PLDT GLO Deal Forges 4G Monopoly: Benefits Seen, Costs Ignored

The market has been looking for anything that would justify a breakaway run from 7,400. So given the limited participation from the ranks of PSEi 30, the latest mega telco deal provided a catalyst for another parabolic move which this time involved telco issues. The pump on telco issues lifted sentiments to drive the PSEi to 7,500. TEL’s weekly gain of 13.67% and GLO’s 7.4% spearheaded the push towards 7,500 

The collapse of the deal between Australia’s largest telecom Telstra and San Miguel’s Liberty Telecom last March, essentially paved way for the Php 70 billion sales of latter’s telecom business to the two major players of the industry, TEL and GLO last week. Both firms agreed to evenly split in the acquisition of SMC’s business unit. And funding for the acquisition will mostly be through leverage or debt. That’s aside from the proceeds from the recent asset sale of PLDT’s 25% stakeholdings in Beacon Holdings (which has a stake at Meralco) to sister company Metro Pacific. 

So unless there will be further changes in the ownership, what used to be sold to the public as a two firm ‘competition’ in the telecom industry has now been structurally changed. With the said transaction, the two competitors have essentially formalized a cartelized relationship or a cartel which becomes an indirect monopoly! Through the newly acquired firm, the 4G becomes a direct monopoly.

Given the market’s response, credit rating Fitch sees that this would be positive for the industry due to the “coveted 700MHz spectrum” which may “provide telcos with plenty opportunities if they offer faster 4G LTE services”. Fitch admitted that “mobile market is highly saturated…but most users are on 2G networks” 

What Fitch essentially has been saying is that the industry’s problems have mainly been about a supply side technology based stasis. And because of the introduction of the new technology, in particular 4G, upgrades would redound to growth! Thereby, such growth would justify the cost of acquisition! 

I wish it had been such a simplistic world. 

To be clear, I will not deny that there will be benefits from the transaction. But it is not just about benefits but about tradeoff with the cost that matters. 

Moreover, the changing nature of the telecom’s political economy will also signify a critical issue. 

And it’s not written on the stone that there will be big demand for 4G, because ultimately demand will depend on prices offered. If upgrades will be priced at ZERO (or close to zero) then for sure there will be a huge demand. However if upgrades will be charged at a Php 1 billion a month, then demand will likely be close to zero. 

So it would be rather parochial to suggest that new technology equals growth! 

Price elasticity (price sensitivity) has been variable among telecom products. According to UN’s International Telecommunication Union’s (ITU) “Telecommunication Handbook Appendices” (2000) “Demand for any given service is less elastic for business users than for residential users.”  (B-9) 

What this means is that if the price for an upgrade will be steeply higher compared to its perceived and or calculated benefits (access and usage) then demand may not be as strong. 

Yet given the huge of cost of acquisition and the transition of the industry from two competitors (or players) to a formalized cartel and a monopoly for 4G services, low or affordable prices will not be a guarantee. 

That’s because in absence of competition, the company have now garnered effective control over prices! Consumer’s choice would now be reduced to buying from them, or not to buy at all. That’s instead of the previous conditions where consumers would have a choice in the products of competing providers. 

Additionally, upgrades are no guarantee of growth if economic conditions falter.

Since 2014, based on 1Q data, the combined gross revenues of both PLDT and GLO have been plateauing. Being a two party competition, GLO has been taking a larger market share of the pie from PLDT. But in general, competition has masked the deteriorating gross revenue conditions of the industry. 

So this could be a sign of industry saturation and this could also be signs of economic conditions. Or in fact both could signify a symptom. 

Five years back PLDT acquired Gokongwei owned Digitel supposedly to take advantage of the “synergies” between the companies and to reduce the former’s capex. 

Yet what happened to the merger? PLDT’s income today has been under pressure. 

And this could be why the duopoly seems desperate to acquire SMC’s telecom business. 

And such desperation has been sold as a game changer. 

On the other hand, of course, SMC seems all too eager to sell to get access to liquidity to finance its highly levered business model

There is another very important component being ignored: the political environment encompassing the industry. 

Below is an excerpt of the arguments I made in my April 3, 2011 “Philippine Telecom Industry: Buyouts And Mergers Don’t Kill Competition, Laws Do” article 

The path towards the monopolistic character of our telecom industry is a product of our existing laws. 

One, there is a constitutional limitation on foreign ownership in public utilities to 40%. 

Two, licenses per se are not issued to telecom service operators in the Philippines unlike many countries. Instead, operators are required of a legislative franchise (issued by Congress). 

Three, another requirement is the certificate of Public Convenience and Necessity issued by the National Telecommunication Commission (NTC), and 

Lastly, approval to provide telecom service via grant authority for operation also from the NTC, which usually covers a provisional period of 5 years. 

The above is a manifestation of the huge structural obstacle imposed against companies wishing to enter and compete with present participants in the telecom industry. 

Such regulatory labyrinth represents as the anti-competitive anti-business nature of the Philippine business climate that enables such monopolistic character to take place because it substantially raises the barriers to entry, increases the hurdle rate for investors just to comply with these web of statutes and whose success to secure license-to-operate would depend on the whims of venal politicians. 

Imagine, any business entity wishing to enter and compete with the entrenched bigwigs would need huge sums of lobby money to get a franchise, and to outbid the existing companies protected by these laws, who would likewise spend enormous amounts of lobby money to oppose their entry! 

And that’s not all. There are other administrative regulatory compliance costs such as the NTC requirements et. al. with which prospective new players need to deal with. 

So in effect, alot of productive capital will go down the drain just to acquire licenses, pay regulatory fees, and also to oppose entry of competition! And alot of those wasted money would only go to the pockets of these grandstanding politicians and the bureaucrats. And this doesn’t even count on the productive time lost to secure licenses and to comply with such regulations. 

The point is: Buyouts and mergers don’t kill competition, (anti-competition) laws do. 

This week’s formalization of a cartel and the forging of an indirect monopoly essentially proved my point and validated my forecast of the trend towards a monopolistic character of the industry. 

And monopolies are a product of a highly politicized environment, or to quote Austrian economist George Reisman, “Monopoly is actually the result of government intervention. Specifically it is the reservation of a market or part of a market to one or more suppliers by means of the initiation of physical force. Exclusive government franchises, protective tariffs, and licensing laws are examples” 

As noted above, by competition, consumers are given the power through choice to discipline or regulate providers or suppliers through the profit and loss system. And given the absence of the discipline from competition, will services actually improve when profits have virtually been guaranteed due to the embedded protectionist political climate? 

Bureaucratic politics have rendered the duopoly to become palpably insensitive to consumers. Yet will more fiat, executive orders and threats from central authorities provide the necessary incentives for such politically incented institutions to align their goals with the consumers? 

The incoming president, Mr. Duterte, had it right when he threatened existing firms that “he would allow the entry of foreign players if service providers failed to make the country's internet service faster” He should make good of this with or without actions by the duopoly. Unfortunately for this to happen means to change the constitution. And a constitutional change could signify a Trojan Horse. 

Mr. Duterte’s ‘improve or else’ stance was also right for the wrong reasons. Why? Because by using consumers as an excuse, he impliedly offered protection to the oligarchs. Of course, services can it improve, but at what price to the consumers? 

If he really cared for the consumers, then he just dismantle ALL THE LEGAL OBSTACLES on the industry for competition to really flourish. 

It’s not just legal barriers to entry, this also should involve the legal obstacles that underpins the incumbent bureaucratic politics. 

In sum, the monopolization of the 4G services from the joint acquisition, as well as, the formalized cartel will insure of a captured stream of income for both TEL and GLO. That’s the benefit. 

But this doesn’t guarantee that such would imply of sustainable growth because prices and economic conditions will play a key part in consumer’s choice and the shaping balance sheet conditions of the duopoly. 

And if growth may not be guaranteed, then vastly increased leverage used for acquisition could mean increased pressures on the bottom line. This could even lead to increased credit risk. 

Additionally there might be other textbook economic costs to such monopolization: high prices, allocative inefficiency, productive inefficiency, less cost sensitive, low output, inflated profits, diseconomies of scale and poor product quality/services