On March 15, 2012 we released a timely report on the Canadian federal government’s announcement of its intended action to roll back foreign investment controls for entry level participants in the telecommunications sector. Our report also noted the complementary proposal to set aside a portion of the anticipated 2013 government auction of the valuable long distance low frequency 700 MHz wireless spectrum (as well as the 2500 MHz spectrum auction to be held at a later date) for small carriers; many of whom may seek cost-effective foreign investment to fund their stake holding interest in this emerging spectrum market. For the benefit of our readers, we include our report below:

Canadians want and expect robust world-class wireless services. Not an unreasonable ask in a country marked by northerly stretching latitudes and pockets of residents separated, and in some cases isolated, by vast uninhabited distances. Underscoring this is an increasingly borderless international business and cultural environment in which we assume that our ability to receive and exchange information, and effectively compete in the international marketplace, should be ubiquitous and defined by consumer and business choice, not geographic situs. However, technical advancement is not without its cost; especially the financial cost of innovative wireless applications and the infrastructure require to make “choice” a seamless exercise to the ultimate consumer.

Canadian airwaves have always been considered a natural resource belonging to all Canadians and administered on their behalf by the Canadian federal government. Thus some level of foreign ownership control to ensure a Canadian voice and presence in the broadcasting and telecom sectors was an understandable and laudable licensing parameter. At present, foreign ownership of a Canadian telecom licensee is limited to direct control of 20%, and indirect control of not more than 46.7%, of the licensee’s voting shares. Clearly this has been effective. The “Three Canadian Sisters” – Bell, Rogers and Telus – currently control over 90% of the telecom market in Canada. They also complete aggressively among themselves for the consumer’s dollar and loyalty. This clearly has benefited the consumer. There is though an unseen cost to the consumer, which one can anticipate will become more poignant if we factor in the cost of remaining competitive in the provision of new and novel wireless solutions. In order to fund their operations and anticipated technological innovation, Canadian telcos are forced to borrow large sums on a debt (as opposed to equity) basis. In doing so, they incur significant debt service costs that have to be factored into the cost of their operations. In turn, these operational costs are ultimately charged back to the consumer in the pricing of telco products and services. Frustrating the laudable objective of some measure of control on foreign investment, is the reality that Canadian telco licensees are precluded from accessing more cost effective financial solutions in international common share markets which might allow them to seek investment of the same dollars from investors looking for capital appreciation and profit over regularized debt service. Prophetically, these foreign ownership controls may very well have the effect of stifling the very innovation and opportunity for choice, and thus a Canadian voice in choice, that they were intended to stimulate and protect.

Foreclosing access to foreign equity markets has a quantum effect on smaller Canadian based telcos (those residing on the fringe in the remaining 5% - 10% of the Canadian telecom marketplace), with the result that these market players face significant barriers to entry. They don’t have the installed customer base necessary to generate the cash flows, and cash flow projections, required to justify the debt borrowings required to tool-up and expand. Ultimately, consumer options end up limited in a marketplace in which market share among competitors is inelastic for reasons that have nothing to do with the quality of product and service offerings.

Yesterday the Canadian federal government announced a few steps to be taken along the road to manage these issues.

First, market share rules will apply to the anticipated 2013 government auction of the valuable long distance low frequency 700 MHz wireless spectrum (as well as the 2500 MHz spectrum auction to be held at a later date). Each of the Three Canadian Sisters will be limited to the purchase of not more than 25% of the 4 prime spectrum blocks in each of Canada’s 14 regions. That leaves 1 prime block in each region (25% of the prime spectrum in these frequencies) reserved for small carriers.

Second, the federal government will also set requirements for telcos that win two or more blocks in the 700 MHz band, to guarantee services to rural populations by specific dates, so that robust service offering are not limited to financially valuable cosmopolitan regions.

Third, and perhaps most importantly, the federal government intends to remove the foreign investment/ownership controls on telcos who possess 10% or less of the market. Moreover, the foreign investment/ownership control roll back will continue to apply even if the exempt small carrier’s market share grows to more than 10 percent; provided that growth is not in consequence of merger or acquisition.

Following along on the Canadian federal government’s removal of foreign-ownership restrictions on fixed and mobile satellite earth stations in 1998, and more recently, the removal of foreign-ownership restrictions on Canadian satellite carriers in 2010, yesterday’s announcement may signal positive Canadian federal government movement towards in-bound foreign investment in other sectors.

These proposals still require parliamentary approval, but that is not foreseen as a limiting or delaying step given the current Conservative Party majority in the House of Commons.