Estimates swerve 23 times on the value of frequency block on offer; Firms, as well as investors, are clueless

By Cho Jin-seo

The lobby of the Telecommunications Technology Association building was too calm to be a place where the largest auction in the history of Korea was taking place. "Reporters and TV cameras came here only on the first day. It has been very quiet since then," a lone security guard said on Thursday, the seventh day of the mobile phone spectrum auction.

One cannot imagine the importance of the auction by merely peeking into the boring office building in Bundang, a bed town south of Seoul (the bids are called from meeting rooms, which are off-limits to the press). When Friday's rounds ended, the price of the right to use a 20-megahertz block of 1.8 gigahertz band for 10 years soared to 995 billion won ($920 million), more than double the starting price of 445.5 billion won.



The game is not over yet. The two bidders — KT and SK Telecom — are expected to continue playing this week.

There is no clear answer on how much is the optimal price for the bidders of the frequency. It is an unprecedented event in Korea. And the usual market principle of supply and demand does not apply here as the mobile phone industry is highly regulated and protected. What is certain, however, is that the firms have already offered bids that far exceeded what they are currently paying for other blocks of frequencies.

Estimates by observers vary too much to be a meaningful guideline. Analyst Yang Jong-in of Korea Investment & Securities says pessimistically that historically the government had sold the right to use a 20-megahertz slot for 10 years at no more than 433 billion won. So this time the bidding is apparently overheated and the bids entered an "irrational territory," he says.



Conversely a paper by the Korea Radio Promotion Agency painted a far more optimistic picture. In December, its researchers estimated that adding a 20-megahertz block to a mobile service firm's assets can raise its corporate value by 10 trillion won over 10 years, as the right to use the bandwidth is the most crucial asset in this industry and increasingly so as the volume of mobile phone data traffic keeps surging.

These two estimates range 23 times on the value.

Despite the lucrative price, the auction has not drawn as much media attention as it deserve. There are probaby two reasons for this. Firstly, the subject is too technical for the general public to understand, or care, and a radio wave does not have a physical form, unlike a gold watch or a Van Gogh painting being sold at Sotheby's.

Secondly, the rule of the auction was designed to minimize the involvement of excessive human emotions and ego. It is a variation of the so-called "Japanese auction" or "simultaneous multiple-round auction." — the firms can make bids one by one in each round, after seeing how much their counterpart offered in the previous round. They have 30 minutes to respond and can call two "time-outs." No new bidders can join and there is no upper limit.



Why is a frequency band so important?

It is the first time the Korea Communications Commission (KCC), the government entity in charge of radio wave spectrums, to hold an auction. Before, it singlehandedly sold or handed out the spectrums to companies and institutions that pass its test. Earlier this year, a revision of law opened the road for the KCC to stage spectrum auctions in order to raise more money from the sales and make the process more transparent.

Like land and fresh water, frequency spectrums are a finite resource and shared by a country, or by the whole world in some cases. National governments as well as international organizations allocate different spectrums for specific purposes in order to prevent jamming of signals by multiple devices using overlapping bands.



The frequency — numbers in front of kilohertz, megahertz and gigahertz — shows how many times the wave beats in a given second, and this is the most distinctive characteristic of a signal. Broadcasters and telecommunications firms transmit a wave on an assigned frequency range, which is called a "channel" or a "block." Multiple channels and blocks add up to form a "band," which is assigned by government for specific purposes. In the current case, the 20-megahertz block is a part of the 1.8-gigahertz "band." To handle more voice and data traffic more efficiently, a larger bandwidth is needed.

In modern days, there are numerous new uses of radio spectrums, from satellites to mobile phones to wireless headsets worn by musicians. The military and other public organizations also demand a significant amount of bandwidth, exclusively, for high-tech, high-security communication and surveillance tools. So allocating spectrums always causes a headache for regulators.



Generally speaking, a high frequency channel can carry more data signals because it has a wider bandwidth, but a low frequency wave can travel farther. So finding a right mix for different uses is essential in allocating frequency bands. For example, spectrums between 300 kilohertz and 3 megahertz are reserved for AM radio transmission because reach is more important than quality. TV and mobile phone services are designated to use spectrums between 300 megahertz and 3 gigahertz in Korea (See chart on top) since that's where the mobile phone network can have both speed and reach.

The problem is that this bandwidth is still not wide enough for everyone who wants to use it, so the government has to intervene. Having a wider bandwidth is a big advantage for faster data traffic such as the LTE standard, so every mobile operator wants to secure as many frequency blocks as possible.

The result of the SK Telecom-KT auction is set to become a reference point for future spectrum auctions. Sometime after next year, the government is planning to put at least five other 20-megahertz blocks on similar auctions — a comfortable way of raising government income in this era of mounting public debt, like collecting an indirect tax.

In other countries

Most national governments apply three basic rules in managing the spectrums — they need to be allocated to maximize their monetary value; they need to serve public interest; and they need to be allocated in a way so they can be used most efficiently.

Since the 1990s, most countries with developed economies have increasingly been opting for auctions in allocating radio frequencies. The prices are often lucrative.

In one of the most famous of such auctions, the U.S. government raised $19.6 billion by selling five frequency blocks totaling 62 megahertz. In Germany, 12 blocks were sold in 2000 at around 50 billion euros. These numbers make the current biddings from SK Telecom and KT look modest, but in other cases there were much cheaper sales in both countries, too, depending on the specifications of the frequency blocks and the competitive landscape of that time.

What concerns national governments most is that firms can collude with each other if there is more than one block to split. Tacit collusion also takes place sometimes. So governments carefully design auctions to prevent such manipulation. Sometimes they mix auctions and other more direct methods of sales. This time, the Korean government let LG U+, the smallest of three mobile operators, to bid for another 20-megahertz block. LG bought it for only 446 billion won. The decision helped LG financially but it also prevented two giants SK and KT from cheating — Now there is only one block left and they have to fight each other.

The remaining block, on the 1.8-gigahertz band, is especially attractive so collusion is not an option for them. That frequency band is being used as the de facto international standard of a next-generation mobile phone service called LTE (Long-term Evolution) in many countries. So with the right to use the block, either SK Telecom or KT will be able to enjoy the economies of scale in purchasing networking equipments from global makers, and in providing international roaming.

KT has another advantage in using it, as the firm already owns a nationwide network of radio towers designed to use the 1.8-gigahertz band.

Winner's curse means more state income

As the bidding price continues to rise over eight days of escalating rounds, the media, as well as opposition party politicians, began to raise voices over the so-called "winner's curse."

By definition, the winner of an auction always ends up paying more than the market consensus — otherwise he can't win. So last month, six lawmakers from the Democratic Party argued that if management of a mobile firm finds out that the frequency block they purchased is not much use, then the burden will be passed to phone subscribers in the form of higher fees, which is a burden on every citizen. They demand the government do some action to stop the bidding. But their logic was weak as the revenue raised in auction goes to the government budget and will eventually be used for the benefit of the public. An auction also is a way to find the best buyer who can utilize the spectrum better than others.

As for shareholders, however, an overheated bidding could be a serious concern. Yang, the analyst at Korea Investment & Securities, says that a 100-billion won increase in the price means a 0.6 percent fall in profit to SK Telecom and 0.8 percent to KT, which will affect their share prices, too. In his calculation, the two firms have already lost 3 to 5 percent of their corporate value.
Therefore, Yang argues that it makes little sense for them to pour more money into it, as the government will start selling more of such blocks in the future anyway.

Five blocks in the 700-megahertz band (between 698 megahertz and 806 megahertz) will be available from 2013 when analog TV broadcasting will be completely replaced by digital broadcasting, and those frequency spectrums are considered to have ideal characteristics for mobile phone services.

"The 1.8-gigahertz band is useful (for next-generation services), but if it becomes too expensive, the 700-megahertz band will be a better alternative," he said.

Meanwhile stock market investors look unsure of what to do. KT's share briefly rose at the start of the auction on Aug. 17 but came back to the same level by Friday. SK Telecom's fell by 3.5 percent during the period. But these changes may not reflect the exact market sentiment on the auction — means of valuation is unclear, and the whole stock market is experiencing high volatility this month. A move of a few percentage points does not seem meaningful these days.