Telecom: Looking for a wireless winner

As new players get ready to enter the Canadian wireless market, communication industry observers say cable companies may be the ultimate survivors — but there are a few others investors should watch.

It’s been a year since Industry Canada closed its auction of wireless spectrum for new mobile communication service providers (see the info box) and the first of them are expected to begin offering service later this year or in Q1 2010. But in a market poised to jump from three national players to four, and 15 in total across various regions, communication industry observers and financial analysts are trying to figure out who among them will survive the long haul.

“The current leading players aren’t just well entrenched. They’re the wireless arms of incumbent players that have deep pockets and experience, or they’re national players,” says Lawrence Surtees, VP and principal analyst, communications research at market research company IDC Canada Ltd. “A new player has to approach the market very strategically, and very differently.”

Lacking substantial competitive differentiators, the newcomers may find it difficult to wrench market share away from national incumbents Telus Corp., Bell Canada Enterprises Inc., and Rogers Communications Inc. And without sufficient funds, the start-ups could find themselves short on staying power.

Most of the industry watchers we interviewed point to cable companies Shaw Communications Inc. in Calgary, Montreal’s Quebecor Inc. subsidiary Videotron Ltd., and Bragg Communications Inc. (EastLink) in Halifax as having the best chances of thriving.

“They have many customers who I think you could bundle the product to,” says Dvai Ghose, Toronto-based telecommunications services analyst at Genuity Capital Markets. “You have a recognizable and, in many cases, a dominant brand. … You already have existing backhaul for your cable and Internet businesses.”

But not all cable companies are created equal. Consider the differences between Shaw and Videotron.

Videotron has been bullish about ramping up wireless. The company says it’s relying on cash flow and unused credit facilities for its $800 million to $1 billion network. (The price includes $555 million spent on spectrum.) It says service will begin in the spring of 2010. It has a roaming agreement with Rogers, which should allow Videotron customers to stay connected across the country. It talks up synergies between its new wireless arm and the media assets held by parent company Quebecor Media Inc., including the TVA Group of television stations, and newspapers like Le Journal de Montréal — as well as bundling opportunities with its own Internet, TV and telephone services.

“There’s an incredible connection there,” says Marc Labelle, general manager, corporate communications. “Not only will we come out with our new services and network, it’s going to be a whole new business model for Videotron and the entire Quebecor Media organization.”

Shaw has been relatively quiet, except for a few instances in which executives have said the firm will use the $190 million spectrum it acquired in the auction (funded via a number of sources, including cash flow, debt, and proceeds from issuing class B non-voting shares) only when it feels that the time is right — when it finds network technology that would give it a competitive advantage, for instance.

Some wonder if Shaw’s future includes wireless at all. “I think they look at their spectrum as an asset to sell,” says Surtees. He explains that Shaw’s high bids in the auction helped drive up the spectrum prices, making it all the more valuable on the open market.

Others disagree. A Genuity report notes that Shaw’s executives have been more pro-wireless in public recently. Executive chair and founder JR Shaw said during the company’s Q3 2009 earnings call in May, “I think wireless is becoming more important, not just for voice, but for all modes of communication. … We want to spring off [the] infrastructure that we have to [so that we can] be the most efficient that we can be in light of the future wireless operations that we want to have.”

This suggests Shaw will develop its own network, Genuity says. “The question seems to be when, not if.”

UBS Investment Research analyst Phillip Huang believes expenditures on a new service could limit the company’s dividend growth. “We expect Shaw’s rollout to be more paced — on a city-by-city basis rather than 80% coverage at service launch in the case of Videotron. I believe Shaw will be able to use its internally generated funds to finance this project, and the company certainly has flexibility to increase its leverage.”

Genuity’s target price for Shaw’s shares is $21, with a hold recommendation because of increasing competition from Telus, which is introducing TV services in Shaw’s territory.

UBS targets Videotron (Quebecor) at $25, and calls it a buy based on the performance of the company’s cable business, which generated a 9% revenue increase year over year in Q2 2009.

Can these regionally-focused companies compete against national incumbents? Most observers seem to think so, but it will still be a challenge. In that the newcomers have spectrum in Canada’s major urban centres, “it gives them a strong presence to at least try to get market share,” says IDC Canada’s Surtees. “But if you just appear and say, ‘Here I am,’ that’s not going to do it.” The newcomers need to hammer out their market differentiators if they hope to thrive.

The cable operators aren’t the only companies worth watching. Private independents such as Data and Audio-Visual Enterprises (DAVE) Wireless Inc. and Wind Mobile (formerly Globalive Wireless Management Corp., which changed its name mid-August) have their own stories to tell.

DAVE spent $243 million in the auction and has spectrum in 10 cities. The company will focus on the biggest markets, such as Vancouver and Toronto, when it rolls out its network — complete with a U.S. roaming agreement via T Mobile USA Inc. — in early 2010. It’s owned by DAVE Investment Inc., a company controlled by John Bitove’s CSRI Inc., and Quadrangle Group LLC, a New York private investment firm.

“I think there’s opportunity to make [market] share,” through unique services such as machine-to-machine communication, SIM-card sales and other offerings not presented by established providers, says Dave Dobbin, president.

Observers point to Dobbin himself as a differentiator for DAVE. He was formerly president of Toronto Hydro Telecom Inc., where he spearheaded an initiative to blanket downtown with a Wi-Fi network. While Toronto now has numerous Wi-Fi hotspots, downtown isn’t fully covered, and Toronto Hydro Telecom sold the network to Cogeco Inc. last year.

Telecom analysts say it will cost any operator $500 million to $1.5 billion to build a wireless network, depending on a regional or national reach. With so many regional networks to build, it seems likely that DAVE faces costs in the $1 billion range. Can the company remain private and still access the requisite funds?

“We wouldn’t need to [go public],” Dobbin says. “And going IPO right now, it’s a bad time. Our partners have enough money for building the company right through operations.”

Surtees agrees. “They have some fairly sophisticated private equity people behind them,” he says. “They know money markets and they’re doing this not just for a hobby.”

Neither is Wind Mobile. The company spent $442 million to acquire spectrum in all of Canada’s major markets except Quebec, where it was out-bid. Wind is the only new entrant aiming to be Canada’s next national wireless service provider. The company expects to spend over $1 billion to roll out services.

This is a private company with deep pockets, thanks to a large and controversial partner: Orascom Telecom Holding S.A.E. (consolidated 2008 revenues of US$5 billion). One of four Orascom companies, the Egypt-based wireless service provider trades on the Cairo, Alexandria and London stock exchanges. Orascom Telecom has 80 million subscribers via subsidiaries operating in Africa, the Middle East and Asia. The company is also associated with wireless providers Wind Telecomunicazioni in Italy and Wind Hellas in Greece, via parent company Weather Investments SpA.

According to OTH’s 2008 annual report, Wind Mobile’s assets total CDN$2 billion, with liabilities of $2.2 billion and revenues of $0.

OTH holds 65.4% of Wind’s shares, and 33.2% of the voting rights. There’s the controversy. While Wind contends that it’s operating within Canadian foreign ownership rules (facilities-based communication companies can be up to 46.7% foreign-owned), Shaw and Telus requested that the CRTC investigate. At press time, the review of Wind’s ownership continued.

OTH carries US$5.2 billion in debt, and reports indicate parent Weather is also debt laden. Still, going national and partnering with OTH could give Wind a purchasing advantage, says Ken Campbell, the company’s president. “In many ways it provides scale … in purchasing everything from terminals to equipment. We actually also benefit from our shareholder relationships on that front.”

According to Surtees, financial stability is part of the battle, but it’s also important to watch the execution.

“Success may come from bringing compelling prices and solutions to the business market, beginning with small businesses,” he says. “All of the entrenched companies have their eyes on that, but I haven’t heard the newcomers making much noise. I would argue that Videotron is in a very good position by virtue of its cable network reach, and its telecom offerings in the business market.”