Auction of New Cellular Licenses In Pakistan

Summary:
This essay debates the auction of two new cellular licenses in Pakistan and the Mobile Cellular Policy. It outlines the factors that prospective buyers of these licenses may consider in their investment decisions and issues of interest for the existing operators. The article concludes with comments on Government’s role in a deregulated telecom market place.

Current Mobile Cellular Landscape in Pakistan
Mobile Cellular Policy and the new license features
Issues of Interest for the new Cellular Operators
Issues of Interest for Existing operators
Regulatory Concerns and PTA / Government’s Role
Conclusions

New Mobile Cellular Licenses in Pakistan up for grabs:
The Government of Pakistan has recently offered for auction two new mobile cellular licenses in the country. These new operators will compete with the four existing operators, Mobilink, Ufone, Instaphone and Paktel, for Pakistan’s mobile users. Pakistan Telecommunications Authority, PTA, has stated that allowing these two new operators will attract fresh investment in the mobile sector. Right from the beginning, the prospects for the auction seem quite promising. Thirty-three parties have expressed an interest for these two coveted licenses including several prominent international firms like MCI, MTC-Vodafone, Singtel, Etisalat and Turkcell. An investors’ conference in February will be followed by the auction itself in the middle of March. Meanwhile, PTA has launched a “Mobile Cellular Policy” to clarify on the existing climate of cellular telephony and to put in writing its expected course for the next few years.

The Government and the PTA deserve credit for their efforts to attract further investment in the cellular sector in Pakistan. However, the history of cellular operations in Pakistan is less than spectacular, ever since the first licenses were issued to Paktel and Instaphone back in 1991. Mobilink was allowed in the market as the first GSM operator in 1994. Up until year 2000, these three firms catered to a tiny market size of less than 300,000 users. Cellular operations suffered a serious set back when mobile services were suspended in Karachi for a couple of years during 1995 -1997 due to law and order concerns. Foreign firms with cellular holdings, Motorola in Mobilink and Cable & Wireless in Paktel, lost interest in the Pakistani market and sold out their shares. A fourth operator – Ufone, a subsidiary of the incumbent land-line monopoly PTCL, started its cellular services in 2000. The same year, a major change was introduced in the market by implementing “Calling Party Pays” tariff structure and the sector has witnessed explosive growth ever since.

The fact is that “teledensity” in Pakistan, the number of people with access to phone services, is quite low both for fixed and mobile phones. With a country of 150 million people, cell phone users in Pakistan are less than 3 million while land-lines are around 4 million. So it appears logical that the Government is issuing these two new licenses so that more investment can be brought into the cellular sector in the country. However, when we dig deeper into the issues, the situation is not as clear as it may seem. The new Mobile Cellular Policy and the two new licenses offered for auction raise several important questions.


Section 1

Current Mobile Cellular Landscape in Pakistan:

Dec 2003 Dec 2002 Dec 1997
Mobilink 1,675,000 56% 555,860 46% 35,000 26%
Ufone 552,000 19% 134,860 11% NA
Instaphone 478,000 16% 310,450 25% 43,029 33%
Paktel 255,000 9% 217,580 18% 53,895 41%
Total 2,960,000 1,218,750 131,934

Table 1: Subscribers of each Mobile Service Provider:

Paktel: Paktel received its license in 1991 and started out as the first cellular firm in Pakistan with AMPS analog technology. It was a joint venture between Cable & Wireless and Hassan Associates. C&W later sold out due to losses in operations and network closures in Karachi. Paktel was taken over by Millicom, which also controls Instaphone. Paktel has a 9% market share.

Instaphone: It received its license in 1991 and started with AMPS service later converted to digital TDMA technology. It is a subsidiary of Millicom and has a current 16% market share. It had a large footprint in Karachi and suffered losses due to networks shutdowns in Karachi.

Mobilink: It started as a joint venture of IWC, Motorola and Saif Group in 1994 with GSM digital technology. Foreign partners later sold out and now Mobilink is a subsidiary of Orascom. It is the current market leader with 56% market share.

Ufone: Ufone started its services in year 2000 as a subsidiary of PTCL. Ufone has a GSM technology and it has also added higher data capabilities with GPRS technology. Ufone has captured a 19% market share in the last four years.

How much competition is good for business?
Why is it that Paktel and Instaphone, the initial cell phone providers are the bottom performers in the current market? One of the reasons can be network technology since these firms started with analog operations and limited network capacity and the newer operators, Mobilink and Ufone, are based on GSM technology that has enhanced capacity and additional network features. However, it is also possible that Government regulation, operational shut downs, high interconnection tariffs with PTCL, tax burdens and too much competition in a small market drove them out of their initial dominant positions. Cable & Wireless, IWC and Motorola did sell out and left the market. Why has Ufone, a firm that started just 4 years ago, been able to capture a greater market share than the incumbents? Is it the GSM technology advantage alone? Is it strong marketing? Is it the financial muscle of PTCL? Or is it that the Government policies tilt to the advantage of the new comers at the expense of the older players?

There are few examples around the world where six operators in one market successfully compete and remain profitable. In Italy the fourth operator BLU went bankrupt. In UK, there are 4 second-generation operators and a new operator with 3G technology is facing a difficult task in capturing a respectable market share. In France, there are 3 mobile operators. In Spain there are also 3 mobile operators. In Japan there are, again, 3 national operators. In USA, with a cellular user base of more than 130 million, there are 6 national operators but there are very few cities in which more than 4 operators compete directly. Scores of small wireless operators have gone bankrupt unable to compete with stronger players and difficult market conditions. The fact is that the business of wireless services requires economies of scale. Too much competition reduces profitability for the competing firms thus reducing their cash flow and hampering their ability to make future investments in the business and resulting in loss of market share and / or bankruptcy. It seems quite probable that after these new two entrants are allowed in the Pakistani cellular market, at least one and maybe two firms, will go out of business or sell out to the other competitors to consolidate their operations.


Section 2

Mobile Cellular Policy and the new license features:
The complete Mobile Cellular Policy covers 36 pages and the important aspects related to the new licenses are summarized below:
· About 3 million people have cellular phones in Pakistan with a population of 150 million people. PTA has set a target of 25 million mobile cellular subscribers by year 2018.
· For new licensees, frequency bands are available at 2*5 MHz in the 900 Band, 2*30 MHz in the 1800 Band and 2*10 MHz in the 1900 Band. The government has not clearly specified which frequency bands it plans to sell and has left the issue for debate with the new operators.
· PTA would like the current operators to also agree to the new policy and become eligible for license renewal for another 15 years, but the pricing for the new licenses for current operators will derive from the pricing of frequency that is established from the current auction.
· PTA is selling these new licenses with a technology neutral stance. The new operator can adopt a technology of its choice.
· The new licenses will be sold in direct auction. The payment for the new license will be 50% down and 50% payable in the next ten years.
· The new mobile operators will be allowed to bid for Local Loop and Long Distance / International Licenses too. If the operator does not hold a long distance license, it will have to buy the capacity from existing operators like PTCL.
· The Government would continue to extract the high incoming international call premiums as long as it can and a portion of this tariff will be added to “Access Promotion Contribution” Fund. Local cellular operators that receive international calls will also have to contribute to this fund.
· PTA will identify Significant Market Power operators, SMPs, and will regulate them further in order to create a level playing field.
· PTA has enacted a specific “Performance Bond” guarantee of 15 million dollars that will be held by PTA until the new operator meets urban and rural coverage requirements.
· PTA has allowed infrastructure sharing and the operators can arrange for infrastructure sharing with existing operators as well as enact national and international roaming arrangements.
· The call termination rates for different networks and operators will be based on cost plus return basis as supplied by the operators.
· Mobile number portability requirements will be provided within two years time.
· Different surcharges levied by PTA include Universal Service Fund – “USF”, Access Promotion Contribution – “APC”, PTA License Fee and R&D fund. On top of these charges, the Government will levy its own duties, surcharges and sales tax etc.
· PTA has declared that the current policy framework will exist for the next five years.


Section 3

Issues of Interest for the new Cellular Operators:
Some of the issues that the prospective buyers will have to resolve before buying the licenses include:

· How much to invest?
This defines the business case of the prospective buyer. A simplistic analysis would go like this. If the current market grows to 10 million users in 2010, and the new operator captures a 15% share, it comes to about 1.5 million subscribers. If the net profit per subscriber is 2$ a month, then the operator would be making 24$ a year per subscriber, tuning to $36 million profit a year with a 1.5 million subscriber base.. The Government of Pakistan has recently launched its Eurobond at 6.75%. Adding business, interest rate and currency risk, a risk premium of at least 5.25% is warranted. Thus the minimum rate of return for an international investor would be at least 12% in $ terms. In current dollars, a $300 million investment at 12% a year should return $36 million a year. Thus in this very simplistic view, a new operator is looking at a $300 million investment for this project. Making up further assumptions, if the project infrastructure costs are around 55%, operating and marketing costs are around 30%, the operator may be willing to pay 15% to the regulator for the license, resulting in a license cost of $45 million. With the performance bond set at $15 million, the operator may be willing to pay $30 million for the license itself. With the current crowd of suitors, it is quite probable that a new entrant may pay as much as $30 million or more for this license since several multinational firms with deep pockets are competing for the licenses including Vodafone, MCI and Singtel. Since the cost of infrastructure equipment for second generation GSM as well as CDMA equipment has been in a tailspin for the last three years, there will be less pricing pressure on the new operator from equipment suppliers, specially when Chinese firms like Huawei and ZTE are undercutting the western suppliers.

The Technology debate:
The technology choice for the new network is of prime importance. Should the new operator select GSM or CDMA technology? The choice of technology is important because it can provide the new entrant with product differentiation in a crowded market. Ufone is the technology leader with GSM and GPRS infrastructure. Mobilink also has a GSM network. Instaphone has a lesser significant TDMA network and its sister network Paktel is also transitioning to GSM. For the new operator, in selecting GSM technology, there are two routes to follow. Either start as a technology leader with large investments in GSM / GPRS / EDGE technology or start a phased roll out and adopt a “build as they come” approach, using infrastructure sharing and roaming arrangements to provide coverage to its users. The first approach will allow the new entrant to charge a price premium and rollout services on top of its higher speed network. The second approach would be accompanied with a price discount strategy capturing the low-end market segment in the initial phase and moving on later to the higher margin customers.

If the new operator selects CDMA technology, it might have a couple of advantages. At this time, services offered on the CDMA 1X and EVDO networks in US, Japan and Australia are much faster as compared to the GSM / GPRS /EDGE standard. Another benefit for CDMA is the enhanced network capacity and spectral efficiency in the CDMA 1X network as compared to a GSM / GPRS network and the availability of CDMA EVDO high-speed data infrastructure. If an operator wants to roll out a CDMA network, the commitment will be much higher in terms of initial capital expenditure, capex, since a nation-wide network would be required to launch service and infrastructure sharing or roaming would not be possible with existing GSM operators. On the other hand, for a GSM operator, the initial investment can be much less if roaming and infrastructure sharing are to be used. However, in the long term, there will be no product differentiation between similar GSM networks except marketing and price competition. It looks like that for a GSM based new operator in the Pakistani market, there is less risk and less return while for a new CDMA operator there is higher risk and financial commitment but it also offers a probability of higher returns in the future.

Another product feature is also worth mentioning in this debate. In the US, the most profitable operator at present is Nextel. Nextel is different from its other five operators in one important aspect of its business. Nextel is focused on business customers, much more than it focuses on consumers. The result is that Average Revenue Per User, ARPU, for Nextel is close to $80, much higher than $60 average for its competitors. The reason Nextel is more popular with businesses is its Push to Talk Technology. A PTT call is like a “walkie talkie” call. A user on one side presses a button to talk, and then after he is done releases it and then the user on the other side of the conversation can push the button and talk. This call uses a small part of the shared bandwidth thus allowing huge amounts of voice data on the network and making the PTT call extremely cheap. If a normal voice call is 10 cents, a PTT call is 2 cents a minute or less. The second benefit of PTT / Nextel service is the formation of Closed User Groups that allow one PTT user to send the voice signal to many members of his Group. For example, most taxicab drivers in New York City carry Nextel phones, since a taxi dispatch service that can send the message to several taxi drives at once enhances their business. Thus PTT is ideally suited for vertical business markets. The PTT feature and Nextel’s network is based on IDEN technology by Motorola which is not quite wide spread. However, several vendors have now implemented PTT over a CDMA network. Both Verizon Wireless and Sprint PCS in the US have rolled out PTT on their networks and cell phones supporting the feature are also available. GSM operators also like this feature but at this time it is not commercially available on GSM networks. A CDMA operator that also offers PTT service will have a clear product differentiation in the market and will be able to take market share from existing operators.

Spectrum Choices:
There is one small 5MHz band available in 900 MHz, potentially two or three 10MHz bands available in the 1800 MHz range and another 10 MHz band in the 1900 range. On a technology basis, CDMA equipment is generally available in the 850 or the 1900 band. So a prospective operator with CDMA based service would most likely buy the 1900 band. For a GSM based network, 1800 MHz band is more suitable. However, most GSM operators in Europe have a 900 MHz network supplemented by a 1800 MHz network and the phones are also available for dual band 900/1800 MHz. Would it make more sense for a new GSM operator to buy a full 10MHz band in 1800 range only or to buy a 5MHz band in 900 range in addition? Another option for the new operator would be to buy a 10MHz band in 1800 range and to roam will the existing GSM operators in the 900 range and allow them to roam into its 1800 MHz band. This option is quite feasible since PTA has already allowed for network sharing. However, written clarification from PTA should be requested if this option is seriously considered.

Hidden Costs and Surprises:
The new operators should clearly understand the various costs including PTA fees, Government surcharges, costs for long distance operations, interconnection costs with existing operators and landlines, and build these costs in their business case. The operators should also clearly understand the commitment in the performance bond and coverage obligations and build the associated costs in their license cost. The new entrants should also consider the previous experiences of C&W and Motorola and make their financial commitments in phases so as not to get bogged down in an overcrowded and over regulated market. The new entrants, if they are foreign firms, should have local partners that understand the culture, functioning of the Government and the competitive landscape so that there are no hidden surprises for the new players in the market.

Collaboration:
The new operators should look at options of infrastructure sharing and roaming arrangement costs before bidding for the license. Infrastructure sharing can reduce the initial costs of the new operator by as much as 40%. Infrastructure sharing would be more feasible for the new operators than national or regional roaming arrangements since customers’ have less preference for additional roaming charges. Paktel, the operator with the smallest market share could be a candidate for network sharing arrangements whenever its GSM transition is complete.


Section 4

Issues of Interest for Existing operators:
Although the existing four operators are not directly involved with the current auction, the entry of two new operators must be a serious concern to them. Some of the issues of interest for the existing operators include:

Price of License Renewal:
Paktel and Instaphone’s licenses are up for renewal in 2005 while Mobilink’s license is due for renewal in 2007. It looks like there is tough competition for the current license auction with several international firms interested in just two licenses. In a bidding war, the price of the spectrum will jump. The PTA will then use this inflated price of the spectrum as a basis for license renewal for the existing operators, which will definitely be much more than they would have had to pay without the current auction. So, it appears that the final pricing of the current auction will burden the existing operators at the same rate as the new entrants, not giving any credit to their previous investments and network infrastructure.

Competitive Strategies:
The existing operators must come up with a clear strategy to fight the increasing competition in the cellular market. As mentioned earlier, the small Pakistani market will not be able to sustain six mobile cellular competitors in a nationwide competition. There will be some winners and losers.
· Mobilink: Mobilink is a clear market leader with a strong nationwide footprint and a leading 46% market share. Mobilink is benefiting from its earlier entry in the market, its GSM technology and availability of a large variety of cell phone models. Mobilink needs to consolidate its lead since Ufone GSM and the new operators will certainly try to steal its customers. It should increase its presence in vertical markets and bring in GPRS to improve its data offerings.

· Ufone: Ufone, although a late entrant in the market, has gained 19% market share. Its clear differentiation has been strong consumer marketing benefiting from market knowledge of PTCL, its technological advantage in terms of GSM / GPRS services and the financial muscle of its backer PTCL. Ufone is undergoing network expansion and increased coverage to further compete with Mobilink. A growing footprint will allow Ufone to create a larger customer base and allow it to compete on economies of scale with the new entrants.

· Instaphone: Although Instaphone moved to a digital standard, TDMA, it has clearly been losing market share to its stronger GSM based competitors. With two new entrants in the local market, it looks like it will lose further market share unless it can improve its product offerings. Instaphone has two options available to it. Either execute a costly transition to a GSM network or to position itself as a discount operator catering to the low end market segment and compete on price. Both strategies have risks associated with them. Since Instaphone has bought into Paktel, it is looks like it is trying to adopt the GSM strategy via Paktel while it continues its focus on pre paid customers. However, with losing market share, Instaphone may face increasing financial pressures in the future.

· Paktel: With less than 9% market share, Paktel has a humble customer base and a difficult transition to GSM facing it. In the long term, it looks like Instaphone and Paktel will merge into one firm to consolidate their operations. A viable option for Paktel would be to aggressively seek the new entrants in the market and to collaborate for infrastructure sharing and roaming when its GSM network is operational. Thus in the short term, collaborating with the new entrants can allow it breathing space that may further lead to a full merger with Instaphone or a profitable sell out / merger with the new entrants in the long term.

Association of Mobile Operators:
The Mobile Cellular Operators should form their association in order to protect their operating rights and freedoms. In the long term, the Cellular Operators will continue to face threats from fixed lines, payphones, Wireless Local Loop operators and probable VOIP operators over narrow and broadband networks. As the number of mobile cellular operators is increasing, the industry should form its own working groups to workout interconnection tariffs, roaming agreements, network sharing arrangements, defining technology road maps and self-regulation. If the cellular industry has a unified voice and is able to resolve its own problems, there will be less need for PTA’s intervention and dispute resolution. A Cellular Operators Association can also collaborate to identify fraudulent users, share equipment black lists and to provide industry’s opinion to the Government. A relevant example is the need for cooperation between operators during the framing of the current licensing policy and the introduction of fresh competition in the cellular market.

To be or not to be? Signing on the new Mobile Policy:
The new Cellular Policy would bind the operators under new licensing, coverage and financial terms. As the auction concludes, the PTA will try to pressurize the existing operators to sign on the new policy. However, it would be more advisable for the existing operators to wait out and see how the competitive landscape changes this year after the arrival of the new operators before any new commitments are made. Besides, the Government is not offering much for the new license commitments, so a wait and see approach would be a better alternative. Paktel and Instaphone’s licenses are expiring in 2005 while Mobilink’s license is expiring in 2007. In Paktel / Instaphone’s case a wait would also allow them to consider the dynamics of the competition, and it is quite possible that a new business case may suggest a profitable deal in selling the existing infrastructure rather than renewing the license. This might be exactly what PTA, the regulator, would have in mind since it is auctioning these two new licenses just a year before Paktel / Instaphone’s licenses expire.


Section 5

Regulatory Concerns and PTA / Government’s Role:
There have been two major revolutions in recent telecommunications history. The first was the introduction of digital technology in the early seventies and the second was the commercialization of networking standards and the advent of the Internet in the nineties. Digitization of standards allowed the Telephone and Telegraph Departments around the world to grow into profitable and cash rich businesses, which in most countries were run as state owned monopolies. Cellular and Networking businesses started more or less in the private enterprise space later embraced by the public sector. The key aspect of the newer technologies has been their ability to provide a better alternative to land line communications. As Cellular and Networking businesses have grown, they have driven a wave of deregulation and privatization in the telecommunications sector in various countries. In Pakistan, the trend of deregulation, private sector participation and denationalization of PTCL and end of its monopoly are linked to these global trends. However, getting things done in Pakistan takes an extremely long time, because bureaucratic controls are held back with the inertia of older paradigms. The privatization drive for PTCL that started in early nineties is very much a subject of debate, a decade after the initial plans were made. However, the present Government is pushing much further to improve the deregulation process and its efforts are commendable.
Some of the regulatory concerns related to the Cellular Market include:

Mobile and Land-Line Competition:
Beyond the technology differences, the issue of fair competition is a subject of great debate in telecommunications. Cellular services are a serious threat to land lines in many countries around the globe and have led to the shrinking of land-lines in some countries (most countries in Europe) and to the commoditization of the land line access in others (like USA). As the price of wireless infrastructure has fallen, it is becoming much cheaper and faster to roll out cellular services than land-lines. However, if call termination charges are excessive with land lines, as is the case in Pakistan, cellular networks will always remain much more expensive than land-lines, with a clear advantage tilted in favor of the monopoly power of PTCL. If the Government is committed in increasing the teledensity in the country, which it has stated that it does, it should bring down the interconnection prices charged by PTCL and decrease the amount of taxes, surcharges and various other duties levied on the phone bill.

Technology Neutrality:
The technology neutral stance from PTA is quite interesting in the current cellular auction since earlier licenses were more specific. Paktel and Instaphone were licensed for a Mobile Cellular Technology license implying an analog AMPS system. When Mobilink was awarded a license and Paktel / Instaphone protested since they were given assurance of no new entrants in the market, the Government declared that Mobilink’s service was GSM technology and not a Mobile Cellular operation. As history has shown, Mobilink has taken a leading market share from the incumbent cellular operators. When PTCL wanted to launch its service it did so under the cover of a separate looking firm labeled “PTML” and a GSM network. However, the fact is, if it looks like PTCL and it acts like PTCL, it most probably is PTCL itself. Now, in 2004, the Government has again opened the door to two new cellular operators but this time it is with a technology neutral position. The technology neutral stance of PTA points to the realization that CDMA is now also becoming a feasible option in Pakistan. It would not be a surprise if at least one of the new operators considers a CDMA network rollout.

Deregulation at a Snail’s Pace:
When cheap infrastructure technology and user equipment has been available for so many years internationally, why does it take such a long time to get the telecommunications services rolling in Pakistan? The primary reason might be the inability of the Government to look beyond its immediate interest – the protection of the incumbent monopoly operator PTCL and the heavy taxes that the government can generate from various duties and surcharges, not to mention the hundreds of millions that it collects from international firms terminating calls to Pakistan. The Government, by protecting the dinosaur of PTCL and burdening the subscriber bills with huge taxes, essentially has been denying the public huge social and economic benefits that emerge from cheap, effective, efficient and productive telecommunication services.

Telecom as a bearer of Technology and IT exports:
The Government of Pakistan must realize a vital aspect of telecommunications. It is the backbone on which IT outsourcing from the USA is moving to India. A person with the right skill set, with access to a computer and a cheap and efficient phone line or data network, can replace an American worker easily, wherever he lives in the world. India’s IT exports to the USA could top $20 billion by year 2010. Pakistan, with a very similar workforce and competence level, is struggling to gain a foothold in the global IT landscape with exports stuck at $30 million for the last three years. Beyond labeling 911 or other political dimensions, the simple fact is that highly regulated and expensive telecommunications services are part of the problem. If Pakistan has to improve its showing in the global knowledge industry, swift deregulation must go ahead, accompanied by substantial decrease in Government taxes and a technology friendly administration in the PTA. Pakistan can hugely benefit this outsourcing wave from the US only if cheap, efficient and reliable telecommunication services are available in the country at par with western countries. The Government must realize that a rapid transformation of the telecommunications industry is a paradigm shift, to gain a strategic advantage and to grasp the opportunities offered from IT and service sector outsourcing from the US.

Investor Confidence:
Foreign Investors shy away from countries where there is no clear visibility of policies and bureaucratic flip flops in decision making make it impossible to earn any real profits from investments. Motorola and Cable & Wireless did not have very good experiences in the Pakistani Cellular market in the nineties. The present Government has followed a much clearer, transparent and investor friendly approach. However, contracts for new licenses should also be signed with a clear indication of the rights and obligations of the investors and the Government. The issues of tariff structure, call origination and termination charges, regional and international interconnection costs, numbering and routing plans, and Government duties and surcharges should be clearly laid down in binding contracts. The history of Government’s mishandling of Independent Power Producers and Hub Power fiascos should not be repeated. It affects the international credibility of the Government to make sovereign guarantees and hampers future foreign investment in the country.


CONCLUSION:
The Mobile Cellular Policy is a good first step but much more needs to be done by the PTA. The Government of Pakistan is also, finally, pushing for denationalization of PTCL and improvements in the telecommunication infrastructure in Pakistan. Foreign Investors are attracted by the market potential in Pakistan especially the explosive growth witnessed in the Mobile Cellular Sector. PTA has an obligation to create a fair market competition in the market place but too much competition can also lead to the erosion of profitability by the market participants.