OTTAWA – Let’s get this out of the way right now… Most of us were wrong. Many had assumed we would have a nice orderly, low-priced auction once there were no wild cards left in the bidding.
Analysts and other observers (us, too) made the mistake in thinking that these ultra-competitive companies would somehow quietly and quickly divvy up spectrum which boasts such excellent distance and barrier-penetrating properties as yet unseen in wireless telephony in Canada, spending only perhaps half of what was spent in the last auction – the $4.2 billion for AWS spectrum in 2008.
Not. Even. Close. Rogers alone spent $3.29 billion (well above the $1.8-$2.3 billion Bay Street analysts had assumed the entire auction would earn) in leading to its $5.2 billion announcement last week. The federal government crowed and rightly so, I guess, that: (cue Charlie Brown’s teacher in your head, because the script never changes. It was something about benefiting Canadian consumers, so, yay!).
The consensus winner of the auction is Quebecor, which grabbed spectrum in Ontario, Alberta and British Columbia at a discount (it helped that it didn’t have to compete with Wind, who pulled out of the auction at the 11th hour). The company acquired spectrum in the C1 block in all three provinces. “All in, it will pay $233 million or $0.83/MHz-POP. There will be ongoing speculation that Quebecor is preparing an expansion of its wireless business to markets outside of its core Quebec footprint,” said Tim Casey, telecom analyst for BMO in his research note to clients. “We remain skeptical (and negatively predisposed) to a national wireless strategy based on the company’s: (1) structural competitive disadvantages outside Quebec; (2) capital requirements for a national operation and (3) the negative impact on the company’s current strategy. The value of the optionality of the spectrum – that is, the ability to flip it to an incumbent or other entity – is very unclear at this time. That said, the spectrum was effectively acquired at a very attractive price.”
Another potential partner for Quebecor’s Vidéotron, now that the auction is settled, could be Verizon. Mobilicity is still for sale, as is Wind. Vidéotron, some of the initial thinking goes, could buy one or both, then be a northern, inexpensive roaming partner for Verizon (which uses spectrum in the C1 block, which Quebecor just purchased), or it could sell the spectrum directly to the big U.S. firm and partner on a build out. If Verizon is interested, that is. “Perhaps Vidéotron simply sells the spectrum to Verizon,” said Macquarie Securities analyst Greg MacDonald. “Regardless, everyone who really knows Verizon says they are still communicating an interest in Canada.”
“We believe that strong arguments could be made that the true market value of (Quebecor’s) spectrum is 3x–4x higher than what the company paid." – Vince Valentini, TD Securities
“We believe that strong arguments could be made that the true market value of (Quebecor’s) spectrum is 3x–4x higher than what the company paid,” added TD Securities analyst Vince Valentini in his note to investors. Using the average price/MHz-POP paid by Rogers, Bell and Telus of $2.38, then Quebecor's 700 MHz spectrum in Ontario, Alberta and B.C. would be worth $432 million, well above the $233 million it paid.
“We believe that owning this spectrum gives Quebecor lots of options to surface value in the future, and based on our discussions with management, we see VERY LOW odds of Quebecor investing significant capital to build or expand a wireless network in ON/AB/BC,” wrote Valentini, who outlined three scenarios for the Quebec company:
1. A new player emerges in the future with an interest in becoming a fourth wireless carrier in the three provinces. The new player would definitely want Quebecor’s 700 MHz spectrum; 2. No new fourth carrier emerges and Quebecor may sell its 700 MHz spectrum to Rogers, BCE or Telus, but under the current government, that’s highly unlikely in the near to mid-term.
Valentini’s third option says “if everything falls into Quebecor's lap at attractive prices and with favourable roaming and/or network-sharing terms, then it could pursue a very low capex fourth carrier strategy in ON/AB/BC via an acquisition of Mobilicity and/or Wind,” he wrote. “We believe we are a long way from having all of those puzzle pieces line up for Quebecor, and regulatory intervention could be required to force Rogers or another incumbent to provide economical roaming and/or network sharing.”
Then again, wrote Scotiabank analyst Jeff Fan in his breakdown of the results, “Quebecor may engage in swap discussions with Telus to get into the lower C band to enable its network sharing with RCI in Quebec.”
As for Telus and Bell, they paid $1.14 billion and $566 million, respectively, which equates to $2.05 and $1.18/MHz POP, notes Fan. “They paid a lower aggregate price than RCI but their holdings are not contiguous, which affects their ability to share the spectrum in the future. We expect BCE and Telus will engage in spectrum swap discussions with Quebecor and Bragg in due course to adjust their holdings.”
Few of the Bay Street analysts appreciated what Rogers shelled out. “Rogers paid top dollar for little lasting benefits,” wrote Fan. “The lower A and B blocks will give Rogers a network advantage due to immediate interoperability. Since the lower A and B blocks are aligned with AT&T, and Rogers operates a 3G HSPA network similar to AT&T, all of Rogers’ existing in-market devices will work on its new 700MHz spectrum as soon as it is deployed. This provides Rogers with a time to market advantage over BCE and Telus, as their spectrum holdings do not currently follow a similar device path to any large U.S. operator. In addition, Rogers’ contiguous blocks allow for greater network speed and capacity, as well as the potential for better utilization of spectrum aggregation with its existing national 850MHz holdings. These benefits do justify some of the higher cost paid relative to Telus, BCE and other carriers,” Fan writes.
"We believe Rogers did overpay relative to Telus and BCE.” – Jeff Fan, Scotiabank
“However, even though Telus and BCE do not share contiguous licenses and Quebecor does not have licenses it can leverage with Rogers (or Bragg) in a network sharing agreement (since they do not currently share contiguous blocks with Rogers), we believe these shortcomings can be rectified through spectrum swaps.
“Therefore, we believe Rogers did overpay relative to Telus and BCE.”
While Valentini said he expected Rogers to be the highest bidder for the contiguous A and B blocks in the 700 auction, “we underestimated the market value of this spectrum in an unfettered bidding war with BCE and/or Telus.” Rogers would not have bid as high as it did on its own. The back-and-forth nature of the auction rules would have necessitated at least one other party bidding as aggressively to get the price that high.
“It should be noted that the second price rule in the auction means that someone else had been willing to pay this same amount for the spectrum that Rogers purchased. The $4.32/MHz/POP paid by Rogers compares with US$4.50 paid in the U.S. 2008 700MHz auction for the top 25 markets and US$4.29 for the Verizon Block B sale to AT&T in September 2013; therefore, one could argue that Rogers paid fair market value for its spectrum,” added Valentini.
Rogers itself has been active defending the spectrum it won, circulating a briefing detailing why it is justified in paying the amount it did for the large chunks of spectrum it now has. Rogers noted the price it paid per MHz/POP is in line with the U.S. 700 MHz auction and those licenses were for 15 years, not the 20 in Canada.
Also, said it's briefing: "Rogers was the only winner of two blocks of contiguous paired spectrum across virtually all key geographic markets across Canada allowing us to deploy 20MHz of spectrum together to provide faster speeds, improved quality and capacity and enhanced network coverage in both rural and urban areas. Rogers’ existing LTE devices already operate in the lower 700MHz band. 100% of all Rogers customers with LTE devices will be able to benefit from our enhanced urban and rural networks as soon as they are deployed.
"One of the key reasons why Rogers wanted to be in the lower 700MHz band is that we wanted to be able to deploy immediately as opposed to having to wait for certain technology issues to be resolved in the upper 700MHz bands, most importantly the absence of Circuit Switched Fallback to HSPA which would have meant that we could not have been able to support voice calls for a significant period. In addition, the two blocks of lower 700MHz spectrum allows Rogers to take maximum advantage from the forthcoming LTE-Advanced capabilities to aggregate spectrum from multiple frequencies to create an even better experience for customers," says that briefing.
"Two blocks of paired 700MHz will also provide Rogers with maximum advantage when its existing 850MHz is re-farmed and converted to LTE." – RCI
Finally, "Two blocks of paired 700MHz will also provide Rogers with maximum advantage when its existing 850MHz is re-farmed and converted to LTE. This would mean that Rogers would be able to have 2x20MHz of lower band spectrum available for LTE Advanced, delivering yet more speed and capacity to benefit our customers. Rogers’ lower 700MHz band spectrum covers 99.7% of Canadian POPs, with the contiguous paired A&B blocks covering 90.7% and the C block Rogers won covering the remainder. " said the company.
Canaccord Genuity analyst Dvai Ghose also noted that the sheer amount Rogers paid also means that any potential merger with Shaw Communications (something which is rumoured about every six months, or if enough people happen to see a Rogers and Shaw exec have a coffee) is punted much farther down the road. “We believe that an RCI take out of Shaw is now even less likely… as a result of spending $3.3 billion or 15% of their market cap and 10% of their enterprise value on 700 MHz spectrum, RCI is now at 3.0x pro forma net debt to LTM EBITDA, up from 2.3x,” wrote Ghose.
The winners of the spectrum auction will be able to comment more fully on their plans for the spectrum 30 days after the end of the auction, when payments are due in full.
