2. Background

Existing spectrum licences are due to expire in 2010. The government has decided to offer renewal options to existing license holders five years before they expire. The renewal prices need to be determined using a transparent formula that can be applied on a regional basis.

Theoretically, the renewal prices should reflect the net present value (NPV) of the expected net cash flows of the holders. Assuming a given discount rate, the NPV formula in this process only requires the estimation of the change in these cash flows over time. To simplify the analysis, it is assumed that the change in cash flow in each year to 2030 is constant and that profit margins stay constant over time.¹

As a result, the change in net cash flows for broadcasters can be estimated by examining changes in revenue. This change in revenue is labelled z. Since advertising accounts for the vast majority of TV and radio revenue, z can be estimated by forecasting annual changes in advertising revenue.

The remainder of this report considers how z may best be forecast in order to develop a formula for pricing spectrum rights. The first stage of this process was a peer review of a report by Covec that contained their estimates of z. In each section we have outlined the results of a specific piece of work, based on our understanding at the time. Hence this report needs to be a read as a whole, describing the evolution of the estimation of z.

¹ It is possible that some licence holders will object to this simplification. If the growth in advertising revenue occurred disproportionately toward the end of the period then assuming constant annual growth would penalise licence holders. However this is unlikely in this instance and is not supported by the data.