3. Case-by-case reviews - process

3.1 Are there reasons for not offering new rights?

3.2 Is the price-setting formula suitable for establishing the current market value of rights?

3.2.1 Adjusting base prices

3.2.2 Establishing the growth factor

3.2.3 Alternative approaches to reallocation

3.1 Are there reasons for not offering new rights?

28. A case-by-case review is required to ensure consistency with New Zealand's international radio obligations and the general objective of maximising the value of the spectrum to society as a whole.

29. The Ministry will consider the current and likely future use of the particular spectrum, based on available market and technical information, and whether reallocation of the rights in the current form will maximise the value of the spectrum.

30. If a spectrum right has not been used over its lifetime, or there has been little or no spectrum-related investment in the band as a whole, offering the right to the present user or in the present form it is unlikely to maximise value to society.

31. Where management rights are held privately, technical parameters (e.g. frequency) for the right may be varied to facilitate alternative uses of the spectrum or to correct co-ordination issues that have arisen during tenure of the existing rights.

32. Where management rights have been retained by the Crown, spectrum licence parameters may be amended to facilitate new technologies or changed uses. Where a viable alternative use is foreseen that would require significant re-planning of the band, new spectrum licences may be offered for periods of less than 20 years.

33. If modifications proposed are minor in nature, it would normally be appropriate to offer the new rights to the current rightholder. If major changes are envisaged, a separate allocation process may be necessary.

3.2 Is the price-setting formula suitable for establishing the current market value of rights?

34. The price-setting formula is intended to approximate the true market value of the spectrum right, to be administratively simple, and to be applicable in a transparent manner. The formula may not prove to be entirely suitable for applications where:

i. The second-price tender method used in tenders 1-3 may have produced anomalous results, as a result of poor market information on the value of spectrum rights, and/or lower demand than might be presently expected.

ii. Allocations at different times have revealed wide variations in base prices for broadly comparable rights. Where the rights are comparable in terms of technology employed and the population covered by the right, simple application of the formula may lead to anomalous results between rights.

iii. Base market prices would not normally be considered reliable if rights were allocated under the transitional provisions of the Radiocommunications Act, or if technical parameters of rights to be offered differ significantly from those used to calculate base prices.

(b). calculation of offer prices for rights is administratively complex due to the number of rights and their history of amendment.

This applies particularly to spectrum licences which have complicated histories including, for example, amendments or replacements following changes to transmitter locations or powers. In such cases, tracing the history of each individual licence can be difficult and, in any case, would be unlikely to produce an authentic market value outcome.

(c). the industry is relatively immature or subject to considerable changes in technology.

In this case, base prices (V1) may be based on outdated assumptions, and the growth factor ("z") may be impossible to forecast with sufficient certainty.

(d). reliable data on historical industry revenues is not available, or it is not possible to forecast future revenues with sufficient certainty.

The growth factor ("z") for the industry that uses the band may be impracticable to calculate in such a case.

35. If the formula is not suitable in its simple form, an alternative approach may have to be used: for example, adjusting base prices or shortening the renewal period. If the base data cannot be adjusted to the particular case, the preferred option is allocation of the rights by auction.

3.2.1 Adjusting base prices

36. The Ministry will consider adjusting base prices (V1) for particular rights or groups of rights on a case-by-case basis, if base price data is not available or does not reflect market value, or to promote administrative simplicity.

Averaging

37. Appendix 2 describes a process by which spectrum licences may be adjusted by averaging "comparable rights" based on transmitters similar in location and coverage, which could be adapted to management rights or spectrum licence sets as required. This approach is further explained in PwC's April 2004 report Averaging of spectrum rights renewal prices.

38. Averaging enables a market value to be determined for a right where an authentic market price is not available for a particular right, provided robust market data is available for comparable rights. The averaging process can also ensure that licences in the same market have a common basis for their respective renewal prices, derived from market size and value, regardless of the time, method or price at which a right was originally allocated. The Ministry already implements averaging of prices within broadcasting markets to determine the value of amendments to licences, a practice with which industry is generally comfortable.

Benchmarking

39. Averaging cannot overcome an overall lack of reliable price data for a group of comparable licences. An alternative in such a case is to use benchmarking to assess reasonable values for spectrum rights. Benchmarks could be drawn from a wide range of sources: for example, secondary market transactions, spectrum rights in comparable locations, international licence allocations and fair value reporting in the financial statements of companies.

40. Benchmarking may be considered as an option at the time of the case-by-case review. An October 2003 benchmark analysis of the value of VHF rights was completed for the Ministry by PwC entitled The initial value of VHF television licences.

3.2.2 Establishing the growth factor

41. The variable "z" defines the growth rate of cashflows during the relevant renewal period, calculated as follows.

(a) Collect relevant data on industry revenues.

(b) Identify the drivers of revenue and, through regression modelling, forecast industry revenues to the end of the renewal period.

(c) Calculate the annual average growth rate of revenues during the renewal period.

42. In some cases it may be possible to forecast industry revenue with sufficient certainty only for a shorter term than 20 years. In such cases, rights may be offered with a reduced term: for example, ten years.

Finalising "z" for broadcasting markets - NZIER and Covec calculations

43. In its October 2003 report, Covec recommended that revenue growth for television and radio broadcasting markets ("z") should be derived from growth in advertising revenue, which, in turn, demonstrated a high degree of correlation with population growth. Since the television and radio industry is relatively mature and stable, Covec projected historical revenue forward on the basis of Statistics New Zealand's medium population growth forecasts. PwC agreed in its peer review that Covec's approach was not unreasonable, but did not itself evaluate or audit Covec's econometric or statistical calculations.

44. Therefore, to ensure that the values proposed were sufficiently robust, the New Zealand Institute for Economic Research (NZIER) was engaged to evaluate Covec's calculations.

45. NZIER undertook a "first principles" calculation of "z" in radio and television broadcasting markets. NZIER ultimately agreed that population growth was the most practicable proxy for revenue growth, and derived similar but slightly higher values for "z" using input data identical to Covec's, by following a different (but equally valid) econometric process. NZIER and Covec subsequently jointly recommended use of averages of the values derived from the two independent analyses. This joint recommendation is adopted in this discussion paper. NZIER's report on this process is Pricing radio and television spectrum licences: Estimates of advertising revenue growth (May 2004).

3.2.3 Alternative approaches to reallocation

46. If the price-setting formula does not prove to be suitable, the Ministry's preferred policy option is to allocate rights by auction.

47. An alternative but non-preferred approach, of fully valuing the business, might generate an indication of the value of the spectrum, but would be complex and time consuming to apply, particularly as valuation would have to be based on information unlikely to be publicly available. A valuation approach may also tend to find the deprival value of the spectrum to the current rightholder, rather than market value.²

2. Do you consider the case-by case review process described in this section, including application of the price-setting formula and adjustment of formula inputs, to be satisfactory?

3. Are there additional matters that should be considered as part of any case-by-case review?

4. What criteria would you suggest to identify "unused" spectrum licences?

²In an auction, the winner pays one bid increment higher than the value placed on the right by the second highest bidder.