What Verizon's Entry Into Canada Means

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

News has swirled fast that American wireless carrier, Verizon (NYSE: VZ), is considering a purchase that will take the company to Canada. In the northern country, three key communications conglomerates control 90% of the wireless market. The question remains whether or not Verizon can gain market share and recoup costs. The other question is what kind of a financial impact the three competitors would face from the entry of Verizon.

The potential deal

Verizon is interested in acquiring Wind Mobile, one of three new wireless companies in Canada trying to compete with the giants. Wind Mobile has over 600,000 subscribers, which gives it only a fraction of the estimated 26.9 million wireless subscribers in Canada. More complicated is the ownership structure of Wind Mobile, which could cause Verizon headaches, or make the company overpay for Wind.

Wind Mobile is 65% owned by Orascom Telecom and 35% owned by founder and CEO, Anthony Lacarera. VimpelCom owns 51.1% of Orascom and is pushing for a sale of Wind Mobile. VimpelCom is expected to seek $500 million for its stake in Wind Mobile. Verizon may have to pay more than that to acquire the whole company. Other estimates see Verizon needing to put $1 billion-$2 billion into the spectrum in upcoming auctions.

The three giants

In Canada, the three leading telecommunications companies have a 90% market share. These three companies, which are all traded in the United States, are Bell Canada (NYSE: BCE), Rogers Communications (NYSE: RCI), and Telus Corporation (NYSE: TU). These are Verizon’s potential rivals.

Bell Canada is the largest communications company in Canada, with the No. 1 television network in the country. The company gets more revenue from the television and internet side. In fiscal 2012, wireless made up 32% of the company’s $19.98 billion in revenue. In 2012, Bell had 7.8 million wireless subscribers. The company’s No. 1 goal is to accelerate its wireless. Plans to expand the company’s market-dominant 4G LTE position are underway. Wireless revenue increased 6.5% in fiscal 2012, and the company increased its wireless customer base by 3.4%.

Rogers will provide the most competition for Verizon. The company is Canada’s largest wireless company, with over 9 million customers. Rogers got 58% of its fiscal 2012 revenue from its wireless segment. Wireless revenue in fiscal 2012 was $7.3 billion. Along with a dominant position in wireless and cable (26% of revenue), Rogers owns a nice portfolio of sports teams and assets that I previously wrote about.

The third leading company in Canada is Telus. Surprisingly, Verizon had a partial ownership stake in Telus until 2004. Telus had 7.7 million wireless customers in fiscal 2012. The company also sees a large portion of revenue (54%) from its wireless segment. Wireless revenue increased 7% in fiscal 2012, which was the best of the three companies. Telus has coverage available to 99% of Canadians and also saw big gains in internet subscribers (+5.7%) and television subscriptions (+33%) in fiscal 2012. Despite its third position and smallest market capitalization, Telus is posting impressive gains.

Canada wants competition

Back in 2008, Canada auctioned off spectrum for new entries into the wireless field. None of the three giants were allowed to bid in the auction. The three companies that won spectrum were Wind, Public Mobile, and Mobilicity.

The problem is, no one has been able to compete with the three telecom giants, despite the Canadian government’s efforts. Wind is now up for sale. Public Mobile was acquired by private equity, and Mobilicity was almost swallowed by the big three. Telus attempted to acquire Mobilicity, but was blocked by the government as it would have given the new spectrum to the company.

Canada eased restrictions for foreign investment. The government now allows foreign ownership in a telecommunications company if it has less than 10% market share. This allows an acquirer like Verizon to buy out Wind Mobile. However, this prevents Verizon from going after a larger company, like Telus, or growing too fast and gaining on rivals. Essentially, Verizon will be capped at 10% market share maximum unless the government changes legislation.

How Verizon can win

Verizon is the No. 1 wireless carrier in the United States. At the end of April, Verizon had a 36.3% market share in the United States, versus a 26.3% share from rival AT&T. With this dominant position, Verizon enjoys a stable flow of cash that could help it build out in Canada. More importantly, Verizon also has good relationships with phone providers, which could help it to gain exclusive rights to certain phones and increase Wind’s market share.

Verizon would need to be dominant in the 2014 spectrum auction. Bids are due by September 2013, so Verizon will have to move fast if a deal is appropriate. The company may also consider trying to buy out Mobilicity or Public Mobile to create a more dominant fourth company and get closer to a starting base of one million customers.

Conclusion

Verizon is smart to enter the Canadian market, as it is adjacent to its market dominance in the United States. However, the worry is the price Verizon will pay to acquire Wind Mobile and additional spectrum. Others have failed at competing with the giants. Shaw Communications, a large Canadian company, recently cancelled plans for the wireless segment and sold its spectrum to Rogers.

Verizon is a "buy" regardless of whether or not the company enters Canada. If it doesn’t go north, it will still have the No. 1 position in the United States and a huge cash flow that will continue to be used for acquisitions or returned to shareholders. Analysts expect the company to post only 4% revenue gains in fiscal 2013 and fiscal 2014, leaving plenty of room for upside with new deals or product launches.

On the Canadian side, the three rivals should not be too worried about Verizon’s entry. I have long loved Rogers Communications for its diversification of media assets and ownership of its sports portfolio. As the wireless leader, Rogers could have the most subscribers to lose, yet also has the best defense for revenue lost. Telus, as No. 3, probably has the most to lose in the Verizon entry. With over 50% of revenue coming from wireless, Telus needs to keep its seven million subscribers. Bell Canada is the largest complete company, but gets the majority of its revenue from wireless. Wireless revenue declined 3.8% in fiscal 2012 to $10.2 billion. The company’s 50% revenue from wireless makes it a more risky play.

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Chris Katje has no position in any stocks mentioned. The Motley Fool recommends Rogers Communications (USA). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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