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Unrealistic reserve prices for the forthcoming spectrum auction in India

On the 11th of March Coleago lead a GSMA sponsored workshop for the Department of Telecommunications in India focusing on the highly unrealistic reserve prices proposed for the forthcoming spectrum auction including the 700MHz band.

It is often assumed that spectrum has value on its own. However, spectrum has no intrinsic value; investment is required to build networks that extract producer and consumer value from spectrum. Mobile operators value spectrum based on the net present value of incremental cash flows that can be generated from the investment.

The reserve prices recommended by TRAI for the spectrum to be auctioned in 2016 amount to INR 536,239 core (INR 5,362 billion) which equates to around 22 times annual free cash flow of the mobile industry in India. Even with extremely optimistic revenue growth assumptions, Indian mobile operators will not generate sufficient operating free cash flow to justify the business case for purchasing the spectrum at the prices recommended by TRAI.

If the prices recommended by TRAI are maintained, there is a high risk of auction failure with most or even all of the much needed 700MHz spectrum remaining unsold. As a result, auction proceeds would be well below the Government’s target and Indian consumers and businesses will not benefit from better 4G mobile broadband services.

TRAI’s recommendation of the reserve price is based on some inaccurate assumptions. Firstly, as described below, using the prices previously paid for 1800MHz as a benchmark is inappropriate. Secondly, the assumption that 700MHz is intrinsically four times more valuable than 1800MHz does not recognise difference between the business case at the time and the current business case.

  • At the time of India’s 1800MHz auction, the 1800MHz spectrum was already in use by the Indian mobile operators. Operators would not have been able to continue in business without retaining the spectrum. Hence the value of spectrum to operators was close to the entire Enterprise Value of their business. In contrast, the forthcoming auction offers additional spectrum and hence the value of spectrum to operators is only based on incremental cash flows that can be generated from deploying the additional spectrum.
  • TRAI assumes that, due to better propagation characteristics, 700MHz spectrum is four times as valuable to operators as 1800MHz spectrum. However, the 700MHz spectrum does not result in a cost saving because it is a complement to, not a substitute for, other spectrum. The incremental investment to deploy 4G (LTE) in the 700MHz band across India amounts to INR 75,822 Core (INR 759 billion). There will also be additional operational costs.

In a spectrum auction, reserve prices should be set with consideration of the larger policy objectives of the auction, namely the maximisation of net present value (NPV) for India and achieve the aims set out in NTP 2012 and Digital India. The NPV of spectrum for India consists of the immediate auction receipts, and the much larger multiplier effect. The multiplier effect is the focus of NTP 2012.

At the reserve price of INR 4,044 crore for the 700MHz spectrum, demand is likely to be low or even non-existent. However, if prices were reasonable, 7 or 8 operators will want two blocks of 700MHz spectrum each. The resulting demand for 14 to 16 blocks will easily outstrip the supply of 7 blocks. If reserve prices were set at, say 10% of the price recommended by TRAI, auction receipts are likely to exceed the reserve as bidders compete for spectrum and total auction proceeds would be higher because all 700MHz spectrum is likely to be sold.

TRAI recommend reserve prices vs. revenue and free cash flow

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