Challenging the Spectrum Auction Orthodoxy May 2014

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 2014
1

Since 2001, Coleago has offered a wide range of advisory
services to the telecom industry
2
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
3

Should auctions always be considered as
the right approach for spectrum allocation
in Latin America?
Challenging the auction
orthodoxy
4

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
5

Implicitly, auctions focus on maximising revenue from
whatever is sold
6

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
7

Allocating spectrum on the basis of private valuations
may be at odds with the public good
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

9
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
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

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.
11

Consolidation is likely in large and small American
markets
12

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.
13

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.
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

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)
15

16
Alright, we are unlikely to get new network based
marketing entry, but why not still have auctions?

Options for spectrum auctions in mature markets
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?

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
18

Excessive reserve prices lead to unsold spectrum, such
as in the APT 700MHz auction in Australia, May 2013
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

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.”
20

21
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
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

Extracting high spectrum fees from the mobile industry is
not sustainable
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 %
+
=
+
=

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.
24

25
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.
26

The 2014 700MHz licence award in Chile broke new
ground and is likely to deliver the policy objectives
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.

Questions?
Stefan Zehle, MBA
Tel: +44 7974 356 258
stefan.zehle@coleago.com
CEO, Coleago Consulting Ltd

Challenging the Spectrum Auction Orthodoxy May 2014

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