4G (LTE Advanced) mobile internet auction: Mobile telephone companies in The Netherlands stepped in the same trap twice. Why the prospects for decent profits on mobile internet are even worse than in the time of UMTS.

Fool me once: shame on you…

Fool me twice: shame on me…

American proverb

In the ‘magical’ year 2000, the mother of all auctions for the telecom industry has been held in Europe: the auction of various UMTS lots (the first broadband mobile internet protocol) in a.o Germany, the United Kingdom and six other countries in Europe yielded record amounts to the money-hungry governments.

Especially the UMTS auctions in the United Kingdom (€39 bln), Germany (€48 bln) and (to a lesser degree) France (€20 bln) hit the jackpot for the governments. The following table is courtesy of Eric van Damme from the Tilburg University in The Netherlands.

Data courtesy of Eric van Damme, Tilburg University
Click to enlarge

The auctions had been so extremely successful in especially Germany and the UK that the Dutch government was overwhelmed when the Dutch UMTS auction ‘only’ yielded a pitiful €2. 7 bln, instead of the €9 bln that had been forecasted by finance minister Zalm. The Dutch government even ordered an investigation into the bids of Versatel (now Tele2 The Netherlands and one of my former employers) and Telfort, as it suspected foul play in the bidding process.

At the time, I was flabbergasted by the fact that the foolish and shortsighted telephone companies got stuck in a feeding frenzy to buy these UMTS frequencies and eventually offered these brainless amounts that they – in my humble opinion – hardly could earn back through sales of telephone subscriptions, telephone minutes and MB’s of data traffic.

If we do the math, you will see my point:

Germany had about 79 million inhabitants in 2000.

I estimate that Germany needed 25,000 UMTS antenna installations and switches for country-wide UMTS coverage (i.e. 25,000 nodes), based on the data from an article, written by telecom guru Eildert van Dijken in 2010. 

In that article Van Dijken stated that The Netherlands needed 3,000 UMTS antennas and basestations for country-wide coverage (link in Dutch). Germany has about 8.5 times as much territory as The Netherlands. Exact numbers might differ slightly, of course.

In the mentioned article, the total costs per node for LTE [Advanced] (i.e. Long Term Evolution; the modern variety of UMTS) have been estimated between €100,000 and €500,000 per node. However, in the year 2000, the UMTS technology was radically different from the previous technologies. It was also much more complicated than the current, new LTE protocol and needed new antennas, basestations and other new infrastructure everywhere. Therefore I estimated the costs per node at €750,000.

When 2/3 of the Germany population (i.e. 53 million) would take an UMTS subscription on their telephone (which obviously not all 53 million people did) and the UMTS installations and license would be depreciated / amortized in eight years (a considerable amount of time when you consider the speed of innovation and development), than every subscriber (!) had to yield an average profit of €160 per year to earn back the investments per node alone. This profit per subscriber would of course go up, when the number of subscribers would be less than 53 million.

Combined, all telco operators in Germany needed a necessary profit of €8.5 bln per year for eight years in a row to earn back the fixed costs alone. 

However, next to the fixed costs, there are variable costs of about €11,000 per telephone company per node per month (see again the article by Eildert van Dijken). This brought the operational costs for UMTS per year to at least €3.3 bln per telephone company for Germany, excluding all other overhead costs, like management, business administration, customer service and marketing costs.

Do you agree with me that this was a mission impossible in Germany and the UK? I truly hope so!

I dare to say that UMTS has not earned any telephone company one cent of real profit, if you leave loss compensation by the Internal Revenue Services and (probably) quicker amortization of the license-costs out of the equasion. Telephone calls and especially SMS have been the cash cows over the years that yielded the real profits. UMTS has been ‘dead on arrival’! 

Please prove me wrong with real evidence (data) if you can!

• It is a fact that the dotcom crisis started quite soon after the UMTS auctions. I am certain that the UMTS disaster in Europe has aided to this crisis! 
• It is another fact that KPN Telecom has been at the brink of defaulting, due to the costs of their investments in UMTS in The Netherlands and Germany. 
• And finally, it is a fact that the UMTS auctions were the beginning of a massive shakeout in the European telecom industry that changed the telecom landscape fundamentally.

After this disaster, it seemed that the Dutch telephone companies had learned their lessons the hard way. A previous auction of regular LTE (one step less advanced than "4G") in 2010 yielded about €300 million, which brought the total investment per telco for deploying LTE to about €1 bln (3000 nodes * approx. €300,000 + approx. €65 mln in license costs). This was still a considerable amount, but not impossible to earn back in those days, as SMS and telephone calls were still cash cows at the time.

However, last year the playing field changed considerably. People increasingly discovered apps like Whatsapp, Ping and Skype on their smartphones and were more and more reluctant to use the very expensive SMS services and telephone calls from the telco’s.

Instead they used these (almost) free apps, which required only a little amount of MB’s. In The Netherlands, the telco’s tried to pinch off these free apps, forcing their subscribers to use their official services. However, this attempt to (illegally) protect that market share was fortunately tackled by Dutch parliament.

My take has been and will be that internet and mobile computing will turn into a utility that will become as normal as electric light, gas and water. These mobile computing services could earn the telco’s as utility companies a decent profit, but nothing more than that:

In my opinion fixed internet and mobile internet will become normal utilities in the near future, just like electricity is a normal utility. You don’t think about it, you don’t compare it often with the offers of other providers (maybe only once a year when the contract expires)… It just needs to be there, when you plug it in; at the highest quality and against the lowest possible price.

Currently, there are lots of tricks and stunts that telecom providers pull to keep customers under contract, while paying lots of money:

• exclusive phone contracts (Apple(!)) with high subscription and usage fees; 
• cheap or free smartphones (non-Apple) with high subscription and usage fees; 
• opaque contracts and subscription forms that are impossible to comprehend for normal citizens; 
• contract-limits for data usage; 
• very expensive data usage beyond the contract-limits;
• pinched-off access to free apps that substitute dearly paid telecom services; 

I think this business model will disappear, only to be replaced with a business model that treats fixed and mobile internet as a utility. The customer buys a phone and pays a very limited fee per month for internet bandwidth. All ´classic´ telephone actions (calling, SMS-ing) will go via IP connections, as there is no need anymore to use the classic digital voice or data connections.

However, that is not how the telephone companies in The Netherlands are thinking about their future.

Yesterday, I was flabbergasted to read that an auction of LTE Advanced in The Netherlands (a true 4G mobile computing protocol) yielded no less than €3.8 bln: even more than the considerable €2.7 bln that had been paid for the UMTS licenses in 2000.

KPN Telecom, the biggest provider of mobile computing services in The Netherlands has paid no less than €1.35 billion for its lot. Its shareholders have to pay dearly for this ‘successful’ auction, according to an article in Het Financieele Dagblad (www.fd.nl) of today. Here are the pertinent snips of this article:

KPN cuts deeper in dividends after expensive auction for mobile internet

Telecom company KPN almost fully abandoned its policy of dividend payments for 2012 and 2013, in order to be able to afford its recent expense of €1.35 bln for new frequency space for telecom and internet traffic.

This became clear on Friday, 14 December, 2012 after the stock exchange had closed. CEO Eelco Blok of KPN responded that evening that the price that KPN had paid for the frequencies had been ‘considerable’. Still, he is convinced that KPN will earn sufficient yields on it. The service to customers has been secured for another 17 years and the new spectrum makes mobile data traffic more than ten times quicker than the current maximum, according to Blok.

However, just like other players in the industry, KPN seemed to be surprised by the price that had to paid for these warranties. The telco behemoth scrapped the closing dividend for 2012 and will reduce the dividend for 2013 to €0.03 per share from €0.35 per share. This action released €800 mln, but Blok could not tell yesterday, whether this amount was sufficient for keeping the balance upright or not.

The cable companies UPC and Ziggo abandoned the purchase of licenses, as ‘the prices had become too high’ in the auction, according to these companies.

Vodafone has paid the peak price in the auction, with €1.4 bln for nine relatively popular frequency blocks. T-Mobile and KPN collected 15 blocks each and paid €900 mln and €1,35 bln respectively. Contender Tele2 collected 2 blocks and paid €160 mln for it.

It seems that in the land of the blind, Tele2 is king: they paid a reasonable €160 mln for 2 blocks. Also T-mobile had not such a bad bargain. It seems that KPN and especially Vodafone are the real losers of this game of chicken. Ziggo and UPC took a fair decision, in my opinion.

In my opinion, CEO Eelco Blok of KPN needs to have his head examined for a number of reasons: 

• He obviously didn’t learn from the recent history of his company; 
• He obviously cannot calculate and thus paid a much too high price for these licenses; 
• He blames the high prices on the blind internet auction (mentioned in the remainder of the FD article), but his people had in fact not the capacity to offer a more decent price; 
• He doesn’t understand that 17 years is a much too long period to write off these investments. Eight years will be much closer for a realistic amortization; 
• He also doesn’t understand that the usage of the cash cows SMS and telephone calls will only further diminish in favor of Skype, Whatsapp, Ping and other future apps. 
• He thinks that his shareholders will accept the disappearance of their dividend for 2012 and 2013 with a resigned ‘smile of understanding’;

I hope that I made my point towards this new proof of auction feeding frenzy in The Netherlands. I will end with a snip of the  article by Eildert van Dijken (see the previous link):

The LTE-technology is indispensable to warrant stable mobile internet for the future. LTE on the 800 Mhz (and perhaps 900 Mhz) band is of great importance to develop a cost-effective national network.

Entering this market is not simple, as large investments are necessary. Keeping such a network in the air is also a very expensive business. The most important factor is getting large amounts of users to the network, that are willing to pay for these services. When looking at the current competition, this will not be easy for new parties in this business. Also existing parties must aggressively diminish costs to remain cost-effective in the long run.

Van Dijken hits the soft spot with this very well-written article. When reading it, you should remember that this was written after a relatively cheap auction in 2010 and before Whatsapp and Skype were really gaining momentum. 

2012's one month during LTE Advanced auction cost the leading telecom companies an enormous amount of money in an industry where margins are under further pressure and where the numerous Dutch wifi hotspots are another threat to the business model.

If I had shares in a telco, like KPN or Vodafone, I would run like hell to sell those. However, this should NOT be considered as an investment advice and I don’t take any responsibility if you follow this up.