Annual licence fees for 900 MHz and 1800 MHz spectrum

Introduction

1.1 In December 2010, the Government issued a Direction which, amongst other things, required Ofcom to revise the fees payable for licences to use radio spectrum in the 900 MHz and 1800 MHz bands so that they reflect full market value. The Direction also required that, in revising the fees, Ofcom must have particular regard to the sums bid for licences in the auction of 800 MHz and 2.6 GHz spectrum (the 4G Auction).

1.2 This consultation sets out our proposals for revising the annual fees payable for licences to use this radio spectrum.

Our proposals

1.3 We have taken into account a range of evidence to inform our estimate of the market value of licences in these two spectrum bands. This includes:

• sums bid in the 4G Auction (as required by the Direction),
• prices paid in spectrum auctions abroad, and
• technical and commercial characteristics of spectrum bands.

Evidence provided by the UK's 4G auction

1.4 We have analysed the bids in the UK's 4G Auction to determine underlying band values within the multi-band packages for which participants bid. We have then taken a view on how these valuations of 800 MHz and 2.6 GHz spectrum might inform our estimates of the full market value of 900 MHz and 1800 MHz spectrum.

1.5 The UK 4G Auction generated prices for multi-band packages rather than individual band prices. We commissioned DotEcon Ltd to analyse bid data using alternative methodologies on which we have previously consulted, and we have published DotEcon's analysis. We favour the linear reference pricing methodology, which indicates an underlying value of £29.85m per MHz for 800 MHz spectrum without a coverage obligation (including co-existence costs) and £4.95m per MHz for paired 2.6 GHz spectrum.

Evidence provided by auctions in other countries

1.6 We commissioned a separate study from DotEcon into prices from relevant auctions in other countries, and we have published DotEcon's report alongside this consultation. Informed by DotEcon's analysis, we have reached a view as to what we consider to be the relative importance of different international evidence points in informing our estimates of the value of 900 MHz and 1800 MHz spectrum in the UK (adjusted for differences such as popuation and licence duration).

1.7 We have considered both the absolute values implied by relevant auctions and the relative values between bands in a single country. For example the auction price for 900 MHz in Spain indicates a UK price of around £25m per MHz, which was around 80% of the value of 800 MHz in Spain. However, applying this 80% ratio to the value of 800 MHz in the UK, rather than in Spain, indicates a value just below £24m per MHz.

1.8 In considering the weight that should be attached to evidence we have had regard both to the likelihood that evidential points reflected market value in the country concerned, and their relevance to the value of 900 MHz and 1800 MHz spectrum in the UK.

Deriving lump sum values for UK spectrum

1.9 We have also considered the extent to which our evidence base might be sensitive to underlying assumptions, particularly around our estimate of the value of 800 MHz and, to a lesser extent, 2.6 GHz spectrum in the UK, which plays a significant role in our analysis. We therefore considered the validity of the assumptions on which these estimates rely and the potential impact of making alternative assumptions, including some suggested by licence holders.

1.10 In order to determine fees we need to identify, for each of 900 MHz and 1800 MHz, a single figure for the lump-sum value of spectrum. We have a limited set of evidence points with a relatively wide distribution of values, and we consider that no specific evidence points can be relied on in a determinative way. Because of this we have not sought to take a mechanistic approach to deriving best estimates from the available evidence. Rather, we have considered the evidence for each band in the round, and used our judgement to decide how much weight to place on the various pieces of evidence to develop a best estimate for each band.

1.11 We propose that the following best estimates of lump sum full market value should be used to derive annual fees.

Figure 1.1: Best estimates of lump sum full market value

Deriving annual fees from lump sum valuations

1.12 The values discussed above are lump sum valuations based on a notional 20 year licence term (the initial term of the 4G licences which we have auctioned). In the case of licences for 900 MHz and 1800 MHz spectrum, we are seeking to apply annual fees rather than lump sum payments. Therefore we propose to convert the relevant lump sum value into an annuity to be paid as an annual fee.

1.13 In doing so, we need to determine an appropriate cost of capital, and decide whether to express annual payments as nominal or real values.

1.14 We propose to use a cost of capital which is consistent with that used to determine current charge controls for mobile call termination (MCT), updated to reflect changes to corporation tax made since the MCT controls were implemented. We consider that values placed by bidders in the 4G Auction are likely to reflect their assessment of post-tax cash flows to be generated by the spectrum. As such, we propose to use a cost of capital on a post-tax basis. The real post-tax equivalent to the real 6.2% pre-tax weighted average cost of capital (WACC) used to derive mobile charge control values is 4.1%. The adjustment to reflect changes to corporation tax increases this figure to 4.2%.

1.15 We further propose to adjust fees to take into account the tax advantage of lump sum payments compared with annual fees. Both can be used to offset a tax liability but only the sums payable in annual fees are adjusted to take account of inflation and the cost of money for the purpose of calculating the allowance for tax purposes. We propose that annual fees derived from the WACC should be increased by 11% to reflect this factor.

1.16 We propose to set a constant level of fees in real terms, so that the fees will be uplifted annually in line with the Retail Prices Index (RPI). We propose that the base date for the purpose of RPI adjustment should be March 2013, this being the month in which the 4G Auction was completed, bids in which are a key component of our benchmarking.

1.17 Setting fees with a constant profile is in our view a pragmatic approach that avoids the complexity of modelling and estimating the potential variations in future spectrum values over a long period of time in the presence of uncertainty. Furthermore, setting fees in constant real terms (as opposed to constant nominal) is in our view a reasonable assumption in the absence of clear evidence of a systematic downward trend in value in real terms.

1.18 Applying this annualisation approach to the lump sum values set out in Figure 1.1 above generates annual fees as follows:

Figure 1.2: Proposed annual fees per MHz

Implementation

1.19 The annual date on which licence fees currently fall due varies widely between licensees. We propose to implement revised fees to a common "effective" date of the first day of the month following the month in which the new fees regulations come into force. For each licensee's first payment after the common effective date, we therefore propose to adjust the amount payable by each licensee to reflect the length of the period between the common effective date and that licensee's next payment date. Thereafter fees payable across the year will be uniform for all licensees.

1.20 We do not propose to phase in fees. Licensees have known since December 2010 that fees would be revised to reflect full market value. We believe that revised fees can be implemented in a single step without having an adverse impact on services delivered to customers. Therefore, we consider that it would be in line with the Direction for fees that are reflective of full market value to be implemented at the outset without a period of phasing in.

Next steps

1.21 We are inviting stakeholders to provide any comments by Thursday 19th December 2013. The purpose of this consultation is to seek input from stakeholders and any other interested parties. In particular, whilst Annex 4 of this consultation document contains a number of specific questions, we are not seeking to limit the issues on which respondents may wish to comment and respondents are invited to include representations on any issues which they consider to be relevant.

Update 1|08|14: We have published a Further consultation and a Notice of proposals to make regulations to give effect to the revised the fees.

Update 16|05|14: We published an update on further European spectrum auctions (PDF, 72.9 KB) that have concluded since publishing the Consultation (see below), which may provide relevant evidence for the purposes of estimating the market value of licences for the 900 MHz and 1800 MHz spectrum bands in the UK.

Update 17|04|14: We have published a consultation on a specific issue relating to the methodology we propose to adopt if we derive the appropriate discount rate for annualising ‘lump sum’ amounts into annual fees on the basis of the consumer price index (rather than the retail price index). Responses can be found here.

Update 18|11|13: The date for receipt of responses on the consultation on revising annual licence fees for the 900 MHz and 1800 MHz spectrum bands has been moved to 16th January (from 19th December) in response to a stakeholder request to have more time to consider the proposals.

Update 11|10|13: We have corrected the description and labelling of Figure 5.3 on page 53 which should have referred to "... base level ALF (£ million)" and not to "... base level of ALF in the first year (£ per MHz).

Responses : Vodafone Annexes 5 and 10 are confidential and are not published.

Responses

Responder name	Type
Analysys_Mason_and_Aetha_Report_Addendum.pdf (PDF File, 645.1 KB)	Organisation
Application_of_the_distance_method_when_estimating__a_lump-sum_value__for__900MHz_spectrum_-_Analysys_Mason___Aetha.pdf (PDF File, 407.6 KB)	Organisation
BT_Response.pdf (PDF File, 142.7 KB)	Organisation
EE.pdf (PDF File, 1.5 MB)	Organisation
EE_Annex_Analysis_Mason_Aetha_report.pdf (PDF File, 1.2 MB)	Organisation

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