Executive summary

1. The Ministry of Economic Development (“the Ministry”) has released a discussion paper on the Renewal of Management Rights for Cellular Services (“the discussion paper”).
2. The discussion paper:
   1. sets out the case-by-case review for the renewal of management rights for cellular services in the 800 MHz and 900 MHz bands; and
   2. describes a valuation methodology recommended by consultants for the renewal of the cellular spectrum, known as the incrementalODV approach (“IODV”).
3. The case-by-case review covers the following issues: future use of the bands, the level of spectrum-related investment, whether the spectrum has been used, whether the rights should be renewed, the appropriate renewal period and the appropriate pricing approach.
4. The discussion paper seeks the views of incumbent right holders and other stakeholders on pricing and other issues relevant to the case-by-case review of the renewal of management rights in the 800 MHz and 900 MHz bands.
    

Telecom’s overall view

5. Telecom welcomes the opportunity to make a submission on the discussion paper. In general, our view is that:
   1. In terms of the case-by-case review, Telecom seeks to renew all of its current holdings of 850 MHz, for a further 20 year term.
   2. The Covec model is, given the information to hand, the only model that is simple to implement, is fully transparent and results in a fair market value and return to the Crown.
   3. The Ministry’s best estimate of a fair market price can be derived from benchmarking recent New Zealand spectrum auctions and reference to the original price, using the Covec methodology. The Covec methodology extreme high and low scenarios suggest a expected value in 2011 of between $22M and $39M. Our analysis indicates the most likely scenarios value the spectrum at $22M to $23M.
   4. IODV is a theoretical model that does not reflect how, in practice management rights are defined and assigned in the New Zealand market.
   5. Our view is that IODV, as presented in the paper, is confusing and open to misinterpretation. We therefore do not consider it to be simple in application or transparent in terms of how each respondent will view it and calculate it.

Telecom’s views on IODV

6. In terms of the IODV model itself, Telecom found it difficult to assess without details of how the model will work in practice. This is because:
   1. We do not know what generic pricing inputs the Ministry will determine appropriate. Although we were asked to choose inputs based on a ‘generic’ model, there is a range of possible inputs, and the choice of input could result in very different output values. For example, if we chose 1.25 MHz as an incremental block, it would produce quite a different result from the result if we were to choose 5 MHz.
   2. As we do not have an actual model, we do not know how the Ministry will combine the various inputs. Again, the way in which the Ministry applies the inputs could result in quite different outcomes. For example, a length of renewal period could range from 1 to 20 years.
   3. IODV is technology dependent. It may therefore unfairly disadvantage technologies such as CDMA, which has different spectral requirements from GSM.
7. Therefore our comments are limited to high-level principles relating to whether IODV is likely to achieve the stated policy objectives and to the subsequent implementation of it.
8. However, IODV could in theory be worked out, if we knew the Ministry’s preferred values and how to apply them. Our key concerns with the methodology are that the model:
   1. is unlikely to produce a fair market value. This is because to reflect the market there must be a scarcity of spectrum and, as noted in the Ministry’s advisors’ reports, this does not reflect the New Zealand situation;
   2. will be difficult to apply as it relies on future forecasts that will shift the value of spectrum, according to the model, significantly. Therefore, there will be significant debate over the correct values;
   3. without worked examples, will result in incumbent right holders and other stakeholders arriving at differing outputs. This would bring into question the validity of their conclusions, comments and suggestions;
   4. should involve benchmarking with other countries in which spectrum is, like New Zealand, considered “non-scarce”.
9. Although we were unable calculate an IODV model (due to uncertainty around how it is to be applied) in terms of generic input values, we would support:
   1. Inputs based on New Zealand conditions;
   2. A single model that applies to all holders of 850/900 MHz spectrum;
   3. 1.25MHz as the incremental block because it can be is the common denominator for both CDMA and UMTS technologies;
   4. 20MHz as the base spectrum package of an optimised network;
   5. A steady state data volume growth. This is because although overall data demand is growing, substitution from other spectrum bands makes the data volume growth in individual bands steady state.
   6. 20 years renewal, with a renewal price up front. This would provide us with the necessary security of tenure to commit to large scale investments. That is, it is a sufficient term to ensure return on investment and payback on infrastructure investments may be met.
10. Telecom’s views on IODV are supported by comments made in the report provided by CRA International¹. Telecom therefore, recommends that further discussion or a workshop be held to agree a ‘generic model’, the associated input values and how they are applied. After that, we would be grateful if we could have the opportunity to review the methodologies in total as we would then be in a better position to assess which methodology is appropriate in the circumstances. If this is not possible then, we still consider Covec to be the only acceptable model, given the uncertainties around IODV. 
     

Telecom’s views on an auction

11. Telecom’s view is that we should be provided with the rules of any proposed auction as soon as possible, because the format of any auction is relevant to air views on the pricing methodology and ultimately the price. We think the opportunity to resort to an auction requires that the form of the auction be made clear in advance.
12. We also note that there are potential economic downsides to the incumbent rightholder losing its management rights. Telecom believes the policy objectives of spectrum renewal require the Ministry to consider those potential effects. In particular, the situation for an incumbent is different from a new entrant, because if an incumbent loses its management rights it may have to write-off sunk assets whereas an entrant does not. This means that the existing rightholder's valuation for keeping the spectrum is likely to be greater than an entrant’s valuation of winning spectrum by the value of the write-off. However, the efficient price is not the incumbent’s valuation but the opportunity cost to society, which in this case would be the entrant's valuation less the cost consumers would incur if the existing rights holder lost the rights.
13. Further, a cellular operator losing its spectrum would have significant impacts on the consumers of mobile services. These impacts are relevant, given Cabinet’s decision that the Ministry should consider the effect of renewal on society. In particular, if the existing rightholder lost its rights, consumers are likely to incur costs when switching to another service provider or existing provider operating at different spectrum bands. Such costs may include having to write-off current mobile phones as well as the time and effort to making the switch. The entrant or incumbent is not likely to bear these costs, therefore these costs are not likely to be factored into the auction bids. As a result, there is a risk that an auction will not result in an efficient allocation of spectrum. The MED can reduce this risk by taking into account the consumers switching costs when calculating the renewal price.
     

Confidential information

14. In this submission we have provided some confidential information. We have identified all confidential information by placing it within square brackets and marking it TCNZCI. We are providing this information in the interests of free and frank discussion with the Ministry. However, we do not consent to this information being made available to any party outside the Ministry.