Quantum Leap: Telus moves aggressively into the east

With its bold $6.6B buyout of Clearnet Communications, TELUS Communications has acquired not only a national footprint for its wireless network, gaining in the process a vehicle for improved brand recognition and an accelerated entry into the lucrative Ontario and Quebec telecommunications markets, home to 60% of Canada’s population.

Background
When the Stentor alliance of Canada’s former monopoly service providers collapsed, the incumbent local exchange carrier (ILEC) companies divided into two camps: TELUS in Western Canada (Alberta and British Columbia) and Bell Canada for the rest of the country. The two camps announced plans to enter each others’ markets: TELUS established TELUS Integrated Communications in the east and Bell Intrigna was established in Alberta and BC by Bell Canada in conjunction with MTS.

Clearnet was one of four national licensed PCS/Cellular networks, with about 10% market share. On the breakup of the Stentor alliance, their cellular affiliates, known as Mobility, broke up into two groups as well, but each group offered service in the other’s territory through resale. As a result, Canada really had three national companies and two regional operators.

Consolidation / Acceleration
The companies named the project Quantum Leap – moving TELUS faster into a national market position, helping to establish brand awareness, physical infrastructure and skilled human resources. The TELUS / Clearnet acquisition results in each of TELUS, Bell and Rogers-AT&T controlling about 30% of the market with Microcell holding about 10% of the market. Canada’s cellular penetration rates are still in the mid 20% range, lagging most of its trading partners. Most analysts agree that there is a significant growth opportunity in the overall Canadian market.

Industry Canada, the federal department responsible for allocating radio frequencies, has plans to auction spectrum later this year. Observers had felt that the auction was geared to facilitate TELUS and Bell acquiring capacity in the other’s territory. Now, TELUS has more spectrum than it requires, and indeed, in Western Canada, it will have more than permitted by Industry Canada rules. TELUS has stated that the acquisition saves it more than $1.5B in construction costs, and a further $0.5B in tax advantages. However, the acquisition will add Clearnet’s $2B debt to the total TELUS cost of the transaction – which was at a 50% premium to the closing share price.

Summary
The landscape for the Canadian wireless industry is strengthened by this merger. There are now two fewer participants in the spectrum auction, which will certainly result in lower spectrum costs for all industry players. The recently announced delay in the auction takes on new meaning as all the players, including the government, adjust their plans.

Canada’s 3G Wireless Auction: impact to be felt in every part of our lives!

The worldwide press has actively reported on each continuing round of the UK auction which saw total bids reach $50 Billion. The UK is auctioning five licenses, one of which, license A, is specially reserved for bidders that are not currently wireless service providers in the UK. Canadian entrepreneur Charles Sirois, through his firm Telesystem International Wireless Inc. (in partnerships with the Hutchison group of Hong Kong), won the “A” license bidding $10B (Cdn) for the right to build a third generation (3G) wireless network in the UK.

Surprisingly, there appears to be little Canadian media attention to an upcoming auction in Canada for similar 3G services. A wireless revolution is at hand yet little can be found in the press in anticipation of its impact on our everyday lives.

Background
Industry Canada plans to auction spectrum for 3G services in the fall of this year. The four incumbents have asked Industry Canada to keep their club exclusive and limit bidding to only the four of them (Clearnet, Microcell, the former Mobility Canada alliance and Rogers AT&T Wireless). Two possible new entrants, 3664341 Canada Inc. (led by Mike Kedar) and Wireless2Net.com (led by Wispra founder Joe Church) have asked for the auction to be open to newcomers and have argued that, like many countries, Canada should reserve some of the spectrum for new competitors.

Stimulating Competition = Stimulating Innovation

In their comments to Industry Canada, the newcomers encouraged the government to allocate to new entrants half of the bandwidth to be auctioned. In most other countries, policy makers have set aside spectrum for new market players, recognizing the innovation and competitive energy stimulated by fresh industry participants.

In fact, Canada has historically (in both 1983 and 1996) allocated half of the licenses for new entrants. In December 1995, 75% of the available spectrum was assigned to the new entrants, Microcell and Clearnet. At that time, Industry Canada said “Three overall objectives guide the development of Canada’s Information Highway: the creation of jobs through innovation and investment; the reinforcement of Canadian sovereignty and cultural identity; and universal access at a reasonable cost.” On April 7, 2000, Minister Manley echoed similar words: “Jobs, growth, knowledge and innovation are priorities of the Government of Canada” perhaps indicating a predisposition toward a similar encouragement of new entrants.

For internet and wireline telephony, the number of licenses is virtually unlimited and any party can enter the market to compete in accordance with the CRTC’s published regulations. For wireless services, Industry Canada manages spectrum allocations and thereby controls entry more directly than its arms’ length regulatory body. Over the next few years, we will see half of all communications carried over wireless networks. The policy for the 3G auction is therefore expected to have far reaching implications.

As we have seen in other telecommunications markets around the world and in other telecom sectors within Canada, increased competition leads to better variety and improved quality of service for consumers – at lower prices. In this way, everyone wins – consumers, service providers and investors. It is our view that only the new entrants are committed to accelerating the launch of new mobile data services and providing a showcase for Canadian applications developers. We believe that the same incentive to open wireline markets to competition should extend to the wireless sector.

With only 22% market penetration in Canada, the incumbents have plenty of room to grow within their existing spectrum allocation. The incumbents have an incentive to use the auction to hoard spectrum, block entry from new companies and then delay the investment in upgrading their networks to provide the broadband mobile data services promised by 3G technology. In the extreme case, it is clear from submissions written by Bell and Telus that their intent is to simply expand current voice services into each other’s territories. This may add a fifth choice for voice services, but does nothing to stimulate the launch of wireless, mobile internet applications.

The new data networks can be expected to complement the existing voice services and serve to stimulate the incumbents to upgrade their current capabilities to include wireless internet. In fact, 3664341 Canada has suggested that it will open its data network to other carriers in order to permit easy roaming between service providers.

Changing our lives… for the better

The future high growth technology area is the blending of wireless services with the internet. 3G blends the innovation of the World Wide Web with the mobility of personal communications to provide lower cost, always on Internet access at speeds of up to 2 Megabits per second. 3G enables Internet-on-the-go, full mobility with high speed connections. On vacation, we will be able to view local tour guides, make last-minute reservations at hotels, find and call the nearest taxi firm, or send video postcards. Cars can be equipped with map software that is always current and customized with the information needed most frequently. Business travelers can receive multi-megabit updated sales presentations while travelling to their client in the cab from the airport. Checking out could be as easy as leaving the store with a full shopping basket and confirming the charges as you load groceries into your car. While on the subway line, customers can check their stock accounts, pay a few bills and buy tickets for the movie at the theatre coming up at the next station.

If the government gets the rules right, in the next year, 3G services will enter the lives of Canadians in all sorts of ways, giving increased access to information, convenience and safety. We expect to see 3G terminals that replace the myriad of carry-along devices like phones, pagers and personal organizers. We believe 3G appliances will replace credit cards and become a kind of pocket ATM. For this reason, the early introduction of 3G is of great interest to Canadian financial institutions.

Summary

The stakes are high. Beyond the cost of the spectrum being auctioned, winners will need to spend more than a billion dollars in launching a national network. The result will be services representing the ultimate in convenience for consumers. In order to commit to such significant investments with correspondingly creation of thousands of jobs, new entrants need confirmation from the government that Canada will continue its history of encouraging competitive entry. It is our view that Canada needs to stimulate innovation in its domestic telecom services markets in order to maintain its global lead in telecommunications technology development. It is important for the government to ensure that the upcoming auction serves to stimulate competition for third generation wireless, and not serve as a barrier to entry. The best way to achieve this result is by setting aside a portion of the 3G wireless auction spectrum for new entrants.

Dividing to Conquer: Rogers and Shaw Asset Swap

Background
On March 23, Rogers Communications and Shaw Communications announced that they would swap certain cable TV properties resulting in Rogers controlling most cable customers in Eastern Canada while Shaw will dominate the west. Rogers Communications Inc. announced on February 7, 2000 that it will acquire Groupe Videotron Ltée. This resulted in the creation of Canada’s largest cable company and the seventh largest in North America, with Rogers providing service in Canada’s four largest cities (Toronto, Montreal, Vancouver and Ottawa) as well as two other top ten markets (London and Quebec City). The new arrangement transfers Vancouver to Shaw while Rogers picks up the former Fundy Cable territory in New Brunswick owned by Shaw as well as Shaw’s ownership position in Cogeco (roughly 10%), allowing equity based interest for Rogers in the portions of the Toronto/Niagara region that it does not own. Shaw picks up Rogers’ stake in satellite operator CanCom. Rogers ends up with about 3.5 million customers clustered together in Canada’s two most populous provinces, all interconnected by fiber. Shaw will have close to 2 million clustered customers in Western Canada.

Feeding Internet Content
The companies are merging @Home Canada and Excite Canada to form Excite@Canada – a broadband portal for 500,000 Canadian cable modem customers. Rogers and Shaw will jointly build a national broadband internet backbone company, using Shaw’s newly acquired cross Canada dark fibers acquired and Rogers plans to share in the Shaw investment in 360 Networks.

Competing with the phone companies
The move will permit greater consistency of network offerings for the former islands of franchises. By consolidating their territories, both Rogers and Shaw will improve their ability to broadcast marketing messages over mass media. As both companies move to increase the level of bundled services – combining offerings from the various operating units (such as @Home internet, Rogers AT&T Wireless) – the geographic consolidation eases the work for both firms in reaching their core customer bases. The role of AT&T Canada in adding voice services remains the open question for analysts. We expect to see AT&T reaching out to touch Shaw in the near future.

A Broadband Blockbuster: Rogers Acquires Videotron

Background

Rogers Communications Inc. announced on February 7, 2000 that it will acquire Groupe Videotron Ltée. This will result in the creation of Canada’s largest cable company and the seventh largest in North America, with Rogers providing service in Canada’s four largest cities (Toronto, Montreal, Vancouver and Ottawa) as well as two other top ten markets (London and Quebec City). Rogers becomes the main provider of cablevision services in Canada’s two most populous provinces, Ontario and Quebec – the home market of Bell Canada. Rogers plans to repurchase some of its outstanding shares using funds from the sale of so-called non-core assets. Such assets were said to include Rogers’ $2B holdings in AT&T Canada and Videotron’s $275M share of Microcell (a competitor to Rogers’ wireless unit). The deal, billed as creating “Canada’s largest broadband communications company” is expected to close in April subject to regulatory approvals.

Competing with Bell

Cable companies appear to be winning the battle to provide broadband residential access to the Internet. DSL has been rolled out much slower in Canada than in the US, largely due to delays in negotiating fair access for DSL collocation (a log-jam recently fixed in an industry wide settlement in late January). The consolidation of Videotron with Rogers will likely help cable maintain its lead through more consistent national branding and engineering.

Videotron is more advanced in its rollout of cable-based telephony products. It would appear that there is a regulatory loop-hole which permits long distance calls originating on an Internet Protocol integrated cable network to avoid costly local service subsidy charges – helping the economics of local phone service. Further, the residential lines provided by the cable companies will in certain cases be eligible to be on the receiving end of such subsidy payments from competing long distance companies – clearly bound to raise the ire of the incumbent Bell Canada.

Videotron represents a strong channel for Rogers AT&T Wireless services. Rogers offers a bundled VIP program in its other territories, enabling customers to benefit from subscribing to Rogers cable and wireless services. We expect Rogers AT&T Wireless to begin bundling with Videotron cable resulting in an increased share of the Quebec wireless market.

Rogers and AT&T

AT&T Canada sold its residential long distance base to Primus last year, in a move designed to shed its unprofitable business under the local subsidy scheme which saw large percentages of revenues being paid to the incumbent Bell Canada. Rogers’ close alignment to AT&T represents a new entry point to the residential market – with a very different set of economics. Rogers’ shedding its interest in AT&T Canada likely foreshadows AT&T Corp. increasing its direct holdings in Rogers. There is no need for Rogers to hold an interest in AT&T Canada when AT&T will be more closely aligned by its holdings in Rogers.

New Contribution Rates and Rules

Background
“Contribution” is the term used in Canada to refer to the subsidy from long distance services towards basic dial tone. The level of Contribution varies by province, however, it is generally in the order of 0.5¢ to 2¢ per minute per end of the call, charged in addition to switched access or egress charges.

The CRTC has updated Contribution rates for the year 2000, and has ruled against AT&T Canada and Call-Net’s applications to lower the subsidy even more due to the effect of increased volumes of minutes stimulated by flat rate calling plans. New rates are set out in the table below.

Contribution on DALs
As reported in the July 24, 1999 update, traffic sent over Dedicated Access Lines (DALs) continues to be exempt from paying contribution, and carriers will continue to apply a “DAL” surcharge on switched traffic charges. Further, at that time, the Commission determined that carriers which do not use DALs at all should be exempt from the surcharge. The surcharge was determined in Telecom Decision CRTC 99-20, released December 15, 1999.

International Issues
Western Canadian telephone companies had complained that international traffic patterns had been distorted because low contribution rates in Bell Canada territory created an incentive for traffic to use Ontario and Quebec as border crossings (thereby saving up to 2.5¢ per minute). In response, the CRTC has determined that all international traffic will attract the Bell Canada rates (about half a cent per minute), effective January 1, 2000.

Summary
As we have reported before, per minute access and contribution charges continue to be a significant issue challenging profitability for Canadian carriers. The competitors for voice services have not been able to convince the CRTC that there is a problem and there are signs of a credibility gap for the industry in presenting numbers to the Commission. There is a continuing proceeding to review the “per-minute” approach to contribution as well as the overall level of funding required to maintain affordable local service.

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