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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 stefan.zehle@coleago.com
www.coleago.com

Agenda
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Introducing Coleago Consulting

Industry trends influencing spectrum policy & management

Considerations for allocating spectrum through auctions

Available spectrum lots and competition safeguards

Reserve prices and licence payment terms

Licence terms

Licence extensions

Challenging the auction orthodoxy

Recommendations for best practice in spectrum auctions


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About Coleago Consulting

A specialist telecoms management


consulting firm

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Since 2001, Coleago has offered a wide range of advisory


services to the telecom industry
Strategy & Business Planning

Telecoms Regulation & Interconnect

Strategy Development, Marketing Strategy

Accounting Separation, Regulatory Price

MVNO and Multi-Brand Wholesale Strategy


Business Planning and Business Modelling

Control
Interconnect Cost Modelling, RIO
Regulatory Consultations

Spectrum Valuations and Auctions

Transaction Services

Spectrum Strategy

Commercial Due Diligence

Spectrum Valuation for Auctions

Tower Due Diligence

Spectrum Auction Bid Strategy and Execution

Preparation of Information Memorandum

Beauty Contest Bid Books

Mobile Network Sharing


Mobile Network Sharing

Business Transformation & Cost


Reduction

Managed Services and Outsourcing

Cost Reduction

Tower Due Diligence

Mobile Network Sharing

Network Audit

Restructuring and Turnaround


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Coleago has carried out over 70 spectrum consultation,


valuation, auction and beauty contest licence projects

Completed in 2013/4

Completed in 2012

Chile - 900/1800 and 700/AWS

Belgium - 2.6GHz

Canada - 700MHz

Netherlands - multi-band

Paraguay - multi-band

New Zealand -1800MHz spectrum

Oman - 800MHz & 2.6GHz

trading

Belgium - 800MHz

Switzerland - multi-band

New Zealand - 700MHz

Russia - 700MHz & 2.6GHz

Myanmar - greenfield

Pakistan - 2.1GHz valuation

Australia - 700MHz & 2.6GHz

Bangladesh - 2.1GHz valuation

UK - 800MHz & 2.6GHz


Sri-Lanka - 1800MHz
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Industry trends influencing


spectrum policy & management
Mobile data drives the need for
spectrum

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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

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)
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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

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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)

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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%

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Existing and new spectrum is required for mobile


broadband services
700/800 MHz

New spectrum for LTE, in some markets previously


used for TV, referred to as digital dividend bands

850/900 MHz

Originally only used for GSM, progressive


redeployment to 3G HSPA and recently to LTE

1800/1900 MHz

Originally only used for GSM, progressive


redeployment to 3G HSPA and recently to LTE

1700/2100 MHz

Currently used for 3G, upgrading to dual carrier


HSPA+, LTE deployment in the Americas

2600 MHz
?

New band for LTE


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


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

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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
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
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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 maximising auction proceeds

Promote the highest value use of

spectrum

Immediate revenue generation by

maximising auction proceeds

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
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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 safeguards
2. Reserve prices and licence payment
terms
3. License terms
4. Licence extensions or renewals

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1. Available spectrum lots and


competition safeguards
Overcoming risks associated with
fragmentation and the implications of LTE

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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

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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

PTSs spectrum strategy recognises

that spectrum which is held back and


hence not used, delivers no socioeconomic value.

The estimated total spectrum


requirements for both the RATGs
1 (pre-IMT, IMT-2000, and its
enhancements) and 2 (IMTAdvanced) 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)
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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.

New spectrum for LTE: More and


wider is better
Band

MHz

7 (2.6GHz)

2x70MHz + 40MHz TDD

28 (APT700) 2x45MHz

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.
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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

Examples

Spectrum 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)


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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.

Capex per LTE e-NodeB


70,000

The maximum downlink speed in

60,000

15MHz is 112 Mbps compared to only


35 Mbps in 5MHz.

US$

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

50,000
40,000
30,000
20,000
10,000
1 Carrier
eNodeB equipment

3 Carriers
5MHz Carrier Cost
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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)
APT Band Plan allocated in 2 x 5 MHz blocks

B1

B2

B2

B2

B2

B1

B1

B3

B3
748 MHz
& 803 MHz

703 MHz
& 758 MHz

Example: Bidders B2 and B3 have contiguous allocations, while B1s allocation


is fragmented, thus increasing deployment costs and reducing efficiency
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Market based solutions to ensure contiguous spectrum


holdings

A possible solution to prevent noncontiguous 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.
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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

These auctions introduce a significant


risk to business continuity
In Norway, incumbent Tele2 lost all of

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.

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.

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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.

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2. Reserve prices and licence


payment terms
Setting appropriate reserve prices in the
context of policy objectives

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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

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.

holdings may be exacerbated.


Potential impact of auction design
Examples
Spectrum remains unsold and hence economic India 850MHz (2012, 2013)
value is lost to the country
Australia 700MHz (2013)
Higher costs are imposed on operators than
necessary and deployment slows down

Australia 700MHz (2013)


Belgium 800MHz (2013)
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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
Australia - 5/2013
Italy - 9/2011
France - 12/2011
Portugal - 12/2011
Canada - Q4/2013
Spain - 7/2011
New Zealand - 10/2013
Finland - Q4/2013
Switzerland - 2/2012
UK - 2/2013
Sweden - 3/2011
Denmark - 6/2012
Netherlands - 12/2012
Germany - 5/2010

1.35
0.80
0.60
0.56
0.47
0.49
0.42
0.32
0.30
0.30
0.25
0.13
0.09
0.00

1.40

1.30

1.20

1.10

1.00

0.90

0.80

0.70

0.60

0.50

0.40

0.30

0.20

0.10

US$ / MHz / Pop

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The Australian reserve prices where set higher than


prices paid at auction in other countries
700/800MHz auction prices paid vs. Australian reserve prices
Australia Reserve

1.35

Average 700/800MHz

0.73

UK - 2/2013

0.65

Denmark - 6/2012

0.37

France - 12/2011

0.88

Portugal - 12/2011

0.56

Italy - 9/2011

0.81

Spain - 7/2011

0.49

Sweden - 3/2011

0.58

Germany - 5/2010

0.91

USA - 2/2008

1.28
-

0.20

0.40

0.60

0.80

US$ / MHz / Pop

1.00

1.20

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1.40
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The Australian APT 700MHz auction resulted in an loss to


society and is an example of policy failure

Potential socio-economic gain for

Between AU$ 7bn and AU$10bn

Australia?
Is the spectrum is actually used?

2x15MHz of 2x45MHz unsold

Can operators deploy the 700MHz

Only Telstra obtained 2x20MHz,

band as cost effectively?


Is there competition to drive down

prices?

hence not all of the potential socioeconomic gain is realised


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
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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

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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.

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Setting high prices for spectrum is problematic

[T]he ratio of social gains [is of] the order


of 240-to-1 in favour of services over
licence revenuesDelicate 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.

Hazlett and Munoz, What Really Matters in


Spectrum Allocation Design, 2010

In short, to maximise consumer welfare,


spectrum allocation should avoid being
distracted by side issues like government
licence revenues.
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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.

Benchmarking

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.
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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 announcement
The 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

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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.
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3. Licence terms

Applying best practice to licence terms is


likely to have beneficial impact on
investment in mobile and the socioeconomic benefits which flow from this

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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.

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An illustration of the effect of network investment on


value extracted from spectrum
Operator A

Holds 2x10MHz of

spectrum

Operator B

Holds 2x10MHz of

spectrum

Invested $300 million

Invested $600 million

2,000 sites

4,000 sites

1 million customers

1.6 million customers

Monthly MoU: 200

Monthly MoU: 220

Monthly ARPU: $10

Monthly ARPU: $11

Annual revenue:

Annual revenue:

$120.0 million

$211.2 million

There are two mobile operators in


a country.
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 Bs
customers also make more calls
and generate a higher ARPU.
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Greater network investment increases efficient use of


spectrum measured in minutes per MHz per year
Operator A

Holds 2x10MHz of

spectrum

Operator B

Holds 2x10MHz of

spectrum

Invested $300 million

Invested $600 million

2,000 sites

4,000 sites

1 million customers

1.6 million customers

Monthly MoU: 200

Monthly MoU: 220

2,400 million minutes

4,224 million minutes

per year

Both operators hold the same


amount of the scarce resource
that is spectrum
Which operator has invested
more?

Which operator is delivering more


economic benefit to the country?

per year

120.0 million minutes

211.2 million minutes

per MHz per year

per MHz per year

Which operator is passing more


traffic through a given amount
spectrum?
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Operator B experiences a lower % return on investment


but delivers greater value to the country
Operator A

Operator B

2x10

2x10

300

600

2,000

4,000

Customers million

1.0

1.6

Monthly ARPU $

10

11

120.0

211.2

EBITDA

40%

40%

EBITDA $ mn

48.0

84.5

Annual capex 5% initial

15.0

30.0

Free cash flow

33.0

54.5

11.0%

9.1%

200

220

Annual minutes mn

2,400

4,224

Minutes (mn) per year per MHz

120.0

211.2

Spectrum MHz
Investment $ mn
Number of sites

Annual revenue $ mn

Annual return on investment


Monthly minutes of use

Operator A extracts more


value for the private
investors
Operator B generates
more value for the country

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Now the government decides to levy fee of 4% of revenue


and describes it as spectrum usage charge
With 4% charge

No charge
Operator A

Operator B

Operator A

Operator B

120.0

211.2

120.0

211.2

(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

11.0%

9.1%

9.4%

7.7%

(4.8)

(8.4)

Annual revenue $ mn
Spectrum usage fee

Annual return on investment


Drop in free cash flow

Operator Bs profitability declines more that operator A and the return


on investment is even lower. A rational investor would invest less and
pursue operator As strategy. As a result the country would lose out.
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Spectrum usage charges to recover administrative costs


are consistent with spectrum policy objectives
The initial licence fee already covers the opportunity cost of allocating the
spectrum for mobile use, hence society is already adequately compensated.
A fee per MHz of spectrum:

A fee based on revenue:

Encourages operators make as much

Penalises operators who make

use of spectrum as possible, i.e.


encourages investment

Is easily calculated and transparent


Covers the cost spectrum

efficient use of spectrum

Discourages investment in the network


Reduces the socio-economic value of
spectrum

management
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.
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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, nondiscriminatory and proportionate criteria.

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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 charges
Any 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
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Best practice provides certainty over investment: Long


licence terms and expectation of renewal

15 Years

20 Years

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 renewal

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.
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4. Licence extension

Why auctions may not be appropriate for


existing spectrum rights

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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
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Auctioning spectrum due for renewal may create


asymmetries that invite predatory bidding
Licences expiring

Licence continuing for another 3 years


Operator B

Operator A
Needs to renew

Operator C

Do not have to renew spectrum, but the additional

spectrum to continue
operating, hence the
value is very high, say
$500 million.
Cash will be diverted

from investment to
paying for spectrum.

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 As investment and thus reduce


competitive pressure for B and C to invest.

Collectively the industry will end up investing less and


the socio-economic benefit of spectrum is reduced.
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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.


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Challenging the auction


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

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Spectrum auctions worked fine in past,


so whats different now?

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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
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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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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:


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

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
Threes acquisition of Orange Austria
can serve as an example.
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Alright, we are unlikely to get new network based


marketing entry, but why not still have auctions?

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Options for spectrum auctions in mature markets

New market entry unlikely

Spectrum caps to preserve


existing competition

Unfettered auction among


incumbents

Each incumbent gets a fair


share, but auction proceeds are
low because there is no real
bidding

Auction proceeds may be high,


but increased industry
consolidation and reduced
competition results

Set high
reserve prices

What then is the


point of an
auction?

Focus on
other policy
goals

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Setting high prices for spectrum is problematic

[T]he ratio of social gains [is of] the order


of 240-to-1 in favour of services over
licence revenuesDelicate 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.

Hazlett and Munoz, What Really Matters in


Spectrum Allocation Design, 2010

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 cant we simply set high prices for spectrum,


surely the industry can pay up?

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To fulfil societal goals for mobile broadband connectivity,


mobile operators require large amounts of spectrum

Radiocommunication Study Groups


Document 5D/XX-E, Sep 2012
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.
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Extracting high spectrum fees from the mobile industry is


not sustainable
Prices Paid for Spectrum
Demand for Mobile
Broadband and Spectrum
Requirement

+
LTE Deployment and
Backhaul Capex

The consequence: The only


way to maintain ROCE is to
reduce investment

Tangible (Network) and


Intangible (Spectrum)
Capex
Revenue

Impact on Operators
Balance Sheet

EBITDA
EBITDA Margin %

=
Free Cash Flow

Return on Capital
Employed (ROCE)
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When returns drop below the cost of capital, investment


ceases to flow into the industry, example Latin America

Cash flows from operations are


declining

Capital expenditure pressure is


increasing

Operators in Latin America have seen

Capex in the Latin American mobile

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 yearon-year decline.

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?

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2009 AWS auction in Chile focused on stimulating new


market entry, but resulted in policy failure
Spectrum caps guaranteed new
market entry

but failed to deliver timely


deployment and competition

A spectrum cap of 60 MHz, effectively

The new entrants were unable to

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.

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
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.


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Recommendations for best


practice in spectrum auctions
Careful choices in spectrum auctions are
required in order to maximise the socioeconomic benefit of spectrum

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A formal consultation process and rational argumentation


should precede any spectrum allocation event

Market
competitiveness

Existing total
spectrum
holdings

Policy objectives

RAN and
spectrum
sharing

Licence
duration and
extension

Supply of Spectrum

Spectrum auction
design

Demand for Spectrum


Number of operators in
a market
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Best practice in spectrum auctions #1 & #2

1. Apply spectrum floors in the event


spectrum-in-use is being reauctioned, 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.

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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.
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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.

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Questions?

Stefan Zehle, MBA


CEO, Coleago Consulting Ltd
Tel: +44 7974 356 258
www.coleago.com

stefan.zehle@coleago.com

Additional information

1. Choice of auction format


2. How do mobile operators value
spectrum?

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Choice of auction format

Regulators should examine their national


circumstances and reflect feedback from
operators in their ultimate choice of
auction mechanism

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Three main formats are used for spectrum auctions


SMRA

Bid on specific blocks of interest (between minimum and

Simultaneous
Multi-Round
Ascending
auction

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

Bid on packages of generic lots rather than on individual lots


Pay second price: minimum needed to win and to avoid

Combinatorial
Clock Auction

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
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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
2500MHz
& 2620MHz

2570MHz
& 2690MHz

Example: Bidders B2 and B4 have contiguous allocations, while B1 and


B3s allocations are fragmented, creating significant problems for them
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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
Package
price

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

Values

And be left with a single,

unprofitable lot on which one is


Standing Highest Bidder
1 lot

2 lots 3 lots 4 lots


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Winners 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
Overpayment

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
Winning
bid price

Next
Highest
bid
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To avoid the winners curse, bidders may shade their


bids
Demand moderation strategies in SMRA
auctions are analogous to bid shading

Shaded
amount =
Surplus if win

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

Bidders Expected
Valuation
rival
valuation

Shaded
bid value

efficiency. By reducing demand too


much, a bidder could miss out on a
larger package that it should otherwise
have won.

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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

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The Second Price Rule eliminates the winners curse

Example1: Second Price Auction for a single lot


Bid for 1
lot

2nd price

Bidder A

40

Bidder B

50

Bidder C

100

50

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)

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


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but this comes at a cost: a 2nd price auction for multiple


lots can lead to significant pricing differentials
Example 2: Second Price Auction for 2 identical lots
Bid for 1 lot

Bid for 2
lots

2nd price

Bidder A

60

75

40

Bidder B

60

100

15

Bidder C

10

20

Bidder A and B pay each


others marginal bid
values for an extra lot

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
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Real Example: impact of second price rule in the Denmark


CCA based 2.6GHz auction in 2010
Hutchison paid 0.9 million for 2x10

Prices paid per MHz

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 Telias prices


reflected Hutchisons bid value for
an additional lot of 2x10MHz FDD

Hutchisons 2x10MHz FDD could


not have been sold to anyone else,
hence the 2nd price was the
reserve price

H3G TDC Telia Telenor

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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.
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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.

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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
exposure
Material price disparities, bidders end up paying
different amounts per MHz
Risk of predatory bidding strategies designed to
raise the costs incurred rivals
Inefficiencies caused by difficulties in aggregating
optimal spectrum packages
Economic inefficiencies caused by demand
moderation strategies
Costly to execute, difficult to understand lack of
transparency
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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.
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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

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How do mobile operators value


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

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Spectrum valuation involves comparing an operators


enterprise value with and without the spectrum

Approach to Valuing Mobile Spectrum


Business value
with the new
spectrum
Business value
without the new
spectrum
Value of the new
spectrum

Net Present Value with

NPV without

Value

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Relative difference in spectrum between operators impact


on the ability to serve customers and hence revenue

More Spectrum

Customers / Revenue

with new spectrum


competitive advantage
Reference case

without new spectrum


competitive disadvantage
Time
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Valuations are based on Discounted Cash Flow (DCF)


analysis

Past

Free Cash Flow Forecast

Need to include
spectrum-licence
Valuation
renewal costs!

NPV of
10/15 year
forecast

Terminal
Value

Enterprise
Value

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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

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Key operational drivers of spectrum value


Spectrum package

Network impact

Commercial drivers

Capacity &
Blocking value

Indoor coverage
quality
(lower bands)

Spectrum roll-out
capex & opex

Network drivers

Performance
(2x20MHz versus
2x10MHz)

Coverage footprint
& Network
densification
needs

Commercial impact
Revenues

Market share

Traffic

Network impact

Network
capex & opex

Costs of sale & overheads

Costs associated with freeing up spectrum / migrating customers need to be taken into
account in scenarios where existing spectrum is lost
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Congestion puts customers and revenues at risk


Mbps per
site
Unconstrained peak
demand per site
Unmet demand
leads to loss of
customers and
revenues if
theres a better
alternative
elsewhere

Constrained peak
demand per site

% of sites
overloaded without
spectrum package

If / where it is not
possible to build
oneself out of
congestion

Maximum capacity per


baseline site (including
max densification uplift)

Baseline sites
(ranked by peak demand)

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
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Extra capacity can drive market share


Mbps per
site

If / where it is not
possible to build
oneself out of
congestion

Unconstrained peak
demand per site
Constrained peak
demand per site

Maximum capacity per baseline


site with spectrum package

Extra demand
addressable with
spectrum package

Increase in
spectrum

% of sites
overloaded without
spectrum package

Without
spectrum
package

Baseline sites
(ranked by peak demand)

Need to take an industry-wide view: consider congestion levels versus any spare
capacity across all operators
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Indoor coverage quality also drives revenue

Probability of
service
With spectrum
below 1GHz
With spectrum
above 1GHz

Offer LTE
performance
deep indoor
with 700MHz
Deep indoor

% Demand

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)


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Stefan Zehle, MBA


CEO, Coleago Consulting Ltd
Tel: +44 7974 356 258

stefan.zehle@coleago.com