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Credit FAQ: The Canadian Telecom Sector Is At Its Financial Bandwidth Limit Amid Spectrum Investments And M&A

On July 23, 2021, Canadian telecom companies completed bidding for new wireless spectrum licenses in the 3.5 GHz band. The spectrum auction, run by Innovation, Science and Economic Development (ISED) Canada, resulted in C$8.9 billion in aggregate bids for the 3.5 GHz radio spectrum, which was about 2x our expectation.

S&P Global Ratings had expected about C$4.5 billion in aggregate spending, with the Big-3 Canadian telecom providers-- BCE Inc. (or Bell Canada), Rogers Communications Inc., and Telus Corp.--investing about C$3.0 million-C$3.5 billion. The approximately C$3.28 MHz-PoP (average) valuation paid by the Big-3 also exceeded all previous valuations and was much higher than we have seen in other jurisdictions. Robust bidding from incumbent rivals was a major factor, although interest from smaller players, including new entrants, was also stronger than we had anticipated. Twenty percent of the payment is due by Aug. 13, 2021, and the remainder by Oct. 4, with the spectrum available to the licensees soon thereafter.

We expect this investment will increase the industry's debt leverage by about 0.4x on a pro forma basis. In our view, the precedent set by the 3.5 GHz auction also has potential implications for the 3.8 GHz (C-band) auction slated for early 2023. As a result, we anticipate credit metrics for some participants to weaken in the near term, and not sustainably improve for some time, which could have negative ratings implications for some operators in the near term while reducing debt leverage headroom for others.

Below we answer investor questions about the recent 3.5 GHz auction and the potential impact on our ratings for Canadian telecom companies.

Frequently Asked Questions

What was at auction?

To effectively deploy 5G services, ISED Canada has planned a series of spectrum auctions, of which the 3.5 GHz band is pivotal. In July, ISED auctioned 30 MHz-140 MHz (about 112 MHz on average nationally) of wireless spectrum licenses in the 3.5 GHz band. The 3.5 GHz range airwaves--similar to other mid-band spectrum in the 1GHz-6 GHz range--are key to scaling 5th generation (5G) wireless services in the near term as they support the carriage of large volume of data over long distances.

The 3.5 GHz radio spectrum comprises 200 MHz of total bandwidth; however, a few incumbent carriers have been allowed to retain licenses to some of their radio waves (transitioned licenses). The auction also included a 50 MHz set-aside (about 25% of the total band) for smaller companies or new entrants in markets where enough spectrum was available. Licenses have an initial term of 20 years, with good certainty of renewal, compliance with minimum build-out requirements, and transfers of set-aside spectrum to non-set aside participants will not be allowed for five years. A total of 23 applicants participated in the auction, although seven providers accounted for most of the winning bids.

Why was bidding so aggressive?

We believe spectrum valuation(s) proved to be higher than we expected for several reasons:

  • Mid-band spectrum offers an attractive balance of propagation (coverage) as well as bandwidth and latency (speed and user experience factors), thereby allowing 5G offerings to be quickly and efficiently deployed.
  • In the near term, it is much easier and more efficient to deploy a new generation of wireless technology using new spectrum compared with other options such as re-farming existing spectrum, spectrum aggregation, and cell-splitting.
  • Exclusive ownership of large bands is critical for 5G, and the opportunity cost of owning comparatively less spectrum, in particular mid-band, at this early stage of 5G evolution could prove to be a competitive disadvantage; hence, Rogers' pursuit of sufficient spectrum to remain competitive with BCE and Telus, as the latter two are likely to continue pooling their spectrum and network resources.
  • Set-asides, together with transitioned spectrum, have limited the availability of open spectrum in many markets.
  • Greater participation by smaller players than expected, with operators such as Videotron Ltee (owned by Quebecor Media Inc.), Cogeco Communications Inc., and Xplornet Communications Inc. remaining more aggressive.
  • The potential for the spectrum to be used for fixed-wireless broadband services in semi-urban markets as well as the ease of deploying 5G services in such markets likely influenced strong bids in these regions.
  • The availability of additional new mid-band spectrum--the next auction, C-band spectrum (280 MHz between 3700 MHz-3980 MHz)--won't be auctioned until early 2023, and would still be entirely unavailable for deployment until 2025; in addition, auction rules/terms for this band are currently unknown.
How does S&P Global Ratings view the strategic significance of spectrum ownership against the price paid and leveraging?

Rating tolerance of wireless spectrum investment is an area of issuer and investor discussion. We acknowledge the importance of access to spectrum licenses for the sustainability and growth of wireless operations--a key ratings driver. Generally, new spectrum can be deployed quickly, and aggregated with other spectrum to offer higher throughput often more efficiently than alternatives. In most cases, wireless investments are long-lead investments: cash flow or returns are generated over the long term (unlike mergers and acquisitions [M&A], which have the potential to produce quicker returns and accommodate faster deleveraging). Too often the spectrum acquisitions are also strategic; for example, failure to acquire these assets means carriers potentially lose them forever or carriers could be placed at a material competitive disadvantage to the extent a rival's service offering improves or other entrants establish themselves in the marketplace. A spectrum license also retains good value as an intangible asset. Understandably, such benefits argue for some degree of tolerance or leverage flexibility, which we have taken into account historically. Still, unlike how we consider leverage tolerance for infrastructure assets with contracted cash flows against potentially regulated backstops, we view telecom cash flows as higher risk, given more competitive markets and risk of more frequent regulatory intervention, as well as cyclical and technological risks that underscore a greater volatility to cash flow underpinned by the intangible assets.

Furthermore, in our view, the credit characteristics of high investment-grade issuers should include anticipating such lumpy investments and building adequate financial buffers into their long-range planning to absorb such investments through balanced risk-sharing policies between stakeholders, as well as proactively and transparently acting to ensure policy compliance. Telus' and BCE's equity issuances over the past couple of years as well as dividend reinvestment plan (DRIP) programs and some asset sales support this view although arguably they have been executed less proactively than we would have expected as companies were influenced by low cost of debt. Issuer return on capital, particularly for the Big-3 investment-grade carriers, is another factor we consider when evaluating credit quality. We consider improving returns through growth investments as a positive credit characteristic; however, we note that the recent track record of the large carriers in Canada has been lackluster (see chart 1). Overall, we expect the 3.5 GHz investment to spur a 0.4x increase in industry debt leverage and for issuers to take a few years to return leverage to lower levels given additional anticipated investments over the next couple of years when including M&A (see chart 2).

Chart 1


Chart 2


How does the auction change the competitive landscape?

Following the current auction, BCE and Rogers now hold a comparable 27% and 34% share, respectively (see chart 3), of nationwide 3.5 GHz spectrum (MHz-Population [PoP] weighted share), when including transitioned spectrum. This corresponds to their relative wireless subscriber market share of about 28% and 33%, respectively, as of June 30, 2021. Telus is a distant third, with 11% of the spectrum share. However, we don't see this as a major disadvantage given that Telus acquired a healthy 40 MHz in its key markets, its network sharing agreement with Bell Canada, and the company's healthy position in 600 MHz, which is also expected to be used for 5G services. On a combined basis, Bell Canada and Telus will have about 38% of the band on a nationwide basis, which places them favorably when compared with Rogers, in our opinion. While both Rogers and Telus paid a higher price than BCE, on an MHz-PoP basis (see table 1), when we include transitioned and other previously acquired spectrum in this band, valuations ease somewhat, but still remain high in relation to most other jurisdictions.

Quebecor (Videotron), benefiting from the set-aside, improved its spectrum ownership, gaining 175 licenses in non-Quebec markets (largely aligned with Freedom Mobile's network) while retaining a solid position in Quebec with 119 licenses, for a total average of about 16% nationally. We believe Quebecor's spectrum acquisition lay the groundwork for a nationwide presence, but by itself does not create a viable position from which to launch a competitive national wireless service as a facilities-based provider. In our view, competitive benefits would only accrue if Quebecor is successful in adding significant wireless assets, specifically additional diversified spectrum (such as from Freedom Mobile) to its portfolio versus a greenfield build or largely pursuing a resale (mobile virtual network operator [MVNO]) strategy. Cogeco Communications Inc. and Xplornet. primarily targeted their core markets, and we expect the latter will mainly focus on its fixed-wireless broadband offering.

Chart 3


Table 1

3.5 GHz Spectrum Auction Results
BCE Inc. Telus Corp. Rogers Communications Inc. Quebecor Media Inc. Cogeco Communications Inc. Xplornet Communications Inc.
Price paid (mil. C$) 2,074 1,948 3,326 830 295 244
MHz PoPs (mil.) 678 577 984 967 260 293
% of band owned (at auction) 17.3 14.8 25.2 24.7 6.7 7.5
C$/MHz-PoP 3.06 3.37 3.38 0.86 1.13 0.83
C$/MHz-PoP* 1.25 2.53 1.64 --- --- 0.29
*Includes transitioned licenses. Source: ISED Canada

Overall, on a pro forma basis, we believe the Big-3 are well positioned, with a balanced ownership of low- and mid-band spectrum, which should allow them to retain their respective competitiveness for existing and new 5G services for the foreseeable future (see chart 4). In our view, BCE's and Telus' ongoing network sharing agreements provide for more absolute spectrum compared with that of Rogers, whose spectrum assets, on a subscriber market share-adjusted basis we believe are attractively positioned. However, the BCE-Telus network sharing arrangement will likely continue to cause a greater investment by Rogers' compared with either BCE or Telus for the foreseeable future.

Chart 4


How does the price paid in Canada compare with what is paid in other jurisdictions?

Canadian spectrum valuation remains among the highest globally, reflecting the competitive structure, regulatory policy, and lower teledensity in the country. Indeed, the 3.5 GHz auction was no different. In aggregate, the C$2.28 per MHz-PoP was similar to valuations paid for the arguably more valuable 700 MHz, and compares poorly to the US$1.11 paid in the U.S. in the recent C-band (3.8 GHz) auction, which we believe has similar characteristics. For the Big-3, the auction average of C$3.28 was much higher than the US$1.12 paid by AT&T and the US$1.08 bid by Verizon for C-band spectrum (with clearing). We estimate that, outside of North America, auction prices globally for this band are significantly lower than what Canada's Big-3 paid, but ease modestly when including the transitioned spectrum. Higher values invariably make it harder to produce competitive returns on capital (and those returns will take longer) and it will likely delay anticipated deleveraging.

Chart 5


What does S&P Global Ratings see as implications to future spectrum investment in Canada?

ISED Canada has indicated that the next spectrum licenses to be auctioned are 280 MHz (10 MHz x 28) of C-band spectrum in the 3.8 GHz band in early 2023, with access to this spectrum through 2025. The spectrum has similar characteristics to 3.5 GHz, and we believe that, given that 5G throughput is optimized at larger bands, these radio waves will be equally attractive, particularly as 5G service commercialization accelerates within this time frame. Although the terms of the auction (unknown at present), which could be influenced by the outcome of the Rogers-Shaw merger vis-à-vis Freedom Mobile's status and the timing of any additional mid-band spectrum the government might release (early), would significantly influence the degree of rivalry, we expect it will result in high valuations. Our preliminary view, which assumes a degree of set-aside, is that aggregate spending will be similar to 3.5 GHz at about C$10 billion. Given the Canadian 3.5 GHz and U.S. C-band precedent, we now incorporate about C$2.0 billion-C$2.5 billion each for BCE and Telus, and C$2.5 billion-C$3.0 billion for Rogers. In addition, we assume about C$1 billion for each player for higher frequency mmWave spectrum in 2024.

How does the auction affect the balance sheets and credit profiles of Canadian telecom issuers?

Following the auction, we anticipate credit metrics for some participants to weaken in the near term (see table 2), and not improve below our downside triggers for some time (see chart 6), which could have negative rating implications for some operators in the near term while reducing debt leverage headroom for others.

Table 2

Projected Leverage Pro Forma 3.5 GHz Spectrum Auction
Leverage (x)

BCE Inc.

Telus Corp.

Rogers Communications Inc.§ Qubecor Media Inc.

Cogeco Communications Inc.

Xplornet Communications Inc.

2020 3 3.8* 3.2 2.9 2.8 6.3
2021 3.1-3.2 3.5-3.6 3.4-3.5 2.9-3.1 2.7-2.9 6.5-6.8
2022 3.0-3.1 3.3-3.5 5.0-5.5 2.7-2.9 3.4-3.6 6.0-6.3
2023 3.0-3.1 3.3-3.5 4.7-5.2 2.8-3.0 3.4-3.6 5.6-5.9
Downside target 3.25 3.25 3.25 3.5 High 3.0†
*3.6x pro forma the acquisition. §Assume no divestiture of Shaw Communications Inc. wireless assets; assume fully debt-financed except equity component to Shaw family. †If including acquisitions. Source: S&P Ratings.

Chart 6


Canadian Telecom Companies

BCE Inc. (BBB+/Stable/A-2)

BCE spent about C$2.1 billion and, with this auction and grandfathered spectrum, now has about 50 MHz of 3.5 GHz spectrum nationwide. Even though spending was double our expectation, given BCE's EBITDA base and the company's annual free cash flow, the impact on BCE's leverage is about 0.1x leading to leverage of 3.1x-3.2x for fiscal 2021. Although we have updated 2023 C-band spectrum spending to C$2.0 billion-C$2.5 billion, we still forecast leverage to stay below our downside trigger of 3.25x through 2023. As a result, we do not anticipate any pressure on our ratings on BCE.

Rogers Communications Inc. (BBB+/Watch Neg/A-2)

Rogers spent about C$3.3 billion and, with this auction and grandfathered spectrum, now has close to 60 MHz of 3.5 GHz spectrum nationwide. The additional C$2.3 billion in auction spending (above our modeled C$1.0 billion) in itself will increase leverage beyond our downgrade trigger. And after incorporating our revised assumption for C-band, we expect leverage to remain above our downside trigger even after assuming strong stand-alone EBITDA growth in the next two years. We see this leverage as credit negative for the company. In addition, assuming a 100% debt-financed Shaw Communications Inc. acquisition (incorporating equity issued to the Shaw family), we now forecast leverage in the low-to-mid 5.0x in 2022, about 0.3x worse than our previous forecast, and leverage remaining in the 5.0x area even in 2023 when incorporating our revised C-band investment. We believe, on a pro forma basis, that it could be aggressive for Rogers to deleverage to the mid-4x area within two years of the transaction's close given the competitive environment, integration risks, and net investment. Therefore, in our opinion, the spectrum investment is decidedly more negative in relation to our previous expectation of up to two notches downgrade on the company. Variables such as remedial divestitures and associated valuation, potential capitalization of the Shaw acquisition, and ability to sell noncore assets proactively are mitigating factors that could offset leverage and reduce pressure on the ratings.

Telus Corp. (BBB+/Negative/A-2)

Telus spent about C$1.9 billion and, with this auction, has about 25 MHz of 3.5 GHz spectrum (population weighted) with 40 MHz in its key markets. With a 0.2x deterioration in debt leverage, we now forecast Telus to exit 2021 at 3.6x instead of 3.4x. In addition, we have updated our projections to incorporate our updated valuation for C-band spectrum spending in 2023, which leads us to forecast Telus' leverage in the 3.3x-3.5x range through 2023, instead of a sustainable improving trend. In our view, equity issuances in the past two years, Telus International IPO proceeds, and DRIP savings have supported Telus' balance sheet, but our forecast leverage for the company is higher than Telus' downside trigger with no expectation of sustained improvement in the next 24-36 months. Management's intent and ability to improve leverage quicker than our forecast would a driving factor in any subsequent rating decision.

Quebecor Media Inc. (BB+/Stable/--)

Quebecor spent C$830 million, acquiring set-aside blocks in Western Canada and Ontario as well as about 70% of set-asides in Quebec. The debt leverage impact is less than 0.5x, with our forecast leverage at 3.0x-3.2x range for 2021, against our downgrade threshold of about 3.5x. Given management's intention to expand nationwide, and these spectrum acquisitions laying the groundwork for that strategy, we now forecast leverage to stay above 3x for the foreseeable future. Assuming Quebecor's acquisition of Freedom Mobile assets, the extent of leverage increase will depend on various factors but not limited to acquisition price, restructuring costs, and synergies generated, along with future capital expenditure spending. The balance between any potential new acquisitions, and ability and time to recoup investment spend, with a focus on strengthening the balance sheet, will be the main factors that will drive any future ratings decisions.

Cogeco Communications Inc. (BB+/Stable/---)

We expect Cogeco's adjusted debt to EBITDA will increase by 0.2x in fiscal 2022 to about 3.5x, based on the company's 3.5 GHz spectrum spend of about C$295 million. We view the spectrum investment to be neutral to the current rating because it holds leverage below our downside threshold of high 3x when including acquisitions. Cogeco has acquired spectrum assets in Ontario and Quebec, which is in line with the company' growth aspirations to provide wireless services in Canada through the Canadian Radio-television and Telecommunications Commission's MVNO mandate or potentially acquiring some of the Freedom Mobile assets.

Xplornet Communications Inc. (B-/Stable/--)

If Xplornet funds the spectrum investment of about C$244 million fully with debt, we expect the company' adjusted debt-to-EBITDA ratio to increase by about 0.5x-0.6x to the mid-6.0x area in 2021, thus potentially delaying the company's deleveraging. However, we view the investment to be neutral to the rating, at present, as this will support the company's long-term organic growth strategy to offer superior rural broadband fixed wireless service across Canada, while the company invests in upgrading its network with 5G capabilities.

Sanket Yadav (Crisil, Mumbai) contributed research to this article.

This report does not constitute a rating action.

Primary Credit Analyst:Madhav Hari, CFA, Toronto + 1 (416) 507 2522;
Secondary Contacts:Aniki Saha-Yannopoulos, CFA, PhD, Toronto + 1 (416) 507 2579;
Silverius Miralles, Toronto + 1 (416) 507 2505;

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