Mark Goldberg


www.mhgoldberg.com





Canadian capital calculations

In The Daily on Wednesday, Statistics Canada reported “Capital expenditures on Canadian infrastructure, 2018”. The statistical agency reported that total capital spending on Canadian infrastructure in 2018 was $93.3B.

An associated table [Table 34-10-0280-01 Capital expenditures, infrastructure assets, by ownership] provides a breakdown by category and ownership, indicating that $5.128B of the 2018 total was for “Communications networks” infrastructure, of which nearly 99% ($5.063B) was in the hands of the private sector.

This caught my eye. The figure seemed lighter than I expected. So I decided to take a look at the annual reports for the major carriers that file public reports to see what was reported for 2018 capital.

2018 Capital Spending
Bell Wireless and Wireline $3.857 B
TELUS Capital expenditures $2.914 B
Rogers Wireless & Cable $2.515 B
Shaw Cable & Telecommunications PP&E additions $578 M
Quebecor Telecommunications PP&E $517 M
Total $10.381B

So, looking at just the 5 largest public reporting mobile companies, we see more than double the amount of capital spending in telecommunications than Statistics Canada reported. Note that the table above excluded media spending by the integrated companies. The table also excludes Cogeco, privately held Eastlink and Xplornet, crown-owned Sasktel, and the hundreds of smaller carriers that deployed communications infrastructure in 2018.

We will try to find out why the capital spending figures are so different from the Communications Networks infrastructure numbers released by Statistics Canada.

Developing good public policy for telecom

A friend of mine in government once told me that what may be good public policy doesn’t always make for good politics. And vice versa.

I nodded in agreement, but thought that strong political leaders should be able to help lead public opinion to support good policy, and failing that, should be willing to do what is right, not necessarily falling back on the easy route of doing what is popular.

An Intelligence Memo was released last week by the CD Howe Institute entitled “Coronavirus Crisis Shows Value of Robust Digital Infrastructure”.

In that memo, William Robson and Grant Bishop observe that Canadian telecommunications services have “held up robustly” to the unprecedented traffic demand levels created by Canadians shut-in by work-place closures and the isolation measures in the effort to contain the COVID-19 virus. The Intelligence Memo says “Lower quality networks would have buckled under the increased demand.”

“Why did this acceleration in digital activity and heightened virtual connectivity work? Because generations of technological progress and physical investment now deliver unprecedented amounts of data across wires and airwaves close to the speed of light.”

The memo refers to a report from BCG’s Centre for Canada’s Future (about which I wrote in late January), highlighting “the history of capital investments in Canadian telecommunications facilities that have yielded world-leading network quality.”

The memo concludes with a message to policy makers: “Recent experience demonstrates that, whatever discontents the federal government may be channeling, the quality and coverage of Canada’s networks, the cost of services, and the variety of platforms and carriers available, is impressive. Our telecommunications infrastructure is a vital asset. Good public policy should strengthen it.”

If good telecom policy isn’t working out to be good politics, strong political leaders will lead and do what’s right.

Did we mention telecommunications is essential?

As various jurisdictions increase restrictions on movement in an attempt to slow the spread of the COVID-19 virus, Canada’s two largest provinces, Ontario and Quebec announced the mandatory closure of non-essential workplaces effective tonight (March 24) at midnight.

So, what is an essential workplace? The Government of Ontario released a list last night. Many of the locations were expected, such as grocery stores and pharmacies. Some were greeted with a measure of relief, such as liquor, wine and beer stores. For those who can’t cook, or those who just a need a little more variety, they will be pleased to see that “Restaurants and other food facilities that prepare and serve food, but only for delivery or takeaway, together with food delivery services” made the list of essential workplaces.

Did I mention telecommunications? It is captured in a section with its own heading:

Telecommunications and IT Infrastructure/Service Providers
14. Businesses engaged in providing or supporting Information Technology (IT) including online services, software products and related services, as well as the technical facilities such as data centres and other network facilities necessary for their operation and delivery; 
15. Businesses providing telecommunications services (phone, internet, radio, cell phones etc) as well as support facilities such as call centres necessary for their operation and delivery;

The province then lists a number of other areas: Transportation, Manufacturing and Production, Agriculture and food production, Construction, Financial activities, Resources, Environmental Services, Utilities and Community Services, which includes waste collection, water, power, natural gas, roads, police, fire.

Oh, did we include telecommunications on the list? I’m glad you asked. Despite already being listed near the top of the list, telecommunications shows up again, alongside newspaper publishers and radio and television broadcasters:

Communications Industries
43. Newspaper publishers;
44. Radio & Television Broadcasting;
45. Telecommunications providers;

Anyone doubting whether telecommunications is essential? Just ask the Premier of Ontario. You won’t get an argument from me.

Investing in the communications sector

When Quebecor reported its results on March 12, Scotiabank observed that it beat analyst estimates for EBITDA, its Free Cash Flow estimates for 2020 and 2021 were raised substantially, its dividend was increased 78%. Still, the company’s stock price fell 11% that day.

These are difficult days in the investment markets. Scotiabank said “With both Canadian and global markets in turmoil, we believe the telecommunications space is a good place to hide” (March 10). In a follow-up late last week, Scotia said, “Communication services are critical during the current COVID-19 crisis. Our financial estimates are not immune to reductions, and the impact could come in waves, but we believe our telecom and cable financial estimates will be more resilient than media and many other sectors.”

Similarly, when TD Securities issued its report “Lowering Estimates for COVID 19”, it said “we want to make it clear that the point of this analysis is to identify opportunities as opposed to highlighting risk. Most of the names we cover are high-quality companies with defensive business models, sustainable dividends, and strong balance sheets.” TD is estimating that net additions for Canada’s wireless industry will decline 10% for the year, due to its estimate of a 30% reduction in net additions in the first 2 quarters of the year. Be sure to note this is a reduction in net additions, not a reduction in total subscribers. Offsetting the reduction in net additions, TD believes churn will be reduced by 0.3 percentage points. “The fact that many of these stocks have sold off as much as the overall market is illogical, in our view, … and we believe it has created some incredible buying opportunities on a risk-reward basis.”

Scotiabank noted “An area we are monitoring closely is network capacity.” So far, the networks for the major carriers are performing well. Still, it was fascinating to see a warning from Open Media, asking its followers to “Be considerate in your internet use”, and suggesting that people “try to keep downloads to sleeping hours when people are less likely to be accessing essential services and information on the web.” It is good advice, but I found it interesting to note that this message didn’t come from service providers.

So far, the networks have performed remarkably well under the stress of increased loads, and service providers have tried to provide some relief for their customers facing significant changes to how they use communications services as a result of quarantines and “social distancing” that has closed schools and sent most people home from work.

As Scotiabank observed,

Telcos and cablecos have stepped up their efforts during the COVID-19 crisis. We started this note by highlighting just how important communication services are during this current time of crisis, as more people are working remotely. We were pleased to see that all of the companies have taken important steps to ensure that services not only remain uninterrupted regardless of their customers’ circumstances but also, in many cases, are enhanced to address more work and entertainment at home.

An opinion piece by Rita Trichur in the Globe and Mail last week said the current pandemic is providing all of us with a better appreciation of how dependent we are on their smartphones. “Data use is surging on wireless networks as more people work remotely, banks encourage customers to use mobile apps instead of visiting branches and Canadians of all ages turn to social media to stay connected and informed.”

The telecom industry has stepped up to the challenge of handling the disruptions on our lives imposed by the COVID-19 pandemic. As Canada’s policy chiefs begin to examine how to respond to a new state of normalcy, the Prime Minister’s Office needs to re-examine the mandates handed to members of Cabinet. Targets that may have seemed appropriate last fall no longer fit within an environment that has yet to settle on a new equilibrium.

The Globe opinion piece concludes, “Wireless is a high-growth industry and one of Canada’s last industrial bright spots. The government’s target of a 25-per-cent price reduction always seemed arbitrary, but in light of the current crisis, it’s downright tone deaf. Ottawa should scrap it.”

There isn’t a need to focus at this time on the pricing objective; my views on such matters were detailed in posts on March 5 [“Moving the goalposts” and “Declare victory. Consumers are winning“]. But there should be a recognition by Ottawa of the value of Canada’s telecom sector as an “industrial bright spot” . Governments should be looking at ways to encourage increased employment created by further investment by the sector. Policy leaders need to explore how government can clear the path for increased capital spending, expanding capacity and extending the reach of networks.

Scotiabank’s review last week commented on the “initiatives that telcos and cablecos have undertaken to help their customers and society cope during the crisis.” How can we clear roadblocks that inhibit or discourage investment? What steps can be taken to enable, and indeed encourage, telecommunications carriers to reinforce Canada’s digital infrastructure to continue to deliver world leading service quality to Canadians throughout this crisis and beyond?

Could political interference create ‘sovereign risk’ for Canada’s digital infrastructure?

A new report released this morning warns “Mandated access could impair Canada’s next generation of digital infrastructure.” The report, “Mandated Competition or Free Ride?” [pdf, 329KB], expresses “concern” that the CRTC would act on political directions to reduce wireless prices and warns of the potential impact of the Minister’s mandate letter on the perception of independence of Canadian regulatory institutions.

In the context of the CRTC’s recent Wireless Review proceeding, as well as the ongoing Cabinet appeal of last year’s wholesale broadband decision [Telecom Order CRTC 2019-288], the Competition Policy Council of the CD Howe Institute held an ”ad hoc” meeting in February to discuss the issue of mandating access to telecommunications facilities. Members of the Council highlighted a lack of clarity for what consumer price level the federal government views as “economically efficient”. The report says certain members of the Council “doubted that the federal government has an empirical basis for its [25%] price reduction target. These members believed that the federal government has established its target arbitrarily and for political aims.”

The report notes the significant risk of setting wholesale rates ‘wrong’ and says that most members of the Council were “skeptical of the institutional competence of the CRTC to consistently identify the ‘right’ regulated rates for mandating access.”

The consensus of Council members present was that competition in telecommunications services involves fast-paced technological change, long lead-time investment in facilities, multiple and highly differentiated service offerings, consumer demand for high-quality services, and rapidly evolving cost structures. All Council members were cognizant of the “enabling” impact of high-quality infrastructure for digital services on Canada’s overall competitiveness. While certain Council members contended that mandated access would provide downward pressure on consumer prices, other members were concerned that short-run price reductions would come at the expense of long-term investment incentives for next-generation facilities. Council members agreed that setting rates for access at too low a level below facilities providers’ required return on infrastructure investments would discourage future investments.

Members of the Competition Policy Council said “Setting rates for access at too low a level below facilities providers’ required return on infrastructure investments would discourage future investments.”

Council members agreed that facilities to transmit information – whether by signals over wireline infrastructure or using radio spectrum – are essential for providing communications services. The question at the core of the discussion was whether competitors ought to build their own facilities, or whether mandating access by some competitors to other competitors’ facilities is preferable.

Recording the divergent views of some members of the Council, the report takes on the tone of ‘meeting minutes’ of the debate among council members:

One group of Council members argued that the CRTC should increase mandated access – particularly by allowing MVNO access to wireless transmission facilities at regulated wholesale rates. These members contended that the CRTC should not assume that the only way to compete is to build alternative transmission systems and operate them more efficiently. In these members’ opinion, such “facilities-based competition” is an out-dated concept in the current technological setting, in which they contend great efficiencies can be generated by superior computer power and algorithms without the need of owning and running hardware transmission facilities. While acknowledging that mandated access requires close attention to appropriate access prices, this group of Council members contended that facilities-based providers would continue to have an efficient incentive for new infrastructure if the CRTC adopts a “cost plus” framework for setting rates for mandated access. That is, these members argue that rates can be calibrated to provide sufficiently high risk-adjusted returns on capital to preserve incentive for new investment at the margin.

In contrast, as discussed further below, a second group of Council members expressed scepticism that the CRTC would have the capacity to set appropriate prices for access that provide the appropriate risk-adjusted rate of return to investment in facilities.

These sceptical members contended that mandating access has failed empirically to foster durable competition. For example, certain members pointed to the CRTC’s arguably unsuccessful earlier approach to compelling unbundling of local loops for telephones in order to foster competition in voice services. Nonetheless it was the development of voice services provided through cable and fiberoptic facilities (e.g., VoIP) that ultimately produced new competitors for telephone facilities.

In this way, these members observed that regulators tend to be “backwards-looking.” That is, regulators arguably focus on static sources of competition. By assuming that existing infrastructure will be the only technology for delivering a given service, certain Council members believe that regulators run the risk of interfering in the dynamic that drives entry of durable new facilities-based competition.

The report concludes with a discussion warning of political interference in the independence of Canada’s telecommunications regulator. “If government pursues short-run political objectives at the expense of returns on long-lived infrastructure investments, certain Council members believe confidence in Canada’s regulatory regime for telecommunications will be difficult to win back.”

According to members of the Council, politically driven policy shifts that result in reduced returns on past investments will be viewed by the investment community as a form of sovereign risk “unless political decision-makers make credible commitments to an independent regulatory process grounded in consistent principles.”