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INTRODUCTION

The Globe and Mail revealed on June 26 2013 that Verizon (NYSE:VZ) had made an offer to acquire WIND Mobile for $700 million. Verizon was also reported to be in talks to acquire Mobilicity and may have intentions in place bids in the upcoming spectrum auction in Canada. This is not the first time that Verizon has attempted to enter the Canadian market but due to foreign ownership rules, Verizon was not able to establish itself in Canada. Now that both WIND and Mobilicity were put up for sale this year, Verizon may have a great opportunity to access the Canadian market. What could this mean if Verizon enters the Canadian market?

IS DEAL LIKELY TO BE APPROVED?

First and foremost, is it likely that Verizon will succeed in acquiring WIND and possibly Mobilicity? The chances are much better than they were a year ago. The Canadian Federal Government opened up the telecommunications industry by auctioning off spectrum in 2008 and reserved the majority of it to new entrants like WIND and Mobilicity. However, since these two companies began operating in Canada, both Wind and Mobilicity have struggled to break even.

Here are the reasons why I feel Verizon would get approval by the Canadian Federal Government:

1. Verizon could not purchase the full ownership of an incumbent however since the foreign ownership rules have been changed, Verizon could now purchase smaller service providers so long as they have less than 10% of the market.

2. The Canadian Federal Government has made a promise to provide increased competition in the telecommunications industry in order to lower prices. If WIND and Mobilicity leave the Canadian market, it will lead to a broken promise. Governments are rarely ever held to keep their promises however this is a political issue as consumers have been screaming for lower prices and better options.

3. The Canadian Federal Government also has a goal of having four wireless service competitors in every regional market. This is working in the province of Quebec and the Atlantic Provinces, but not in the provinces of Ontario (which has the largest population base), Alberta and British Colombia. Alberta also happens to be where the Prime Minister is from and holds his elected seat, thus placing a bit of additional pressure to come through with these goals in the province that has strongly supported him politically.

4. The object of the spectrum sale was to increase the competition for the incumbents Rogers (NYSE:RCI), Bell (NYSE:BCE) and TELUS (NYSE:TU) to drive prices down. This has not occurred and requires some other form of catalyst which Verizon could bring to drive prices down.

5. The Canadian Federal Government has also said that the spectrum sold specifically to new entrants like WIND and Mobilicity were never meant to go into the hands of the incumbents. This could be a positive for Verizon as it will ensure that this does not happen.

Here are the reasons why I feel Verizon would be rejected by the Canadian Federal Government:

1. The recent revelation that the NSA had direct access to all communications by Verizon may be a serious concern. It may not be a concern for the Canadian Federal Government if Canadian owned and operated telecommunication companies do this, but a foreign company would raise serious privacy concerns. This has already become a sensitive topic in Canada already and because Verizon was specifically named, Canadians may retaliate against its approval.

2. Privacy is a serious concern in Canada. The use of customer information is also another concern. If Verizon is unable to meet Canada's specific privacy regulations, it may be rejected on these grounds.

MARKET REACTION

First and foremost, there were these comments by Desjardins analyst Maher Yaghi:

"Should Verizon ((VZ)) enter the Canadian market (previous), investors in Canadian wireless providers can expect a hit of up to 18% in stock prices. Yaghi thinks that BCE stock could decline by 10%, Telus ((TU)) by 17% and Rogers Communications ((RCI)) by 18%, if as he expects Verizon gained 15% Canadian market share."

Yaghi wasn't far off. When the news broke out, there was an immediate selloff in the stocks of the incumbents. Rogers dropped 9.2%, Bell dropped 4.0% and TELUS dropped 8.0% on the Canadian TSX exchange. Similar drops were experienced on the American exchanges. It would appear that many fear that Verizon is capable of taking market share away from the incumbents. For investors, this could mean either an incredible buying opportunity for Canadian telecom company stocks if you think that the Canadian Federal Government will block the sale or it could represent the first in a series of declines in shares prices if this deal is approved and Verizon begins to establish itself.

WHAT DOES VERIZON GET?

The following maps show the coverage areas for WIND and Mobilicity. WIND is established in the markets of Toronto, Ottawa, Edmonton, Calgary and Vancouver. WIND has 4G capabilities but access to this appears limited to a premium plan.

WIND Coverage Map
(Click to enlarge)

Mobilicity is established in Montreal, Toronto, Edmonton, Calgary and Vancouver (look for the pink dots). It too has 4G capabilities and runs a similar structure to WIND.

Mobilicity Coverage Map
(Click to enlarge)

If consumers are outside of these cities, there are roaming charges that apply. These roaming charges pay for network access on the incumbent's network. For Verizon, these cities are central to the Canadian market, particularly if Verizon can close a deal on Mobilicity and obtain the city of Montreal. These six cities are essentially the business hubs and the most populous cities in Canada. Expansion outside of these cities is almost not necessary since the majority of the population in Canada and businesses are found within them.

DOES VERIZON HAVE A CHANCE IN THE CANADIAN MARKET?

This is one of the most difficult questions to answer. First of all, the incumbents control about 90%-95% of the Canadian wireless market. Thus far the efforts by the Federal Government to open up the telecommunications industry has not succeeded, nor has it made an impact on the incumbents.

Verizon has several key advantages though that could propel it to success in Canada.

U.S. ROAMING: Due to its established network in the U.S., Verizon could offer one of the most incredible packages or rates for roaming and long distance. Since all calls would operate on the same network, it may be able to offer free roaming or seriously discounted roaming rates than the incumbents. This along would make a serious impact on business consumers looking to cut costs. Verizon could obtain a fairly sizable share of business contracts if it can offer significant savings in roaming and U.S. long distance.

MARKET CAP: Verizon has money! This is something the new entrants really did not have. Verizon can use this cash to advertise more effectively than the new entrants. Also, Verizon's market cap is twice the size of the incumbents meaning that it can challenge the incumbents' efforts to tarnish Verizon's image or advertising.

PURCHASING POWER: Due to Verizon's large handset purchasing power, they could offer subsidies that would impact the margins of the incumbents if they tried to match their offers. Verizon has the ability to be more aggressive in its subsidies than the incumbents. This is particularly important given the recent changes made by the Canadian Radio-Television and Telecommunications Commission which lowered the length of time a customer can terminate their contract from 3 years to 2 years. This will be something new that the incumbents will have to deal with, however the U.S. has had this standard in place for some time already and Verizon has already adapted. Verizon may have greater access to popular handsets and may even be able to negotiate exclusive rights to several handsets.

SPECTRUM: The 700-MHz spectrum that WIND owns at the moment is contiguous with spectrum in the U.S. This means that Verizon will have fewer changes to make and less investment is required to join it with its current network.

CUSTOMER SATISFACTION: Canadians have for years rated the incumbents as having the worst customer satisfaction. Verizon on the other hand has been rated the best out of the four biggest telecommunication companies in the U.S. for customer satisfaction and not far off from other service providers who were rated higher. This alone may intrigue Canadians who are looking to actually have a good experience and act as a mechanism that encourages them to switch service providers.

Verizon has several issues that could limit its success in Canada.

CONSUMER HABITS: One of the troubling signs regarding consumer habits in Canada was that despite all the complaining regarding high prices and lack of options, few Canadian consumers switched over to the new entrants like WIND and Mobilicity. It may be that consumers like to stick with what they know and are hesitant to try something new. However, Verizon is not something really new. Verizon is one of the largest telecommunications companies in the U.S. Canadians see commercials for Verizon while watching American television. So Canadians have already been exposed to Verizon which may remove that "new" feeling to something more "familiar".

LIMITED SERVICES: Verizon may only offer wireless services in Canada. This may prevent many consumers who are accustomed to bundling their services under one bill. The incumbents also offer discounts (albeit not large discounts) for bundling services together such as home phone, wireless, internet, and television. Consumers may be hesitant to break up their services and begin paying two companies for all their services. To encourage consumers to do break up their services, Verizon will have to have a compelling offer that shows consumers that they will be saving money.

PERSPECTIVE: Verizon is considered an incumbent in the U.S. If Canadians begin to associate Verizon with the current incumbents, they may be hesitant to sign up with Verizon as they may see the company as just another Rogers, Bell or TELUS. Verizon will have to show Canadian consumers that they are different and really distinguish itself from the current Canadian incumbents.

NSA ISSUE: This issue could have a large ranging impact if Verizon enters the Canadian market. Due to Verizon being named specifically as a company that the NSA has access to their information, this may prevent certain businesses from seeking contracts with Verizon due to concerns about their information. The Federal and Provincial Governments would most likely not negotiate with Verizon due to this concern.

CONCLUSION

The possibility of Verizon entering the Canadian market has caused quite the stir. Some are very excited about the prospects. However, Verizon will have some work ahead of it if it will be able to succeed in Canada. WIND has approximately 600,000 consumers at the moment. This is very low and will mean that Verizon may have to aggressively advertise in order to keep and increase this consumer base. This level of advertising could have an impact on margins and free cash flow. Verizon also continues to expand and improve its network in the U.S. which begs the question about how much money if Verizon really willing to invest in Canada?

Will this acquisition make a big difference for Verizon's earnings? I don't suspect so. Given several factors that Verizon may have to use to win over consumers such as aggressive advertising, subsidized rates for handsets, and possibly subsidized rate plans to set them apart from the incumbents, Verizon may not see a significant increase in earnings or margins for quite some time. It is also unlikely that there will be a significant increase in earnings or margins given the limited number of cities it will be found in. Yes they are the biggest cities however it will still be missing out on other populous cities and areas that could contribute to earnings. The other point to consider is that only has a population of over 36 million people. Some of these places don't have access to cell networks. A fair proportion of these consumers just won't switch over. The impact on earnings and margins I believe will be minimal. It will however position Verizon for further expansion and provide it with further opportunities in the future, opportunities that its rival AT&T (NYSE:T) currently does not have.

From an investment perspective, I continue to look for an attractive entry point for Verizon to initiate a position. I will also look to increase my position in Rogers as I feel the sell-off is over hyped and that the incumbents are oversold. The incumbents will still be able to pay their dividends for years to come.

Verizon will have to play this well there is no doubt. Canadians are tired of paying high wireless costs and Verizon could be the breath of fresh air that they are looking for.

Source: What Verizon's Expansion Into Canada Could Mean