Verizon's Entry Into Canada Was Never An Existential Threat To The Big 3

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 |  Includes: BCE, RCI, TU, VZ
by: Matthew Brown

Over the summer of 2013 there was a lot of discussion, innuendo and rumors about Verizon (NYSE:VZ) making a competitive entry into Canada for wireless service.

Initially it was about Verizon purchasing WIND Mobile or Mobilicity or both. Verizon, more recently, cooled to the idea of buying the two orphans of the Canadian Wireless scene and the speculation was that they would just make a play at the spectrum auction and come in fresh.

To be honest with all of you, from an investor's standpoint, I was always puzzled as to the market and analysts' overreaction, and I will tell you why.

The 'Big Three' Defined

In Canada, telecommunications companies are dominated by Rogers (NYSE:RCI), Telus (NYSE:TU) and Bell (NYSE:BCE). They have the nationwide wireless coverage, IPTV or Cable TV service, data connections and fiber networks that allows them to compete in a way that the other, regional telecommunications companies have not been able to. Both BCE and TU are the children of the Bell Canada mandated breakup, and Rogers is the dominant nationwide cable competitor akin to Comcast in the USA.

Infrastructure

All of the rumors of Verizon's interest in Canada came bundled in the assumption that Verizon would 'win' against the Big Three. I do not agree that would be the case. Canada is a huge country and has infrastructure requirements, per capita, that dwarf that of the United States and most other countries. Industries such as telecommunications in Canada had a unique start in their corporate lives. By necessity and government decree, the very start of the nationwide telecommunications infrastructure was government mandated through various monopolies, oligopolies (railroads) and various regulations. Because Canada did not have the population density, the government felt it had to have a hand in the start of the nationwide network. This largely created the seeds of today's high tech, cross country network that the Big Three are able to leverage today.

Whatever your thoughts are on if this was good policy or not, it is in large part the 'moat' that makes any of the Big Three a great long-term investment. Verizon would have had none of that. The thought was that they would compete only on the wireless side, but that would put them in a competitive disadvantage that would have been very difficult to overcome. Businesses, where the larger margins are, prefer to deal with one company for their data, voice and wireless services. The Big Three, in competing with Verizon, would have been able to discount their wireless margins and make it back on their other services.

Vertical Integration

Both Rogers (RCI.B) and Bell are also content providers. In the 1990s and early 2000's, BCE started to vertically integrate into providing content. They may have been a little early to the game, but the strategy is a sound one and is now being pursued by Rogers as well. Verizon, even in the USA, does not have this component to their strategy. They are a pure play 'provider' and would have been that in Canada as well. So in addition to Verizon (or any other foreign entrant) having to rent infrastructure from the Big Three, they would also have to license content to be played on their wireless devices.

Buying Power

One of the themes of the proponents of Verizon's imagined 'dominance' over the Big Three would be their 'buying power'.

Verizon would also be able to deploy its massive scale and buying power against the relatively small Canadian incumbents. Verizon earned US$115.8-billion in revenue last year, compared to BCE's $19.9-billion, Rogers with $12.5-billion and Telus with $10.9-billion. The Big Three control just under 90% of the Canadian mobile market

Sure, I would imagine being a company that has over 10 times the sales of wireless devices than the Big Three combined would give you a certain bargaining power with the manufacturers of the wireless devices, but I am unclear how this would have been a disruptive force in any entry to the Canadian market. We must remember that WIND is part owned by VimpelCom (NASDAQ:VIP), a company that, by many accounts, is larger than Verizon.

With these things in mind, why then was the Big Three so upset about Verizon's possible entry?

From my perspective I think that, collectively, they are weary of the constant CRTC oversight that is, frankly, antiquated in this day and age. When they saw a very large foreign competitor that was going to be able to have access to the most valuable wireless spectrum that will be available in a generation at a discount, they had had enough.

Future

Canada's low population, huge and challenging geography are the moats that will continue to make the 'Big Three' excellent candidates for a Dividend growth buy and hold strategy. This moat is effective not because it would be expensive to build out a national telecommunications infrastructure, (although it surely would be) it is because it would be uneconomical to do so.

If, in the future, the government again gets a populist streak and wants to truly bring in a foreign competitor, they will have to lift the current CRTC ownership restrictions placed on the Big Three. If that were to happen, then I would expect Big Three shareholders to be richly rewarded.

For these reasons and others, Verizon's possible entry knocking the Big Three's stock price down between 10 and 20% was a great buying opportunity for investors who had the background knowledge needed to see through the hype that was generated around this issue.

Verizon now officially declining to come to Canada has merely made the return to norm in price valuations for the Big Three come faster than it would have otherwise.

Disclosure: I am long RCI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.