TORONTO – While acknowledging any changes to the 700 MHz wireless auction rules at this stage are “a long shot,” telecommunications and cable analyst Jeff Fan of Scotia Capital still believes that the chances of Verizon coming to the Canadian market are less than 50%.
Simply put, there doesn’t seem to be enough of a return on what would be about a $2.7 billion investment available to the big American cellco, were it to buy Wind Canada and purchase spectrum in the auction, as has been rumoured, plus other costs.
In a research note to investors on Monday, Fan provided an update to his model of a potential Verizon Canada saying high domestic roaming costs and ongoing equipment subsidies make any opportunity the company might see somewhat unattractive – as does the ongoing public relations campaign being waged by Rogers, Telus, Bell and others to try to get the federal government to listen and change its policies.
“At this late stage… changes to the auction rules are a long shot,” writes Fan. Initial deposits declaring intentions to bid are due September 17th with the auction slated to begin January 14th. “However, from VZ's perspective, we believe the public debates add to the regulatory uncertainty that we have highlighted and will likely be an important factor in VZ's final decision.”
In his initial analysis of Verizon coming to Canada done back in July, Fan says Scotia did not put enough weight into the costs associated with roaming within Canada. While federal government policies say that the big three must make their nets available for roaming, they certainly don’t have to do it free of charge. Fan estimates that current domestic roaming rates in Canada are above $0.30/MB and while Verizon may be able to negotiate that downwards, even cutting it by a third, data use is growing at a rapid pace and that will have an effect.
“We also assume that the average data usage for a typical customer is approximately 1GB/month and the average off-net usage will be approximately 10% (or 100MB/month). This results in average roaming cost of approximately $10/month per subscriber and has a significant margin impact,” he writes.
As for smartphone subsidies, Fan said those are likely to be in the $325 per unit range, “derived from $200 revenue per smartphone and $525 cost per smartphone. Even after adjusting for the new 2-year plans’ subsidies, we believe the relative subsidy is still higher in the Canadian wireless market compared to the U.S.”
For the Scotia Capital analyst, this shows the investment prospects for Verizon are less attractive than many are assuming, with long term EBITDA service margin outlook cut from 60% to 43% compared to Fan’s last analysis; the 10-year internal rate of return would drop to 2%, below the weighted average cost of capital; and payback for Verizon would take a decade instead of eight years.
So what does this mean? Verizon may just wait for a while longer to try a move farther north. “Based on the return profile, the regulatory uncertainty, and VZ’s strong track record in capital allocation, we believe there is a <50% probability that VZ will pursue the Canadian opportunity,” he writes, alluding to how the federal government has altered its policies to suit political goals. “And if it decides to move forward, we believe the pursuit will be spectrum driven and the deployment will be very cautious and limited.
“If VZ enters the market, we do not believe it will be satisfied with being #4 for the long-term and will patiently await the opportunity to gain scale when telecom foreign ownership is fully liberalized and when the broadcasting distribution undertaking (BDU or pay-TV providers) foreign ownership policy is restructured as part of the Canadian Telecommunications Act,” writes Fan.
On the other hand… Prime Minister Stephen Harper told reporters out east on the weekend: “Our government has pursued extremely consistently and extremely clearly a policy of fostering greater competition in this industry for the benefit of consumers,” said a number of reports. “We have every intention of continuing that policy… including proceeding with the auction as we have laid out.”
That means, to BMO Nesbitt Burns analyst Tim Casey, “the likelihood that Verizon… will enter the market has increased, at the margin,” he told investors over the weekend in a note of his own. “We expect it would be 2015 before Verizon had a meaningful presence in the market, but we also expect incumbents would ‘front run’,” meaning we’d see a number of promotional discounts from the big three and others – which would injure the bottom lines of all wireless players in Canada.
Of course, few know what is actually going to happen, but we might find out more today on Verizon’s Canadian plans when chief financial officer Francis Shammo speaks at the Oppenheimer 16th Annual Technology, Internet & Communications Conference in Boston at 12:30 p.m. ET. We’ll be listening in and you can too by clicking here.
