UMTS License Auctions Point to Trouble with 3G Wireless

At the turn of last year, the European cellular market was astonished by the bid from Mannesmann , the German mobile network operator, of approximately $25 billion for the UK's Orange wireless network. The bid, along with the large quantities of money being offered in the UK's 3G spectrum auctions, was seen by many as a sign of vitality in the mobile telecom sector.

But some 12 months later, despite a year of growth that would be the envy of most other industries, there is diminishing confidence in the mobile sector across Europe. Some evidence points to the run-up to so-called "3G" broadband mobile services.

The auctioning of Europe's Universal Mobile Telecommunications System (UMTS) licences, looked like easy money for European governments after the UK and German auctions raised around $30 billion and $43 billion, respectively. However, in late October, the Italian auction of 3G mobile phone licenses raised only half of what was expected when the Blu consortium, which includes British Telecom, pulled out of the bidding after only a few days, leaving five bidders for four licences.

As a result, the winners in the Italian auction paid only around $180 per inhabitant, compared with the German and British price of about $540 per inhabitant.

Following on the success of the UK and German auctions, the flop of the UMTS auction in Italy -- Europe's largest mobile phone market -- has raised questions about the whole process and cast a shadow over the upcoming auctions in Austria, Switzerland and Sweden. The UMTS licence processes in Belgium and Poland are also fraught with problems.

The auction of 3G spectrum is a leap of faith for the mobile operators, for added to the billions of dollars they already have spent acquiring the licences for European markets, will be the costs of building the 3G network infrastructure. And this is all before 3G users actually turn on their handsets. At this point, operators have yet to propose the kinds of "killer applications" that could conceivably make 3G wireless services profitable.

Rough Road Ahead

"After being witness to the well-publicized third- generation auctions in the UK and Europe, we have to ask ourselves, how and when are these organizations going to recover the cost and become profitable?," says Alain Lefebvre, associate vice president of marketing for Europe for Objective Systems Integrators , a manufacturer of software for telecom service providers.

"When you also consider that these companies will have to pay out a great deal for UMTS infrastructure, we sometimes wonder if it is all possible. To achieve such a return on investment, it is necessary to charge a high premium for services, but how many users will be willing to pay for these services?"

As with any new technology, there is uncertainty concerning the mass adoption of 3G technologies. "The sums of money that were paid out for the licenses seemed necessary when balanced against the unlimited promise of 3G technology - unlimited bandwidth to provision any application to any number of people," said Daniel Sumner, client partner for the mobility practice for marchFIRST, an Internet professional services company offering branding, technology and strategy. "But there are other ways to access wireless bandwidth, such as wireless LANs and Bluetooth, which enable high bandwidth in selected areas known as hotspots. The pace of technology also means that there are likely to be other ways of accessing bandwidth without using the wireless network."

Amidst such concerns, European mobile network operators are facing difficult questions about how they will be able to finance the move to 3G. The money market's enthusiasm for the sector has waned recently, especially after financial results from handset manufacturers like Motorola and Ericsson failed to impress. Other telecom stocks like Nortel and Alcatel have also suffered recently.

3G Roll-Out Will Not Be Deterred

A recent report from German broker WestLB Panmure on UMTS, predicts that licensing costs for a West European 3G carrier will total around $17 billion, eclipsing capital expenditure of a further $13 billion. WestLB Panmure believes that there is more consolidation to come as the enormous investment required for a pan-European presence in the 3G mobile telephony business will lead to further alliances in the industry. However, the broker is optimistic about the future.

"We believe that the current scepticism about the chances of success for the UMTS business is overplayed," said analyst Frank Wellendorf. "Our valuation model indicates that under realistic and conservative future scenarios, probability ratios are satisfactory. As a result, we are currently seeing an under-valuation of various mobile network operators."

Alistair Warren, managing director of nCoTec, a pan-European technology venture capital firm which focuses exclusively on technologies supporting wireless communications, also believes the current uncertainties will not affect the roll-out of 3G. He says that in an increasingly competitive environment the network operators need to differentiate themselves on the basis of the services that they offer.

"The operators want to broaden their service offering beyond voice in order that they can be competitive with [terrestrial] networks. To do that they have to have additional spectrum and if they want that spectrum, governments are only going to allow them to access it through 3G or UMTS frequencies. Some sort of beauty parade or auction process is necessary to win those licences," Warren explained.

"Once those licenses are awarded, there is always a requirement to invest a specific amount of dollars within a specified time to create a specified amount of coverage. That time frame is becoming increasingly shortened and the cost of doing that - because 3G requires effectively four times as much infrastructure as GSM - is absolutely enormous," Warren added.

Warren argues that to remain competitive, network operators must bid for the licenses. If they do not, new or existing competitors will gain the upper hand. "They can't afford not to bid. You have to be there or you will be forced out of the market," he said.

Who's going to pay?

With voice charges falling, operators offering voice-only services may soon have trouble competing against networks that can subsidize voice business with added income from data and multimedia services. Yet, how much of the costs of 3G can be passed on to customers remains to be seen.

Business users will doubtless be happy to pay premium rates for an always-on, reliable, Europe-wide mobile Internet service, but that these fees will be enough to meet the operators' high start-up costs is doubtful.

"There is no question that the huge cost of the infrastructure over and above the significant costs of the licences probably means that the sorts of returns network operators will earn, will be well below the returns that were possible on the GSM infrastructure. I don't think those returns will be possible again," Warren said. "The consequence of that is, that if you can't get the full return from the customer, there is only one other place the capital can come from, and that is in effect out of the balance sheet and ultimately that means the shareholders of the operators are likely to be the losers."

MarchFIRST's Sumner offers a more optimistic vision. "In the future, with 2.5G and 3G, it will be possible to charge consumers via micro-billing (say, a few pence at a time), which is not possible with current GSM circuit-switched networks," he said. "There is revenue to be made. The biggest challenge is making the service compelling and useful to users, and building in mobile-specific characteristics such as personalization, location and time dependence.

"Future services can and will make money, but the money will go to those who have the best value-added services" says Sumner.