best practice spectrum auction workshop india 24 sep 14

Criteria for successful spectrum auctions

Spectrum Auctions: Best Practices Workshop New Delhi, 24th of September 2014

Stefan Zehle, CEO, Coleago Consulting Ltd+44 7974 356 258 [email protected]

Agenda

Successful Spectrum Auction Design - © Copyright Coleago 2014 - www.coleago.com1

1 Introducing Coleago Consulting

2 Industry trends influencing spectrum policy & management

3 Considerations for allocating spectrum through auctions

4 Available spectrum lots and competition safeguards

5 Reserve prices and licence payment terms

6 Licence terms

7 Licence extensions

8 Challenging the auction orthodoxy

9 Recommendations for best practice in spectrum auctions

A specialist telecoms management consulting firm

About Coleago Consulting


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

3Successful Spectrum Auction Design - © Copyright Coleago 2014 - www.coleago.com

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 70 spectrum consultation, valuation, auction and beauty contest licence projects

Completed in 2013/4 Chile - 900/1800 and 700/AWS 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


Mobile data drives the need for spectrum

Industry trends influencing spectrum policy & management


New technology enables operators to offer faster services and enables to pass more traffic through a given amount of spectrum

GSM Not well suited for modern data needs Download speed of up to 384 kbps

with EDGE technology

3G HSPA Spectral efficiency: 0.7 bits / Hz / cell Download speed of 42Mbps

LTE and LTE Advanced Spectral efficiency: 1.4 bits / Hz / cell

(possibly twice that for LTE-A) Download speed of 150Mbps (300 for

LTE advanced)


3G HSPA

Demand for mobile broadband requires more mobile network capacity


The mobile data tsunami Mobile data traffic is growing at a

very rapid rate in all regions of the world.

In many mobile networks data now exceeds voice.

Technology alone cannot deliver the required capacity, additional spectrum is required

Mobile broadband is a key ingredient for the development of the digital economy …

An increase of 10% in mobile adoption boosts GDP growth by 0.8% (World Bank, 2009)

For a given level of total mobile penetration, a 10% substitution from 2G to 3G increases GDP per capita growth by 0.15 % points (Deloitte, 2012)

Doubling broadband speeds for an economy can add 0.3% to GDP growth (Arthur D. Little, 2011)


… and there are tangible benefits to society which illustrate the impact of mobile data

A 12% increase in financial inclusion in developing countries in India and Bangladesh

Healthcare: up to 70% improved compliance for TB

10-15% increase in farmer income mEducation solutions can significantly

improve the affordability of education by up to 65%


Existing and new spectrum is required for mobile broadband services


700/800 MHz

1800/1900 MHz

1700/2100 MHz

850/900 MHz

2600 MHz

?

New spectrum for LTE, in some markets previously used for TV, referred to as “digital dividend” bands

Originally only used for GSM, progressive redeployment to 3G HSPA and recently to LTE

Originally only used for GSM, progressive redeployment to 3G HSPA and recently to LTE

Currently used for 3G, upgrading to dual carrier HSPA+, LTE deployment in the Americas

New band for LTE

The mobile industry is seeking over 1GHz new spectrum for mobile broadband

Implications for spectrum management and auctions

Supply of new spectrum Focus on making a maximum of

spectrum available for mobile broadband as fast as possible

Allocate new spectrum Allocate new spectrum to mobile

operators to facilitate and encourage rapid deployment of 3G HSPA and LTE

New technology in existing spectrum Ensure that new technology, notably

LTE, can be deployed in existing bands


Spectrum auctions provide transparency but do not necessarily result in efficient spectrum allocations unless they are designed consistent with best practice

Considerations for allocating spectrum through auctions


Auctions are the default mechanism for spectrum allocations

Beauty contests were used at the start of the mobile industry growth Difficult to administer Open to dispute due to subjectivity

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


Implicitly, auctions focus on maximising revenue from whatever is sold


Policy objectives for the allocation of mobile spectrum are wider than maximising auction proceeds

Promote the highest value use of spectrum

Ensure spectrum is deployed rapidly and widely and the maximum spectral efficiency is extracted

Promote investment and innovation Promote rural broadband access and

increase digital participation rates Promote competition Promote customer convenience Provide a high net economic return to

the public

Immediate revenue generation by maximising auction proceeds


Spectrum auctions provide transparency but do not necessarily deliver the policy objectives efficiently

Assessing best practice in spectrum auctions should cover at a minimum the following aspects:1. Available spectrum lots and

competition safeguards2. Reserve prices and licence payment

terms3. License terms4. Licence extensions or renewals


Overcoming risks associated with fragmentation and the implications of LTE

1. Available spectrum lots and competition safeguards


Available spectrum lots and competition safeguards

The quantity, nature and packaging of the spectrum that individual operators are able to pursue will bear significantly on auction outcomes.

Relevant aspects include: Supply of spectrum Spectrum set-asides, floors and/or

spectrum-acquisition limits Allocation of specific or generic lots Lot sizes The inclusion of expiring usage-rights

in combined auctions Competition safeguards


Efficient allocation requires the timely availability of large amounts spectrum

The Swedish telecoms regulator PTS is at the forefront of best practice spectrum allocation and management.

PTS shall increase the availability of useful spectrum through least restrictive conditions, in the work for international harmonisation, assignments at a good rate to meet demand, and promotion of secondary trading. PTS Spectrum Strategy, Draft summary of the consultation report, Feb 2014

PTS’s spectrum strategy recognises that spectrum which is held back and hence not used, delivers no socio-economic value.

The estimated total spectrum requirements for both the RATGs 1 (pre-IMT, IMT-2000, and its enhancements) and 2 (IMT-Advanced) are 1,340 MHz and 1,960 MHz for lower user density settings and higher user density settings, respectively. Future spectrum requirements estimate for terrestrial IMT, Report ITU-R M.2290-0, (12/2013)


When a new band is released, all of the spectrum in that band should be made available at once

Auctioning small amounts of spectrum is inefficient When few lots are on offer demand will

exceed supply by a greater factor. High auction prices will reduce investment.

Small amounts of spectrum increase deployment costs and prevent operators from delivering true mobile broadband services.

LTE and LTE advanced require an allocation of at least 2x10MHz or 2x20MHz of contiguous spectrum per operator.


New spectrum for LTE: More and wider is better

Band MHz7 (2.6GHz) 2x70MHz + 40MHz TDD28 (APT700) 2x45MHz

Spectrum set-asides, floors and/or spectrum-acquisition caps can lead to inefficient outcomes

Spectrum set-asides, floors and/or spectrum-acquisition caps are typically designed to prevent excessive spectrum concentration.

However, if at all, these measures need to be determined with great care to avoid unduly distorting outcomes.


Potential impact of auction design ExamplesSpectrum is acquired by inefficient users who deploy little and fail to gain market share

Chile AWS auction (2009)Canada AWS (2008)

Spectrum remains unsold and hence the economic value is not extracted

Netherlands 2.6GHz (2010)Belgium 2.6GHz (2011)

Spectrum is not deployed and held for resale at a profit for private investors Canada AWS (2008)

Increased spectrum costs for incumbents damage operator Netherlands 800MHz (2012)

Ensuring a minimum block size of 2x10MHz is key for efficient LTE deployment

Deploying LTE in 2x15MHz costs around $3,900 per MHz; deploying in only 2x5MHz costs $9,900 per MHz.

The maximum downlink speed in 15MHz is 112 Mbps compared to only 35 Mbps in 5MHz.

Potential solutions: – Allocate wide enough bands to

individual operators – Allow spectrum sharing so that

operators who hold, say 2x5MHz each, may jointly deploy in 2x10MHz

– Allow spectrum trading


-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

1 Carrier 3 Carriers

US$

Capex per LTE e-NodeB

eNodeB equipment 5MHz Carrier Cost

Auctioning specific blocks of spectrum in parallel may lead to non-contiguous allocations

Potential non-contiguous allocations are a key drawback of a regular SMRA Not technically efficient Vulnerable to anti-competitive bidding (e.g. attempt to isolate individual blocks)

23

B1 B2 B2 B2 B2 B1 B1 B3 B3

Example: Bidders B2 and B3 have contiguous allocations, while B1’s allocation is fragmented, thus increasing deployment costs and reducing efficiency

703 MHz& 758 MHz

748 MHz & 803 MHz

APT Band Plan allocated in 2 x 5 MHz blocks

Successful Spectrum Auction Design - © Copyright Coleago 2014 - www.coleago.com

Market based solutions to ensure contiguous spectrum holdings

A possible solution to prevent non-contiguous spectrum holdings, is to auction generic lots instead and to assign contiguous ranges during a separate process, after the quantities secured by each bidder are known.

The use of generic blocks might skew results if the position within a given band has a significant impact on values: uncertainty over the final assignment may distort bid behaviour.

An approach taken in some instances (e.g. the UK multiband auction in 2013) has been to include a single specific lot in a band alongside generic lots, and applying a contiguity constraint during the assignment stage.

This mitigates both the risk of technical inefficiency and of distorting the allocation process.


The inclusion of expiring usage-rights in combinatorial (package bidding) auctions is poses great risks

In some cases, spectrum on offer in a combinatorial auction included expiring licences alongside new mobile spectrum All existing spectrum in use was sold

together with the new Digital Dividend frequencies, in ‘Big Bang’ combined awards in Switzerland, Ireland and the Netherlands during 2012.

The Norwegian 800MHz auction that concluded in December 2013 also included expiring 900MHz and 1800MHz licences.

These auctions introduce a significant risk to business continuity In Norway, incumbent Tele2 lost all of

its existing 2G holdings, leaving the business crippled. Tele2 has since announced its exit from the Norwegian market, with a sale of its assets to rival TeliaSonera.

“Big Bang” auctions are vulnerable to distortions caused by the adoption of predatory bidding strategies by a dominant operator, as evidenced Switzerland.


Auction design no longer focuses on new market entry but accepts a reasonable level of consolidation

Wireless markets are mature. At the maturity stage of the industry life cycle we can expect consolidation but not new market entry, at least at network level.

Ensuring efficient use of spectrum in competitive markets with an optimum number of operators becomes a policy goal.

In Europe, regulators are now accepting that the benefit of consolidation from 5 or 4 operators to 3 exceeds the potential negative competition impacts, provided safeguards are put in place.


Setting appropriate reserve prices in the context of policy objectives

2. Reserve prices and licence payment terms


High reserve prices are prone to distort auction outcomes and harm the public interest in a number of ways.

Spectrum may be left unsold and hence unutilised. This represents a productivity loss to society and reduced auction receipts.

National imbalances in spectrum holdings may be exacerbated.

An unnecessarily high cost-burden may be imposed on the industry, leading to adverse downstream consequences in terms of roll-out, competition and consumer choice.


Potential impact of auction design ExamplesSpectrum remains unsold and hence economic value is lost to the country

India 850MHz (2012, 2013)Australia 700MHz (2013)

Higher costs are imposed on operators than necessary and deployment slows down

Australia 700MHz (2013)Belgium 800MHz (2013)

Driven by the desire to plug a hole in the budget, Australia set extremely high reserve prices for 700MHz


700/800MHz Digital Dividend Spectrum Reserve Prices Compared

0.00 0.09

0.13 0.25

0.30 0.30 0.32

0.42 0.49

0.47 0.56

0.60 0.80

1.35

- 0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

Germany - 5/2010Netherlands - 12/2012

Denmark - 6/2012Sweden - 3/2011

UK - 2/2013Switzerland - 2/2012

Finland - Q4/2013New Zealand - 10/2013

Spain - 7/2011Canada - Q4/2013Portugal - 12/2011

France - 12/2011Italy - 9/2011

Australia - 5/2013

US$ / MHz / Pop

The Australian reserve prices where set higher than prices paid at auction in other countries


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

700/800MHz auction prices paid vs. Australian reserve prices

The Australian APT 700MHz auction resulted in an loss to society and is an example of policy failure

Potential socio-economic gain for Australia?

Is the spectrum is actually used?

Can operators deploy the 700MHz band as cost effectively?

Is there competition to drive down prices?

Between AU$ 7bn and AU$10bn

2x15MHz of 2x45MHz unsold hence not all of the potential socio-economic gain is realised

Only Telstra obtained 2x20MHz, can deploy at lowest cost, Optus obtained only 2x10MHz

One operator, Vodafone, did not obtain any spectrum and the leading operator Telstra increased its competitive advantage, thus reducing competition


Lessons learned from the Australian 700MHz auction

High reserve prices are not a good approach to spectrum auctions They have a market distorting effect Regulators might do not achieve their

policy objectives Even if a large amount of money is

raised up-front this is likely to reduce overall economic value in the long term


The societal value of allocating spectrum

The return to the community from spectrum auctions goes well beyond any direct payment made to government for spectrum.

Implicitly all governments recognise the trade-off between spectrum fees and wider goals.

Otherwise they would simply auction off monopolies which would undoubtedly bring the highest direct receipts.


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.”


Benchmarking based on auction outcomes is not an appropriate method to set reserve prices

The value of spectrum to a mobile operator is specific to its business and based on a discounted cash flow forecast for the business.

Prices paid at an auction reflect outcome based on the value operators assign to spectrum in that country under a particular set of circumstances.

More recently prices paid reflect high renewal prices. For example, the cash strapped government in Greece in 2011 set extremely high reserve prices to renew spectrum. Operators had the choice to pay up or shut down.


Benchmarking

Reserve prices should be set based on cost

Two costs of allocating spectrum to mobile can be identified.

Reserve prices should be set to compensate for the higher of either one of those costs: – The opportunity cost, i.e. the value

that would be generated from the next best alternative use of the spectrum.

– The cost moving incumbent users to free up the spectrum for mobile use.

Example New Zealand, 700MHz auction 2013 announcementThe reserve price for each of the nine lots of 5 MHz paired has been set at NZ$22 million [NZ$198 million in total].The Government has spent $157 million clearing the 700 MHz band to allow the spectrum to be used for 4G mobile networks.Communications and Information Technology Minister Amy Adams, 700MHz auction announcement, 4 Sep 2013


Offering the option of upfront versus staggered payments constitutes best practice

“Allowing staged payment will enable mobile network operators to invest immediately in building their 4G networks to increase their service to New Zealanders.” Communications and Information Technology Minister Amy Adams, 700MHz auction announcement, Sep 2013

In principle, operators can reflect the timing of payments in their valuations. However, requirements to pay the full amount as a lump sum may have a disproportionate impact on more highly geared operators, which could threaten allocation efficiency.

Offering the option of upfront versus staggered payments, subject to a market-based interest rate, reduces this risk and therefore constitutes best practice.


Applying best practice to licence terms is likely to have beneficial impact on investment in mobile and the socio-economic benefits which flow from this

3. Licence terms


Setting spectrum licence terms to maximise spectrum value to society

Spectrum has no intrinsic value. Value is only created through the use of spectrum.

The more spectrum is used, the more socio-economic value is created. Therefore spectrum licence terms should encourage the maximisation of the use of spectrum. In practice this means setting terms that encourage investment in the radio access network.


An illustration of the effect of network investment on value extracted from spectrum


Holds 2x10MHz of spectrum

Invested $300 million 2,000 sites

1 million customers Monthly MoU: 200 Monthly ARPU: $10 Annual revenue:

$120.0 million



1.6 million customers Monthly MoU: 220 Monthly ARPU: $11 Annual revenue:

$211.2 million

Operator A Operator B

Each holds the same amount of spectrum.

Operator B invested twice as much as operator A.

Since operator B has a much better network, operator B attracted 60% more customers than operator A. As a result of better network quality B’s customers also make more calls and generate a higher ARPU.

There are two mobile operators in a country.

Greater network investment increases efficient use of spectrum measured in minutes per MHz per year



1 million customers Monthly MoU: 200 2,400 million minutes

per year


1.6 million customers Monthly MoU: 220 4,224 million minutes

per year

Operator A Operator B

Which operator has invested more?

120.0 million minutes per MHz per year

211.2 million minutes per MHz per year



Both operators hold the same amount of the scarce resource that is spectrum

Which operator is delivering more economic benefit to the country?

Which operator is passing more traffic through a given amount spectrum?

Operator B experiences a lower % return on investment but delivers greater value to the country


Operator A Operator BSpectrum MHz 2x10 2x10Investment $ mn 300 600Number of sites 2,000 4,000Customers million 1.0 1.6Monthly ARPU $ 10 11Annual revenue $ mn 120.0 211.2EBITDA 40% 40%EBITDA $ mn 48.0 84.5Annual capex 5% initial 15.0 30.0Free cash flow 33.0 54.5Annual return on investment 11.0% 9.1%Monthly minutes of use 200 220Annual minutes mn 2,400 4,224Minutes (mn) per year per MHz 120.0 211.2

Operator A extracts more value for the private investors

Operator B generates more value for the country

Now the government decides to levy fee of 4% of revenue and describes it as “spectrum usage charge”


Operator A Operator B Operator A Operator BAnnual revenue $ mn 120.0 211.2 120.0 211.2 Spectrum usage fee - - (4.8) (8.4)EBITDA 40% 40% 36% 36%EBITDA $ mn 48.0 84.5 43.2 76.0 Annual capex 5% initial 15.0 30.0 15.0 30.0 Free cash flow 33.0 54.5 28.2 46.0 Annual return on investment 11.0% 9.1% 9.4% 7.7%Drop in free cash flow (4.8) (8.4)

With 4% chargeNo charge

Operator B’s profitability declines more that operator A and the return on investment is even lower. A rational investor would invest less and pursue operator A’s strategy. As a result the country would lose out.

Spectrum usage charges to recover administrative costs are consistent with spectrum policy objectives

A fee per MHz of spectrum:Encourages operators make as much

use of spectrum as possible, i.e. encourages investmentIs easily calculated and transparentCovers the cost spectrum

management

A fee based on revenue: Penalises operators who make

efficient use of spectrum Discourages investment in the network Reduces the socio-economic value of

spectrum


The initial licence fee already covers the opportunity cost of allocating the spectrum for mobile use, hence society is already adequately compensated.

Calling a levy on revenue a “spectrum usage charge” is a misnomer because it has nothing to do with the policy of objective of maximising the use of spectrum. It is simply a form of taxation.

Relevant European Union legislation is generally considered at the forefront of good practice

DECISION No 243/2012/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL,

of 14 March 2012,

establishing a multiannual radio spectrum policy programme

Article 2: paragraph 1 (a)

General regulatory principles (a) applying the most appropriate and least onerous authorisation system possible in such a way as to maximise flexibility and efficiency in spectrum use. Such an authorisation system shall be based on objective, transparent, non-discriminatory and proportionate criteria.


Best practice relates spectrum usage charges to the cost of spectrum management

DIRECTIVE 2002/20/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL

of 7 March 2002

on the authorisation of electronic communications networks and services (Authorisation Directive)

Article 12, paragraph 1 (a)

Administrative chargesAny administrative charges imposed on undertakings providing a service or a network under the general authorisation or to whom a right of use has been granted shall: (a) in total, cover only the

administrative costs which will be incurred in the management, control and enforcement of the general authorisation scheme and of rights of use…


High expectation of renewal

Best practice provides certainty over investment: Long licence terms and expectation of renewal

Certainty over business continuity improves the business case and hence 20 year terms are recommended Investors are prepared to accept lower

returns and as consequence the ratio of investment to revenue increases.

Prices can be than they otherwise would be.

High expectation of renewals at reasonable terms constitutes now best practice UK and New Zealand are leading in

this area. In the UK renewal will be the norm

unless there are spectrum management reasons not to do so. Administered Incentive Pricing is used to determine the fee payable.


20 Years15 Years

Why auctions may not be appropriate for existing spectrum rights

4. Licence extension


Extending existing licences poses different problems

Licence extensions or renewals are now common as many 15 or 20 year licence come to the end of their term Not obtaining an licence extension or

renewal, may put a viable business at risk.

There is evidence that mobile operators reduce investment as the end of the term approaches.

If licences are not extended, considerable disruption would result with a cost to consumers, employees and the attraction for future investment


Auctioning spectrum due for renewal may create asymmetries that invite predatory bidding


Operator A Operator B Operator C

Needs to renew spectrum to continue operating, hence the value is very high, say $500 million.

Cash will be diverted from investment to paying for spectrum.

Do not have to renew spectrum, but the additional spectrum would have a value of $100 million to B & C.

Operators B and C estimate the value of the expiring spectrum licence to A at $500 mn, and hence bid $300. They are unlikely to win, but have imposed a high cost on A.

B & C know that because financing is not unlimited this will slow down A’s investment and thus reduce competitive pressure for B and C to invest.

Licences expiring Licence continuing for another 3 years

Collectively the industry will end up investing less and the socio-economic benefit of spectrum is reduced.

Solutions for licences extensions or renewals

Harmonise licence expiry dates In many markets licences do not expire at the same

time. Some regulators harmonised licence expiry by granting partial extensions, e.g. Ireland.

All expiring spectrum could then be auction together, thus eliminating the predatory bidding problem that may otherwise arise from asymmetries.

Use an administered method with pricing based on opportunity cost Recognise that auctioning spectrum that is in use by a

successful mobile operation is not necessarily the best method.

An administered process based on the opportunity cost to other potential users (AIP) may be a better solution.


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

Challenging the auction orthodoxy



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


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.


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.


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.


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


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

Options for spectrum auctions in mature markets


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?

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.”



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


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


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 %

+

=

+

=

The consequence: The only way to maintain ROCE is to

reduce investment

When returns drop below the cost of capital, investment ceases to flow into the industry, example Latin America

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.



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.


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


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.

Careful choices in spectrum auctions are required in order to maximise the socio-economic benefit of spectrum

Recommendations for best practice in spectrum auctions


A formal consultation process and rational argumentation should precede any spectrum allocation event


Market competitiveness

Policy objectives

Existing total spectrum holdings

RAN and spectrum sharing

Licence duration and

extension

Demand for Spectrum Number of operators in

a market

Supply of Spectrum

Spectrum auction design

Best practice in spectrum auctions – #1 & #2

1. Apply spectrum floors in the event spectrum-in-use is being re-auctioned, to minimise the threat to business continuity.

2. Set reserve prices to reflect the cost of alternative use or the cost clearing spectrum so as to avoid imposing high costs on the industry that would be passed on to consumers in the form of higher retail prices and result in reduced investment.


Best practice in spectrum auctions – #3, #4 and #5

3. Provide deferred licence fee payment terms to equalise the opportunity for operators to secure the resources they need to pay for spectrum, in light of possible differences in their ability to raise substantial funds in advance, and also to speed up deployment.

4. Adopt auction rules that minimise the scope for predatory bidding and further efficiency.

5. Impose non-band specific roll-out obligations provisions to minimise the threat of spectrum hoarding.


Best practice in spectrum auctions - #6 and #

6. Avoid the use of auctions when an obvious distribution of available resources among operators can be readily identified, to minimise the risk of outcomes that are both perverse and unexpected.

7. Adopt licence terms that encourage efficient use of spectrum: Usage charges to reflect spectrum management costs only, long licence terms and high expectation of renewal by means of AIP.


Questions?

Stefan Zehle, MBA

Tel: +44 7974 356 258 [email protected]

CEO, Coleago Consulting Ltd

www.coleago.com

1. Choice of auction format

2. How do mobile operators value spectrum?

Additional information


Regulators should examine their national circumstances and reflect feedback from operators in their ultimate choice of auction mechanism

Choice of auction format


Three main formats are used for spectrum auctions


SMRA

Simultaneous Multi-Round Ascending auction

Bid on specific blocks of interest (between minimum and maximum set by auctioneer for each block)

‘Standing high bids’ for each lot in each round Auction ends when there is no excess demand ‘First price’: pay what you bid

CCA

Combinatorial Clock Auction

Bid on packages of generic lots rather than on individual lots Pay ‘second price’: minimum needed to win and to avoid

‘unhappy losers’ Separate assignment round for positioning in the band Also pay ‘second price’ for assignment

First-price sealed bid

Bid on individual lots First price: pay what you bid Auction ends when bids are opened

SMRA auctions with bidding on specific blocks carry a fragmentation risk

Auctioning specific blocks of spectrum in parallel may lead to non-contiguous allocations Key drawback of regular SMRA Threatens ‘technical efficiency’ Vulnerable to anti-competitive bidding (e.g. attempt to isolate individual blocks)


B1 B2 B2 B2 B2 B1 B1 B3 B4 B4 B4 B4 B3 B3

Example: Bidders B2 and B4 have contiguous allocations, while B1 and B3’s allocations are fragmented, creating significant problems for them

2500MHz& 2620MHz

2570MHz& 2690MHz

SMRA auctions lead to exposure risk

Risk of being stuck with an unwanted subset of the target package Potential value destruction: paying more than the final package is worth Key drawback of SMRA Package bidding (CCA) avoids this: either win entire package pursued or nothing

at all


1 lot 2 lots 3 lots 4 lots

Packageprice

€

Val

ues

Example: SMRA in a single band A package of 2 or 3 lots is still

profitable at current prices But one may ultimately be outbid And be left with a single,

unprofitable lot on which one is Standing Highest Bidder

‘Winner’s curse’ arises in a sealed bid auction when a bidder pays more than would have been necessary to win

Typical of first-price, sealed-bid auctions

In the first Brazilian spectrum auction in Bell South paid more than twice as much as the next highest bid for the Sao Paulo Metro licence

Can also occur under SMRA: pursuing a large package and failing can drive up the price for the smaller package ultimately secured


Winningbid price

NextHighest

bid

Over-payment

€

To avoid the winner’s curse, bidders may ‘shade’ their bids

Demand moderation strategies in SMRA auctions are analogous to bid shading SMRA invites a tacit ‘negotiation’

between rivals. The faster participants settle on the

final allocation, the less everyone pays.

But there is a risk to allocation efficiency. By reducing demand too much, a bidder could miss out on a larger package that it should otherwise have won.


Bidder’s Valuation

Expectedrival

valuation

Shadedbid value

Shaded amount =

Surplus if win

€

First price sealed bid auctions should be avoided

“Under a first price rule, there is an incentive for bidders to reduce the value of their bids to less than their full valuation in order to pay as close as possible to the minimum necessary to beat other bidders (bid shading). By doing so, they risk not winning at all when it would be efficient for them to do so” Ofcom, UK


Whoever values the resource most highly wins (economic efficiency) “2nd price” rule: pay no more than the minimum required to win Incentivises truthful bidding: no penalty for bidding full ‘walk-away value’ No unhappy loser: Bidders A and B would not have been prepared to pay more

than the price paid by Bidder C

The Second Price Rule eliminates the winner’s curse …


Bid for 1 lot 2nd price

Bidder A €40 -

Bidder B €50 -

Bidder C €100 €50

Example1: Second Price Auction for a single lot

Winner

Bidder C wins (highest bid amount) but only pays the “opportunity cost” (amount the auctioneer could have sold the lot for if Bidder C were absent)

…but this comes at a cost: a 2nd price auction for multiple lots can lead to significant pricing differentials

Allocating 1 lot to bidder A and B maximised bid value and is therefore winning The “2nd price” (or Vickrey price) is the opportunity cost imposed by each bidder

– If Bidder A were absent, the auctioneer could have sold its winning lot to Bidder B for €40 (the extra that B would pay for an additional lot = €100-€60)

– If Bidder B were absent, the auctioneer could have sold its winning lot to Bidder A for €15 (the extra that A would pay for an additional lot = €75-€60)

No-one has any grounds complain: neither Bidder A nor B were prepared to pay more to win an extra lot, and Bidder C was not prepared to pay this price for any lots


Bid for 1 lotBid for 2

lots 2nd price

Bidder A €60 €75 €40

Bidder B €60 €100 €15

Bidder C €10 €20 -

Example 2: Second Price Auction for 2 identical lots

Bidder A and B pay each other’s marginal bid values for an extra lot

Real Example: impact of second price rule in the Denmark CCA based 2.6GHz auction in 2010

Hutchison paid €0.9 million for 2x10 MHz of FDD plus 25 MHz of TDD

The other bidders who acquired 2x20 MHz FDD paid ~20x more per MHz

This dramatic outcome was a product of a second price combinatorial auction with tight spectrum caps:

– TDC, Telenor and Telia’s prices reflected Hutchison’s bid value for an additional lot of 2x10MHz FDD

– Hutchison’s 2x10MHz FDD could not have been sold to anyone else, hence the 2nd price was the reserve price

84

*Prices paid per MHz


H3G TDC Telia Telenor

The CCA format has some technical problems that are difficult to understand and communicate

A CCA format may lead to inefficient allocations due to budget constraints in conjunction with lack of visibility over price exposure.

Given the second price rule in a CCA auction, participants have limited visibility over their actual price exposure. This introduces a potentially intractable strategic dilemma for bidders who are constrained by a fixed budget rather than by their spectrum valuations. – To minimise the risk of knock out, such bidders might focus their war chest on a

smaller package. Yet in so doing, they would be forced to squeeze their marginal bids for extra resources, in order to respect the overall budget limit.

– This could prevent them from securing the larger package that, given the relative valuations and constraints of each participant, it would be efficient for them to win.

– Adopting an opposite strategy increases the chance of winning a more ambitious prize, but also the risk of walking away with nothing.


Inefficient allocations due to budget constraints in conjunction with lack of visibility over price exposure

Given the second price rule in a CCA auction, participants have limited visibility over their actual price exposure.

This introduces a potentially intractable strategic dilemma for bidders who are constrained by a fixed budget rather than by their spectrum valuations.

To minimise the risk of knock out, such bidders might focus their war chest on a smaller package. Yet in so doing, they would be forced to squeeze their marginal bids for extra resources, in order to respect the overall budget limit.

This could prevent them from securing the larger package that, given the relative valuations and constraints of each participant, it would be efficient for them to win.

Adopting an opposite strategy increases the chance of winning a more ambitious prize, but also the risk of walking away with nothing.


While no format appears to be perfect, policy makers need to consider the problems associated with each


Vulnerability of auction format CCA SMRA First-price sealed bid

Inefficient allocations due to budget constraints in conjunction with lack of visibility over price exposureMaterial price disparities, bidders end up paying different amounts per MHzRisk of predatory bidding strategies designed to raise the costs incurred rivalsInefficiencies caused by difficulties in aggregating optimal spectrum packagesEconomic inefficiencies caused by demand moderation strategiesCostly to execute, difficult to understand lack of transparency

Best practice in choice of auction format

First price sealed-bid auctions are the most distorting type of auction and should be avoided.

Second price sealed-bid auctions are better and retain simplicity.

Opinions will differ on whether CCA or SMRA is more prone to distortions overall. – The relative levels risks will also

depend on circumstances as well as the detailed rules.

Regulators should examine their national circumstances and reflect feedback from operators in their ultimate choice of auction mechanism.


Auction rules may matter more than auction formats

Rules are set to prevent gaming and vexatious bidding while ensuring that all spectrum is sold efficiently Spectrum packaging Spectrum caps Spectrum set-aside Activity rules Provision of information Bid increments Spectrum trading Reserve prices


A brief overview of the methodology operators use to value spectrum in order to set auction bid limits

How do mobile operators value spectrum?


Spectrum valuation involves comparing an operator’s enterprise value with and without the spectrum

91

Net Present Value with

NPV without

Value

Business value with the new

spectrum

Business value without the new

spectrum

Value of the new spectrum

Approach to Valuing Mobile Spectrum


Relative difference in spectrum between operators impact on the ability to serve customers and hence revenue

92Successful Spectrum Auction Design - © Copyright Coleago 2014 - www.coleago.com

Reference case

“without new spectrum”competitive disadvantage

Mor

e Sp

ectr

um

“with new spectrum”competitive advantage

Time

Cus

tom

ers

/ Rev

enue

Valuations are based on Discounted Cash Flow (DCF) analysis


Free Cash Flow ForecastNPV of 10/15 year forecast

Terminal Value

Enterprise Value

ValuationNeed to include

spectrum-licence renewal costs!$

Past

$

Sources of spectrum value may include the following


Capacity

Access speed claim

Blocking value

Geographic & in-building coverage

Impact on other business

Avoid additional site build

Technology migration

Key operational drivers of spectrum value

95

Capacity & Blocking value

Coverage footprint & Network

densification needs

Traffic

Indoor coverage quality

(lower bands)

Spectrum package

Costs of sale & overheads

Performance(2x20MHz versus

2x10MHz)

Market share Network capex & opexRevenues

Network driversCommercial drivers

Commercial impact

Costs associated with freeing up spectrum / migrating customers need to be taken into account in scenarios where existing spectrum is lost

Network impact

Successful Spectrum Auction Design - © Copyright Coleago 2014 -

Spectrum roll-out capex & opex

Network impact

Congestion puts customers and revenues at risk

96

Mbps per site

Baseline sites(ranked by peak demand)

Maximum capacity per baseline site (including max densification uplift)

Unmet demand leads to loss of customers and revenues if there’s a better alternative elsewhere

Unconstrained peak demand per site

Constrained peak demand per site

% of sitesoverloaded withoutspectrum package

If / where it is not possible to build

oneself out of congestion…

Mobile networks suffer from ‘Pareto’ effect: a minority of sites tends to carry a disproportionate amount of traffic, with the bulk of sites under-utilised


Extra capacity can drive market share

97

% of sitesoverloaded withoutspectrum package

Mbps per site

Baseline sites(ranked by peak demand)

Maximum capacity per baseline site with spectrum package

Unconstrained peak demand per site

Constrained peak demand per site

Withoutspectrum package

Extra demand addressable with spectrum package

Increase in spectrum

Need to take an industry-wide view: consider congestion levels versus any spare capacity across all operators

If / where it is not possible to build

oneself out of congestion…


The superior propagation characteristics of low band spectrum yield a higher probability of (deep) in-building service at a given performance

This may be translated in terms of a % of demand that is only addressable with low band spectrum (or with potentially expensive in-building solutions)

Indoor coverage quality also drives revenue

98

Probability of service

With spectrum below 1GHz

With spectrum above 1GHz

% DemandDeep indoor

Offer LTE performance deep indoor with 700MHz


www.coleago.com

Stefan Zehle, MBA

Tel: +44 7974 356 258 [email protected]

CEO, Coleago Consulting Ltd

best practice spectrum auction workshop india 24 sep 14

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