challenging the spectrum auction orthodoxy may 2014
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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 stefan.zehle@coleago.com
A specialist telecoms management consulting firm
About Coleago Consulting
© Copyright Coleago 20141
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
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
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Should auctions always be considered as the right approach for spectrum allocation in Latin America?
Challenging the auction orthodoxy
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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
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Implicitly, auctions focus on maximising revenue from whatever is sold
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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
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Allocating spectrum on the basis of private valuations may be at odds with the public good
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“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
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Spectrum auctions worked fine in past, so what’s different now?
We need to rethink the method of allocating spectrum in the light of maturing mobile markets
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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
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.
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Consolidation is likely in large and small American markets
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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.
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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.
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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
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)
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Alright, we are unlikely to get new network based marketing entry, but why not still have auctions?
Options for spectrum auctions in mature markets
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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?
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
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Excessive reserve prices lead to unsold spectrum, such as in the APT 700MHz auction in Australia, May 2013
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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
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.”
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But why can’t we simply set high prices for spectrum, surely the industry can pay up?
To fulfil societal goals for mobile broadband connectivity, mobile operators require large amounts of spectrum
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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 GroupsDocument 5D/XX-E, Sep 2012
Extracting high spectrum fees from the mobile industry is not sustainable
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Demand for Mobile Broadband and Spectrum
Requirement
Prices Paid for Spectrum
LTE Deployment and Backhaul Capex
Tangible (Network) and Intangible (Spectrum)
CapexRevenue
EBITDA
Free Cash Flow
Impact on Operators Balance Sheet
Return on Capital Employed (ROCE)
EBITDA Margin %
+
=
+
=
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.
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How can we do things differently?
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.
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The 2014 700MHz licence award in Chile broke new ground and is likely to deliver the policy objectives
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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.
Questions?
Stefan Zehle, MBA
Tel: +44 7974 356 258stefan.zehle@coleago.com
CEO, Coleago Consulting Ltd
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