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19. The management rights in the 800 MHz and 900 MHz spectrum bands, the main bands currently used for cellular services in New Zealand, will expire in 2011 and 2012. The current holders of management rights to these bands are Telecom and Vodafone. Telecom's management rights represent all of their spectrum holdings for cellular services in the 800 MHz band. Vodafone's rights for possible renewal account for approximately 66 percent of their holdings in the 900 MHz band.

The Non-Scarcity of Cellular Spectrum in New Zealand

20. In conformance with International Telecommunications Union (ITU) designations, the Government has made available to the market at least as much spectrum as that available in most European countries. New Zealand's population and population densities, however, are significantly lower than most of these countries.

21. It appears that despite the physical limits on the available quantum of spectrum, cellular spectrum in New Zealand is, in fact, in surplus relative to what is technically needed to operate networks in the country. It can, therefore, be assumed that cellular spectrum in New Zealand is 'not scarce'. This implies that the value of a marginal piece of spectrum to an operator is likely to be low, all things remaining equal. While likely, this cannot be determined with certainty as there had been sufficient demand at previous sales to lift prices well above zero.

Current Usage

22. Spectrum licences that cover the entire 800 MHz and 900 MHz band have been issued under existing management rights. Telecom uses the 800 MHz band for all of its existing cellular operations. Vodafone uses the 900 MHz band as its core network for 2G services but also uses the 1.8 GHz and 2.1 GHz bands for 2G and 3G services, respectively.

Likely Future Use

23. Recent work by the ITU study group on future cellular technologies suggests that the 800 MHz and 900 MHz bands will continue to be used for cellular services until at least 2025. These bands are currently used for 2G and 3G services and are candidate bands for 4G services, anticipated to be implemented from 2015.

24. It should be noted that, following the conclusion of the regulatory stocktake of the telecommunications sector, the Commerce Commission decided to commence a review of the mobile sector to determine the reasons for the lack of new entry into the mobile market. Ministry officials will take into account the outcome of the review and any potential implications concerning the allocation of spectrum.

Length of the Renewal Period

25. Under the case-by-case review of commercial spectrum rights, an appropriate length of the renewal period can be considered. This paper presents three options with respect to the length of the renewal period:

1. renew the management rights for 20 years, with a renewal price determined up front;
2. renew the management rights for 20 years but recalculate the renewal price using the approved methodology; or
3. renew the management rights for a period shorter than 20 years. In May 2004, Cabinet noted that in particular circumstances, it may be appropriate to make renewal offers for a term shorter than 20 years [POL Min (04) 12/1].

Pricing of Renewal Offers for Cellular Spectrum

26. The case-by-case review of commercial spectrum rights will also consider whether direct application of a price-setting formula meets policy objectives. Where it is inappropriate, such other options as an auction or valuation may be proposed.

27. The policy objectives are to approximate market value and use a methodology that is transparent and simple to implement. It must be recognised that there is a trade-off between these objectives (of accuracy and simplicity) and a balance needs to be struck between them. There is a level of uncertainty as to the extent to which any methodology would predict the outcome of an actual market transaction. A methodology that is relatively practical to implement and also has a strong underlying logic as to how it approximates market value is, therefore, desirable.

28. Covec expressed reservations on the suitability of applying the Covec formula to the cellular market. This is due to the difficulty of determining a value for the growth factor (z) with confidence for the following reasons.

1. The Covec formula requires robust industry data on historical revenues. Unlike the broadcasting industry, where revenue data as far back as 1985 is readily available, there is limited publicly available data on the revenues of cellular operators in New Zealand for the 1990s. For example, Vodafone entered the market only in 1998.
2. In using the Covec formula, it is important that the original auction prices reflected expectations that have proven to be reasonably correct. When the rights were initially allocated, the cellular market was immature compared to the current environment.
3. The formula is suited to an industry that is not subject to dramatic technological or other changes so that revenues can be expected to follow a relatively stable growth path over the longer term. The cellular industry faces significant future uncertainty, with the convergence of technologies and the introduction of high speed and high data rate services.

29. PricewaterhouseCoopers (PwC), who peer reviewed the Covec report, supported this view.

30. The Ministry decided that such concerns on the applicability of the Covec formula to the cellular market offered a reasonable ground to explore alternative approaches. The Ministry engaged PwC and the New Zealand Institute of Economic Research (NZIER) jointly to re-examine the Covec formula and assess alternative pricing approaches.

31. PwC and NZIER re-confirmed their agreement with Covec's view that the same level of confidence on the formula's applicability to the mature and relatively stable broadcast market could not be applied to the cellular market, for the same reasons stated above.

32. The standard definition of market value is the price that is struck between knowledgeable, willing but not anxious buyers and sellers, acting at arm's length. This is reflected by the price paid at auction. Market value could also be estimated by forecasting future cash flows, discounted to present value. Simulating an auction and adopting forward-looking approaches, such as a Total Service Long Run Incremental Cost approach, were initially identified but were not considered further. CRA International, the peer reviewers, advised the Ministry that, based on their international experience in asset pricing, the assumptions underlying forward-looking approaches are frequently challenged and results are established only after years of adversarial proceedings.

33. The pricing approaches examined by PwC and NZIER are listed in Table 1.

Table 1. Comparative assessment of options

Source: PwC and NZIER (2006)

34. Based on a comparative assessment of options against policy objectives [Table 1], the consultants considered incremental ODV to be the most suitable approach for the cellular market. Each of these approaches is detailed in the PwC-NZIER report, which is released with this paper.

35. There are several accepted methodologies in determining the market price, which could be at any point in a wide range of possible values. Incremental ODV may not approximate market price in the way that other methodologies do. However, given the difficulty of implementing alternative approaches, including the Covec formula, incremental ODV represents the best compromise and most practical methodology of forming an estimate of market value for cellular rights.

36. The ODV-calculated value will be checked that it is within reasonable range from New Zealand and overseas benchmark spectrum values.

Question of the Case-by-Case Review of Cellular Rights