TORONTO – Expect network investment to plummet, the growth of the digital economy in Canada to stall and an invasion of well-heeled foreign broadband resellers if the recent CRTC decision on third party internet access wholesale rates is not overturned, says a report published this week by TD Securities.
While saying he expects the decision to be challenged and overturned or at least revised, TD telecom and media analyst Vince Valentini pulls no punches in his analysis, saying the Commission-set wholesale rates and retroactive rebates are bad for the incumbent carriers, their customers and Canada as a whole – and that facilities-based competition must remain a bedrock of the industry and government policy.
Should the decision stand, however, “total investments per annum in wireline/cable infrastructure in 2021 and beyond would be estimated to decline by about $1.68 billion in aggregate for the six publicly-traded telecom and cable companies,” reads his research. Those companies are of course, Bell, Rogers, Telus, Shaw, Quebecor, and Cogeco. The calculation doesn’t take into account the other two incumbents affected, SaskTel and Eastlink.
There are deadlines approaching by which the incumbents will have to file appeals. An appeal to the Federal Court must be filed within 30 days of a CRTC decision, which is Monday, September 16th, and also during the start of the federal election campaign. Appeals to federal cabinet to overturn or to send back for review, or to the CRTC itself to review and vary, must be made within 90 days of a decision (on or about November 13 – or after the election).
(Ed note: While none of the incumbent carriers have stated their plans on the record, it’s a lock this decision will be appealed, perhaps using all avenues available.)
Valentini’s primary complaint – which is also the incumbents’ complaint – is that the new wholesale rates set by the Commission are way too low and are in fact, unfair, as is the retroactive portion. As well, it’s not just spending on rural broadband which will be decreased, which is what the incumbents targeted first – but investment will be curbed across the board, from fibre rollouts in urban areas to 5G wireless.
“The regulatory policy in the past, and numerous CRTC decisions, have promised a system that leans primarily on facilities-based competition, so it can be argued that it is not fair to alter the rules midway through the game (with material retroactive payments for the past three years) when a lot of capital has already been invested in next generation networks by the cable and telecom industry,” writes Valentini.
“It can also be argued there is somewhat of a regulatory bargain between telcos/cablecos and the government, with the industry accepting foreign ownership restrictions as well as meaningful taxes and subsidies that go to support cultural and societal goals (like Canadian TV content, 911 services, and law enforcement support), so, in return, the telcos and cablecos do not expect to have their network assets made available to others on what we consider unreasonable terms.
“We also question if it is fair and reasonable to have rules that could allow large foreign players (or even tech giants like Google or Amazon) to take advantage of cheap wholesale access rates with no obligations either to have Canadian ownership, or to invest in any networks (rural or urban), or to support culture/employment in this country.” – Vince Valentini, TD Securities
“We are not aware of many industries in Canada that do so much in terms of private investment in infrastructure, while also facing such unpredictable and arguably intrusive regulations. We also question if it is fair and reasonable to have rules that could allow large foreign players (or even tech giants like Google or Amazon) to take advantage of cheap wholesale access rates with no obligations either to have Canadian ownership, or to invest in any networks (rural or urban), or to support culture/employment in this country.”
Valentini’s report also says despite the fact this took three years for the CRTC to finalize, the rates make little sense.
In the past, the Commission used a retail price-minus 30% discount to set wholesale rates for resellers, but it has switched to a cost-plus format, which it used to set the new rates. Eastlink says the rates are actually below its own costs. Based on the retail-minus approach, says Valentini, a typical wholesale rate would come in at about $45/subscriber/month.
However, the new mandated wholesale rate is about $16, says the research, in which is baked a 30% supposed margin for the incumbents.
This cost assumption makes no sense when the public companies’ returns are analyzed, simply because if their costs were actually that low, they’d have a lot more money. “If this was the case, then FCF (free cash flow) generation and ROIC (return on invested capital) would be much higher for wireline telecom and cable operators based on $70+ broadband ARPU levels and only $12-$13 in total costs (the average FCF margin across our six wireline companies was only 15% in 2018),” writes Valentini.
Not everyone believes the new rates will sting as much as Valentini does, however. Scotiabank’s telecom and media analyst Jeff Fan wrote in a note to investors in August that as reseller customer usage climbs, the amount those third party internet providers have to pay also climbs, meaning the indepedents will be competitive on lower speed broadband tiers, but not on the very high speed offerings the incumbents are selling hard.
“(U)nder the interim tariffs, the wholesale ISPs were generating positive gross margins in the lower speed 10-30 Mbps tiers, and they could not even come close to competing in the speed tiers 75 Mbps or higher,” wrote Fan. “With the final rates, they are able to compete more effectively in the higher speed tiers (but) wholesale ISPs would not be able to compete in the 300 Mbps+ service tier.” (see image below. Click to enlarge.)
Besides, Fan adds, it’s not as though the incumbents’ arms are tied behind their backs. They can all win bundle battles with packages of Internet, wireless and TV (this is the reason TekSavvy has launched its own TV service) – and three of them have their own low-cost wireline internet brands to fight with in Fido, Virgin and Fizz, for example.
“These compete directly with the wholesale ISPs. The main and the flanker brands can all be bundled with other services, including mobile and/or video. The facilities-based providers can also leverage their owners’ retail pricing flexibility, flex their marketing muscle, and take advantage of their distribution and scale to maintain share in the ISP market,” wrote Fan.
“Remember that even with lower wholesale costs, wholesale ISPs have a variable cost model that becomes less profitable if actual usage is higher than they expected. Finally, with the investments in FTTH and DOCSIS 3.1, the facilities-based telcos and cablecos have the ability to offer higher speed services (300 Mbps+) where the wholesale ISPs cannot compete.”
