December 5, 2013

Headlines in Canada’s $20 billion wireless industry continue to be made in Ottawa. As a case in point, , the relevant cabinet ministers have clearly indicated –again – that a bid by Telus for financially-weakened carrier Mobilicity will not be tolerated. (Mobilicity was overwhelmed by its debt load and is currently operating under the protective umbrella of a court.)

As both the business and political press has reported, the Federal Government’s over-arching objective has been the creation of a strong fourth rival to the overwhelmingly dominant oligopoly of Rogers, Telus and Bell. Despite the many powers at the disposal of the relevant ministries, this has not happened. Why?

Flawed Auction Design & The Impact On New Entrants

Mobilicity’s problems, as was the case with those facing rival Wind, emerged out of the last, flawed, spectrum auctions in 2007-8. These auctions were interesting in that they underscored the consequences of both conflicting objectives as well a failure to deploy sufficiently joined-up-thinking.

The bureaucrats overseeing the auction sought to produce a coherent (if complicated) process that reserved some spectrum for new entrants whilst also maximising the value of a scarce public resource. This, in itself, is a perfectly legitimate set of goals.

In this regard the auction was an undoubted success. Prices for the AWS spectrum (which was not going to be suitable for iPhone usage for some time) climbed to $4.25 billion in reasonably fast-paced bidding. Manitoba Telecom – the obvious candidate (given its ownership of Allstream, owner of national backbone and metro fibre networks) – to create a national competitor to the oligopoly of Rogers, Bell and Telus – pulled out as prices exceeded levels it deemed reasonable. So too did a European family office that had rich telecoms expertise and a track record of a dozen investments in the sector. (In the interests of full disclosure Cheverny was an adviser to this group.) Videotron and Wind Mobile (backed in a convoluted structure by Orascom, the Egyptian-headquartered emerging markets telecoms conglomerate) submitted bids of $554 million and $442 million each – and neither bought a national network with those substantial amounts. Other non-oligopolist bidders, including Mobilicity, spent a combined $638 million.

Predictably, high spectrum costs translated into financial stress.

New entrants discovered that retail distribution is a critical, and costly element, in any roll-out strategy. Mobile phones must somehow get in the hands of consumers. In Poland, where new entrant Play swiftly grew to 10%, and thence to over 15%, market share, the new entrant merged with a distributor of mobile technology and rebranded this national chain of shops with the operator’s logo. When burdened with high fixed spectrum costs less capital is available to build market share.

Videotron fared somewhat better than the other rivals because of a tightly defined, Quebec-centric, philosophy of selling a quadruple play of cable, internet access, telephony and mobile. The other new entrants either pulled out (Shaw), remained defiantly regional, or had a quasi-national approach and suffered deep losses (Wind, Mobilicity).

Opaque Application Of Foreign Ownership Rules

A second area where contradictory messages from Ottawa have hobbled development of the telecoms market is that relating to foreign ownership of carriers.
Ottawa’s initial response to the pressure on new entrant mobile operators was to change foreign control guidelines for operators with less than 10% market share. Orascom (which was subsequently to merge with global wireless giant Vimpelcom) was allowed to combine de jure with de facto control of Wind.

A second decision, which further undercut the sense that Canada would maintain strict, nationalistic rules regarding telecoms ownership, came earlier this year when various government officials led an abortive attempt to bring Verizon to Canada. Noises were made suggesting that Verizon (VZ – NYSE – VZ) would be welcome in the impending auction of 700 Mhz spectrum (which offers substantially higher service quality than the AWS auctioned at such high prices half a decade earlier). The oligopolists were predictably – and publicly – outraged. Rather embarrassingly for the Harper government, the U.S. telecoms giant investigated the opportunity and then backed away when offered the strategically critical opportunity to buy out Vodafone’s stake in its Verizon Wireless business. Given that this was a $130 billion transaction the reduction of focus on Canada was perhaps understandable.

Conflicting with these two initiatives were two other recent decisions. Firstly, Vimpelcom (which has significant Russian ownership) was brushed away from full control of Wind and Accelero (a private equity fund with an Egyptian telecoms billionaire – and co-founder of Wind – as a major backer) was suddenly and unexpectedly blocked from buying control of MTS Allstream. In both instances “national security considerations” were cited.

Oligopolists Feast Or Yet More Government Action?

Given this, the 700 Mhz auction is looking increasingly like an oligopolists’ feast. Catalyst, a Toronto-based fund that is a substantial bondholder in Mobilicity, is the most recent firm to remove its name from the bidders’ list. Two smaller firms – Vecima and Corridor Communications – recently made similar decisions, and private equity firm Birch Hill pulled out in October.

The imperatives of raising substantial amounts of money from an auction and encouraging new competitors have, at least thus, proved to be contradictory. If Ottawa wishes to create a strong rival to the domestic oligopoly then it must find some sort of “white knight”. Given that local capital has seemingly decided that competing against Rogers/Bell/Telus is unappealing, this rescuer of governmental ambition may have to come from abroad. A canny strategic player –presumably from a jurisdiction that enjoys the approval of the Federal government – could attempt to snap up Mobilicity under the condition that it be granted significant concessions regarding spectrum. Whether Ottawa could find a way through the tangled legal and public relations thicket this would entail is quite another matter.

It is therefore ironic that Vodafone’s contribution to Canada is not the launch of “Vodafone Canada”. Rather it is Mr Guy Laurence, the incoming CEO of Rogers, who brings with him a successful track record reviving Vodafone UK. He has announced that improving Rogers’ reputation for customer service is a priority. Ongoing lack of customer choice may give him the time to achieve this goal.