Canadian Telecom

Met with Dvai Ghose today.

Few disclaimers

1) I did not understand approximately 40% of the conversation – he was pulling out way too much at the same time for me to follow never mind understand... but I tried my best.

2) He was just telling the story – having said that, Globalive is VERY serious

3) Ergo, the main points to be taken away from the meeting are

a. At the end of the spectrum, Rogers will have 2 new types of entrants – cable companies and globalive

b. It will be hard to keep the kind of CAPEX to Sales ratio (currently 13-15%) that Canadian Telecos are enjoying.

c. Prepaid and Unlimited market (nonexistence will start to show up, eating away at existing teleco companies)

PROFILE OF COMPANIES

Novator – Swedish Private Equity firm – one of the funding companies of Globalive.

Orascom – “Axis of evil wireless” Based in Egypt, but has operations in all the “evil” countries like Bangladesh, Iraq, Pakistan, Zimbabwe.

That being said, here is The Story.

Right now, the auction is at 3.5 billion dollar and still going – it is projected to end at around 4 billion dollars.

This is about 2.5x the anticipated price. Why?

1. There is no restriction in ownership

2. The 40MHz that was set aside didn’t do the job properly.

3. Independent bidding – especially Globalive, backed by 2 foreign companies – Novator and Orascom. This changes things as foreign entrant was something that has been waved off.

The reason why we haven’t seen a foreign entrant is because most of other Telecos want absolute control over the space - Orascom (the major funder)’s interest lies in the economic pie instead of controlling the place. Also, their return expectation is very low.

THE REAL PROBLEM

Globalive wants to buy 10-20MHz in all the major cities of Canada – this isn’t just Vancouver Toronto Ottawa gig, they actually want the nationwide footprint.

The current landscape of Canada’s Telecom industry is very different from anything else out there. We only have one provider of GSM, no unlimited plans, prepaid customers are largely ignored and Rogers is the only real wholesaler. It has one of the highest CAPEX to Sales yield (13%) and 44% margin.

Three parts to Orascom/Globalive plan, obviously, are to introduce.

1. Wholesale

2. Prepaid

3. Unlimited Plan

All of the plans are laughable in theory and a lot of things need to be approved and done. However, it’s visible from the bids that Globalive is very serious about this plan. Projected time is 1 year, although it’s more likely that it’ll be in the range of 1-3 years.

With all the plans, the competitive advantage comes from being the low cost provider. As mentioned, Orascom will be fine with having returns that are lower than Canadian industry average – Orascom can live with lower margin and return.

Orascom also argues that since they are the largest customer of Alcatel-lucent, they can force them to build the network at cost for them. This will give them huge capital advantage. This type of vendor financing isn’t anything revolutionary, and it’s been done before, but it’ll be hard to get and is definitely the weakest part of the story.

As for the foreign ownership restriction, there is only one – foreign owner cannot own more than 47% of VOTING shares of a company. There is no debt or no non-voting share restriction. That leaves Orascom with 2 choices with Globalive – 1. Just “lend” them money, or 2. Go private placement and then flip to IPO.

THE PLAN

1. Wholesale

This is the most non-disruptive part of Orascom’s plan with Globalive.

Companies like Shaw are bidding for the spectrum because they want to sit on it and speculate – they realize that in the future, all cable companies will need part of the spectrum. The technology might not be here, but they are getting in now to avoid being left out when it arrives.

There are few rules you have to honour in order to sit on a spectrum. They are the “5 yr rules”

1. You can’t resell within 5 years

2. You have to do something with it

3. I forget.

Having no explicit plans but needing to do something with the spectrum, it is likely that Shaw will outsource network building – to Globalive/Orascom. With previously mentioned deal with Alcatel-lucent (which is NOT even half concrete yet) theoretically, they can build the network at much lower cost than what it’ll take other carriers to build.

Also, Rogers is the only wholesaler of GSM services in Canada at the moment – however after Globalive builds their towers (which took only 120 days for over million users in Latin America,) Rogers’ wholesale may be depressed.

2. Prepaid Segment

One of the major reasons why wireless penetration in Canada is so low (vs over 100% penetration in Europe) is because of ignored prepaid segment (pay-as-you-go). Postpaid ARPU is greater (average $70), and it allows for lower churn due to huge popularity(?!?) of 3 year plans forced onto customers by the telecos.

Right now the gap between payment-per-minute of prepaid airtime is ridiculously more expensive than postpaid-per-minute of airtime. Gloablive, with their low cost structure and lower hurdle rate, can really play this segment. Sure they’ll have high churn and lower margin, but they can be the niche player, serving huge number of people.

3. Unlimited Plans

Right now, Canada lacks unlimited plan – they were wildly popular

This is the reason why Canadian Telecos are majorly profitable – they lock in for long term, go for high margin postpaid customers (83% of Canada is postpaid) and they make you use your cellphones as little as possible. After all, all the major carriers run a landline service as well – they would never want you to replace your home phones! Result is that average monthly usage in Canada is 450 minutes per customer. In U.S, it’s 1100 minutes per customer.

Trouble isn’t that Globalive will eat up all the customers – the trouble is that once Globalive starts offering it, other carriers will likely have to follow. Then, they will be placed in a difficult position to make a choice between losing wireless customers vs possibility of stunting the home phone growth (cable phone for Rogers and other Cablecos) This will be disruptive on CAPEX to Sales basis.

Consumers today are pissed the most about unpredictability of their wireless bills – there is a huge demand for services The discontinued City Fido plan, which was introduced in the 2002 and gained a religious following, is going for 500-1000 dollars on craigslist.

IN SUMMARY

There are 2 “evils” to the incumbents in this spectrum race.

1. Shaw/Quebecor.

They have the brand, the bundle, financial position and customers already. These are threats to incumbents – however they won’t push for home phone replacement, because they are in that industry as well

2. Globalive

Although they have no brand and customer, they have the global scale behind them and the ability to push disruptive model.

So essentially, this has been the question of the evil that you know vs the evil you don’t know. However, with Globalive’s backing companies (Orascom, especially), the problem now becomes you will have BOTH the evils.

This by no means is suggestion that it’s the end of the world. But logically, Canada has to lose the advantage out, as U.S did – someday we will have all the carriers on similar technological level, someday it is likely that we will have unlimited plans (most likely initiated by new entrants) and although barriers to entry is high, it is not impossible. As worldwide carriers look over the world for next place to set their businesses up, Canada’s lucrative margin will keep attracting them. With their capital and ability to push the disruptive models, expectation for future profitability in Canadian Telecom industry can be significantly lowered.