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Threats to Third Generation Wireless

By Bill Mann (TMF Otter)
June 29, 2000

Summary: A mobile telecommunications industry leader says there are some potentially prohibitive costs looming on the wireless horizon. One Fool says his worries might turn out to be overblown in the end -- but they certainly can't be ignored today.

The president of Swedish mobile communications company Ericsson (Nasdaq: ERICY) said in an interview with Dagens Indsutri newspaper that growth in the mobile telecommunications markets could slow over the next few years. His statement immediately caused a large drop in the share prices of Ericsson and other large players in the mobile market, including Nokia (NYSE: NOK), Vodafone (NYSE: VOD), and Alcatel (NYSE: ALA).

So, is the slowdown due to decreasing demand? After all, cellular phone usage has grown exponentially and simply can't grow apace forever. Penetration rates in countries such as Finland, Hong Kong, and Israel have exceeded 70%, according to industry sources. Ah, but no, public demand is not the issue here. In fact, a spokesman for Nokia said in a conference on Tuesday that it did not expect to be able to keep up with demand for next generation mobile products and network equipment.

But Ericsson's president isn't just making stuff up. There is a real threat to the rollout of third generation (3G), and it has to do with licensing costs for the spectrum needed to operate 3G units, which will include such features as high-speed Internet access, high resolution video and audio, and other data-rich applications.

Five 3G licenses auctioned off this spring in the U.K. sold for $35 billion, a 600% premium over the expected amount. As a result, many countries have jacked up the cost for their licenses -- Germany expects to receive around $60 billion for six 3G licenses, Hong Kong could sell its for $4 billion, Canada about the same. These prices, averaging about $600 per head, would only be the beginning, as companies would then have to build out their networks, something that could come much slower behind the financial strain of the licenses. Further, the individual cost of the 3G handsets could be severely impacted, slowing the initial surge in demand previously expected.

Could. I'd give this a yellow flag -- something to watch with caution. Companies are shelling out the money for these licenses because there is such demand growth for wireless services, and because they rightfully believe that should they fail to receive a license they will be marginalized within five years. But the operating companies will have to be quite cautious in bidding. Those that overbid for spectrum will likely go bust. The bigger problem is the restraint on competition these prices will cause, since only companies with really deep pockets have any chance of winning a choice spectrum auction.

The companies with enough cash to win auctions also are presumably interested in recouping this investment as quickly as possible. So even though they will likely price their enhanced services at the highest level the market will bear, it is also possible that they cede initial profits for customer acquisition for the benefit of the efficiency of rapidly populating their networks with users. In such a case, the risk to the equipment manufacturers may not come to bear. Ericsson's president was right to mention it, though.

Your Turn:
Companies are paying auction premiums significantly beyond their current cash flows. Governments are seeing a willing source of big money, enough to wipe out some budget deficits and fund some programs. Is it right for governments to maximize their intakes of licensing fees even if it threatens the commercial viability of the services offered?

Post your thoughts on our Wireless World discussion board.

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