September 27, 2014

Earlier this week cable, data centre and managed hosting firm Cogeco (TSX/CCA) called for the creation in Canada of a mandatory framework for MVNOs (mobile virtual network operators).

Cogeco (TSX/CCA) is seeking the ability to offer a quadruple play bundle (cable, internet, landline and mobile telephony), primarily to customers in its service area in Quebec and Ontario. Cogeco would  lease spectrum from an existing operator in order to offer Cogeco-branded services. Yet in making this proposal it also highlighting the competitive deficiencies – and opportunities – in the Canadian market for wireless services.

In the conference call outlining the plan, CEO Louis Audet (whose family controls the company) ruefully reflected on a dozen years of efforts (“numerous discussions”) to secure reasonably priced wireless spectrum through private negotiation. (This is hardly surprising. Inter alia, Rogers owns 21.9% of the single voting shares of Cogeco and is widely believed to have a long term ambition of acquiring the firm.)  “We have all been witness to the efforts by the federal government to bring about a fourth facilities-based competitor in the marketplace. We have witnessed the fact that virtually all the newborns were strangled before they could actually develop into something better.”

The MVNO plan would require that the regulator (the CRTC) – presumably with the support of the Federal government – step in to require existing national wireless operators to provide direct access to the radio network (and MNO codes) under a regime of regulated access fees (by minute, by megabit of data or by text).

Cogeco’s proposal was unveiled less than two weeks after it was announced that the CEO of Wind Canada had partnered with a Canadian hedge fund (West Face Capital) and certain US private equity groups (Tennenbaum Capital Partners from California being the most prominent) to purchase control of Wind Canada from its owner Vimpelcom in a transaction worth $285 million.

Wind Canada had, despite substantial investments, failed to breach the 1 million subscriber mark. Most of the company’s 750,00 strong subscriber base are lower-margin customers concentrated in urban areas in Ontario, Alberta and British Columbia: a reflection of the fact that Wind had built its infrastructure out in cities in these jurisdictions. Network coverage outside of these areas is at best patchy, and the company will require substantial capital to replicate the network of a Rogers or a BCE.

This is hardly surprising given that Ottawa had over-designed the original spectrum auction, impelling spectrum prices well above reasonable levels and hampering new entrants from the outset. The regulatory framework in operation since 2009 also allowed incumbents to levy impressively high roaming rates, diminishing the attractiveness of new entrants to premium post-paid customers. In effect, Wind was operating at a disadvantage even before Ottawa blocked various ownership changes involving original investor Mr Naguib Sawiris and (subsequently) Vimpelcom. (Please see our other blog posts on this topic.)

Whether Cogeco succeeds before the CRTC,  the company has a strong case to make about market concentration and pricing in Canada : BCE, Telus and Rogers control 90% of the mobile market.

How does the US compare? When Sprint (which had seen control pass to Japan’s Softbank in a $20 billion transaction two years ago)  took a run at the fourth largest operator T-Mobile (66% owned by Deutsche Telekom), the US authorities made their displeasure known in a swift and unambiguous manner. Such a merger would have produced a wireless carrier with 103 million subscribers (the same as Verizon and slightly below AT&T’s 116 million).

“Four national wireless providers are good for American consumers,” Tom Wheeler, the chairman of the Federal Communications Commission (FCC) remarked in a statement. “Sprint… has an opportunity to focus their efforts on robust competition.”

Indeed trends in the US market underscore what a robust four-player market can produce and hint at a future wherein the ability to contractually constrain customers and deploy pricing models that generate excess returns will be reduced.

T-Mobile (NASDAQ/TMUS) was historically viewed as the weak player in the market. Currently the subject of considerable (M&A) interest on the part of Iliad, the disruptive French wireless carrier, T-Mobile’s recent operating strategy has been strikingly successful.

Under the leadership of its relatively new CEO Mr John Legere , the company decided to overturn much conventional thinking in designing its consumer offering. It defined this as removing customer “pain points”, painting itself in so doing as being an “un-carrier”.

Some key elements of this include:

  • 100% no contract
  • anytime upgrades
  • Free international data roaming
  • Simplified pricing plans (not necessarily

This was supplemented by accelerated roll-out of LTE. Many Canadian readers will be scratching their heads at the sheer unfamiliarity of this.

The results have been impressive. T-Mobile became the fastest growing wireless carrier in the US: 4.4 million new subscribers in 2013, with 2014 demonstrating continued momentum (552,000 postpaid subscribers were added in August 2014 alone and there is strong evidence that many consumers were waiting for Apple’s launch of iPhone6 before switching carriers).

Iliad’s interest in T-Mobile is understandable, as they are in some ways cut from the same cloth. Iliad disrupted the French market with a ~$25/month pricing plan allowing for unlimited calling and texting and a data cap of 20 GB. This resulted in Iliad securing 15% of the French market in extremely short order.

Both T-Mobile and Iliad have shone a light on the essential fragility of the traditional wireless model of two-year contracts, hefty penalties, a miserly approach to upgrades, steep roaming charges and almost impenetrable pricing complexity.

Yet aggressive marketing (at which T-Mobile is adept) and innovative pricing do not diminish the truth that, in the long term, both scale and capital are important.

T-Mobile posted four quarters of losses as it rolled out its strategy but moved strongly into net profitability in Q2. Whilst buoyant about these results, the CEO was a realist about balance sheet flexibility.

“If I really want to bring long-term competition and lead this entire industry, capital is important,”  John Legere remarked.

Cheverny believes that there is room for T-Mobile type innovation in Canada. The MVNO route proposed by Cogeco is an obvious way forward, though Ottawa would have to be extremely rigorous in ensuring that the cost base – and therefore pricing for MVNOs – is not inflated.  Alternately existing wireless (and fibre backhaul) assets could be merged into an adequately capitalised entity that could serve the many regional players seeking to offer service bundles incorporating wireless.