing deals. Investors should expect further M&A, but at a less frantic pace. © Copyright Coleago 2014 11
  13. 13. Consolidation is likely in large and small American markets © Copyright Coleago 2014 12
  14. 14. Given the existing spectrum, new entrants will have too little spectrum to compete In an LTE world, large contiguous spectrum holdings confer particular competitive advantage  The exit of some operators in Europe and the insolvency of Mobilicity in Canada demonstrates that it is impossible to succeed in the market with small spectrum holdings.  When industry logic has driven consolidation, trying to reverse the process by regulatory is unlikely to produce societal benefits. © Copyright Coleago 2014 13
  15. 15. Using new spectrum auctions to increase network-based competition is unlikely to succeed Regulators may wish to consider:  Allocating spectrum in a manner which does not reduce competition while at the same time maximising the benefit of a wide band.  Facilitating a transition from network based competition to other forms of competition.  Focusing on other regulatory remedies if competition is failing, such as a regulated access price offer. The conditions attached to Hutchison Three’s acquisition of Orange Austria can serve as an example. © Copyright Coleago 2014 14 Consolidation is normal when the industry life cycle reaches the maturity stage Wide band allocations are required for an economically and spectrally efficient deployment of LTE
  16. 16. Competition is now the main concern in auction design  At the maturity stage of the industry life cycle we can expect consolidation but not new market entry, at least at network level.  Ensuring competitive markets with the existing number of operators becomes a policy goal.  “In a highly concentrated industry with large margins between price and incremental cost of existing wireless broadband services, the value of keeping spectrum out of competitors’ hands could be very high”. Submission of the United States Department of Justice before the Federal Communications Commission (April 11, 2013) © Copyright Coleago 2014 15
  17. 17. © Copyright Coleago 2014 16 Alright, we are unlikely to get new network based marketing entry, but why not still have auctions?
  18. 18. Options for spectrum auctions in mature markets © Copyright Coleago 2014 17 New market entry unlikely Each incumbent gets a “fair share”, but auction proceeds are low because there is no real bidding Set high reserve prices Unfettered auction among incumbents Auction proceeds may be high, but increased industry consolidation and reduced competition results Spectrum caps to preserve existing competition Focus on other policy goals What then is the point of an auction?
  19. 19. High spectrum prices conflict with other policy goals High reserve prices are not a good approach to spectrum auctions  High reserve prices of auction rules designed to increase auction revenue have a market distorting effect  Focusing on one policy goal, i.e. to maximise immediate auction revenue will come at the expense of other policy goals  Even if a large amount of money is raised up-front this may reduce overall economic value in the long term © Copyright Coleago 2014 18
  20. 20. Excessive reserve prices lead to unsold spectrum, such as in the APT 700MHz auction in Australia, May 2013 © Copyright Coleago 2014 19 1.28 0.91 0.58 0.49 0.81 0.56 0.88 0.37 0.65 0.73 1.35 - 0.20 0.40 0.60 0.80 1.00 1.20 1.40 USA - 2/2008 Germany - 5/2010 Sweden - 3/2011 Spain - 7/2011 Italy - 9/2011 Portugal - 12/2011 France - 12/2011 Denmark - 6/2012 UK - 2/2013 Average 700/800MHz Australia Reserve… US$ / MHz / Pop 2x15MHz of 2x45MHz unsold One operator, Vodafone, did not obtain any spectrum and the leading operator Telstra increased its competitive advantage, thus reducing competition
  21. 21. Setting high prices for spectrum is problematic Hazlett and Munoz, “What Really Matters in Spectrum Allocation Design”, 2010 “[T]he ratio of social gains [is of] the order of 240-to-1 in favour of services over licence revenues…Delicate adjustments that seek to juice auction receipts but which also alter competitive forces in wireless operating markets are inherently risky. A policy that has an enormous impact in increasing licence revenues need impose only tiny proportional costs in output markets to undermine its social utility. In short, to maximise consumer welfare, spectrum allocation should avoid being distracted by side issues like government licence revenues.” © Copyright Coleago 2014 20
  22. 22. © Copyright Coleago 2014 21 But why can’t we simply set high prices for spectrum, surely the industry can pay up?
  23. 23. To fulfil societal goals for mobile broadband connectivity, mobile operators require large amounts of spectrum © Copyright Coleago 2014 22 The GSMA has commissioned Coleago to undertake some initial spectrum requirement estimates for IMT to the year 2020. A report on this work from Coleago is attached indicating the total spectrum required for IMT of 1600 to 1800 MHz for the year 2020. The GSMA believes this is a reasonable number. Radiocommunication Study Groups Document 5D/XX-E, Sep 2012
  24. 24. Extracting high spectrum fees from the mobile industry is not sustainable © Copyright Coleago 2014 23 Demand for Mobile Broadband and Spectrum Requirement Prices Paid for Spectrum LTE Deployment and Backhaul Capex Tangible (Network) and Intangible (Spectrum) Capex Revenue EBITDA Free Cash Flow Impact on Operators Balance Sheet Return on Capital Employed (ROCE) EBITDA Margin % + = + =
  25. 25. When returns drop below the cost of capital, investment ceases to flow into the industry Cash flows from operations are declining  Operators in Latin America have seen EBITDA margins decline in recent years.  In Q2 2013, the average service revenue EBITDA % margin for Latin America was 34.3% compared to 39.4% in North America and EBITDA cash flows showed a significant year- on-year decline. Capital expenditure pressure is increasing  Capex in the Latin American mobile industry is set to increase driven by LTE deployment.  However, this is only the investment in tangible assets.  Spectrum capex is a key variable in determining total capex. © Copyright Coleago 2014 24
  26. 26. © Copyright Coleago 2014 25 How can we do things differently?
  27. 27. 2009 AWS auction in Chile focused on stimulating new market entry, but resulted in policy failure Spectrum caps guaranteed new market entry …  A spectrum cap of 60 MHz, effectively excluding the three incumbent mobile network operators - Movistar, Entel and Claro.  Cable television company VTR won 30MHz of the AWS spectrum paying US$3.02 million, and Nextel won 60MHz, paying US$14.7 million.  Revenue raised amounted to a tiny $0.011 / MHz / pop. … but failed to deliver timely deployment and competition …  The new entrants were unable to launch their 3G mobile service until May 2012, one and a half years after the October 2010 deadline.  VTR and Nextel together only have 1.3% market share, nearly three years after the AWS spectrum licence award. … and private investors may pocket the new entrant discount.  In a secondary market VTR and Nextel are likely to sell the spectrum for more than they paid. © Copyright Coleago 2014 26
  28. 28. The 2014 700MHz licence award in Chile broke new ground and is likely to deliver the policy objectives © Copyright Coleago 2014 27 The 700MHz spectrum award process focussed on connectivity and competition policy objectives …  connect 1,281 rural towns and 500 schools  obligation to build fibre  mandated MVNO access and roaming … rather than extracting money from the mobile industry.  Auction proceeds amounted to a relatively tiny 0.017 $/MHz/pop.  The reserve price in Australia was set at 1.35 $/MHz/pop - 78 times higher.
  29. 29. Questions? Stefan Zehle, MBA Tel: +44 7974 356 258 CEO, Coleago Consulting Ltd