Canadian investment market melting

Lax foreign ownership rules may not create stampede of new investors

Some Canadian telecommunications and cable operators are champing at the bit for increased foreign ownership in their businesses, but it's unclear to what extent foreign investors would flock to Canada.

VC watch

Brian Tobin, Canada's Industry Minister, said the government will consider lifting Canada's foreign ownership limits by this fall after a group of telecommunications companies, known as the National Broadband Task Force, urged the federal government to ease foreign ownership as part of an effort to deploy broadband connections across the country by 2004. Foreign companies are restricted to owning no more than 33% of a Canadian telecom holding company and 20% of a Canadian operating company.

U.S. investments in the Canadian telecom market allow Canadian and U.S. companies to make joint capital-expenditure decisions and give it more leverage with suppliers.

Cable operators as well as AT&T Canada are leading proponents of looser rules, believing increased foreign ownership will provide broader access to capital to compete with global players. But Canadian telecom giants such as Telus and Bell Canada are more reluctant, playing on Canada's strong sense of nationalism. Both companies say they support more gradual changes in foreign investment policy.

"This goes far beyond business. It's a policy issue," said a spokesman for BCE, which owns 80% of Bell Canada. "The most obvious danger from a national perspective is we would lose control over the industry. We need to track foreign investment and still allow Canadian companies to be in control."

Telus supports elimination of foreign ownership and control rules in principle, said a Telus spokesman. "However, we don't see an immediate need for removal of those rules."

Cable operators have publicly argued that Canada's telecom sector is in danger of becoming a near-monopoly if the rules don't change fast. Several small telecom companies have gone out of business trying to compete with the likes of Telus and Bell Canada, which analysts say control about 90% of the Canadian telecom market.

Like their U.S. counterparts, the largest Canadian carriers disagree and claim that the state of competition is strong, with low entry barriers. “Some new entrants are having difficulties, but that is more predicated on the business case, not the industry,” said the BCE spokesman.

Relaxed foreign ownership, however, may benefit one of the largest carriers AT&T Canada. Standard and Poor's recently revised its ratings outlook for the company from “positive” to “developing,” saying the outlook reflects the possible effect of AT&T Canada's eventual ownership by AT&T on the relaxation of foreign ownership restrictions. S&P has been concerned about AT&T Canada's revenue growth prospects, its lower-than-expected performance in the second quarter and the impact of more aggressive competition from incumbents.

Canada's telecom market has been the target of investments from U.S. companies seeking to offer a seamless North American footprint. Verizon owns 22.8% of Telus. SBC Communications owns 20% of Bell Canada, while AT&T Wireless recently increased its stake in Rogers Wireless by acquiring BT's 15% interest for $380 million and upping its stake in Rogers to approximately 34%, pushing the foreign ownership limits (see figure).

A little bit of Canada Major companies with minority investments in Canada
Rogers Wireless	At&T Wireless (34%)
Microcell	Deutsche Telekom (15%) (via VoiceStream Wireless)
Bell Canada	SBC Communications (20%)
Call-Net	Sprint (25%)
Telus	Verizon (22.8%)
Source: Companies

Such investments allow Canadian and U.S. companies to make joint capital-expenditure decisions and give it more leverage with suppliers. Telus said its buying power with Verizon saved the company more than $26 million in 2000. This year, Telus and Verizon continue to align products and services as well as integrate network and infrastructure elements across North America.

Even with more lax ownership rules, it's unclear how much more foreign companies are willing to ante up in Canada. SBC indicated a potential change in Canada's foreign ownership restrictions would have little impact on the company. Verizon says it is pleased with its minority interest in Canada but wouldn't comment on future prospects if foreign ownership restrictions were lifted.

"I don't think Canada is a pressing concern on anyone's radar screen," said Iain Grant, managing director of The Yankee Group in Canada. "Canada has the lowest communications costs in the world. Why on earth would anyone want to come here?"

At first glance, buying into Canada's telecom market should look attractive to U.S. companies because stock prices are depressed and the exchange rate makes the Canadian dollar worth about 65¢ U.S. dollars. Wireless operator Microcell Telecommunications, which has struggled to raise capital to build out its network, has become the cheapest wireless operator in North America, trading at $7 in the U.S. If Deutsche Telekom, which now owns 15% of Microcell through its acquisition of VoiceStream Wireless, wanted to purchase Microcell, it would pay around $1100 per subscriber to acquire Microcell compared with VoiceStream's $15,000 per subscriber price.

But the cheap prices translate into lower revenues. For instance, Canada's wireless operators record an average revenue per user of around $26, compared with $60 of ARPU for U.S. carriers AT&T Wireless and Sprint PCS.

To make matters worse, Canada's expansive geography translates into low density rates.

"The economics of particular technologies is much worse than in other places," said Mark Hugh Sam, technology analyst with Dundee Securities in Toronto. "Deployments only make sense in major cities."

Perhaps the best investments U.S. and other foreign companies can make are in bellwether companies such as Bell Canada and Telus, analysts said. Telus is likely to seek more investments from Verizon to compete with Bell Canada. Telus recently issued about $325 billion in bonds but may incur increased costs by competing with a BBB+ rating from S&P.

"I think this whole question of foreign ownership has passed by," Grant said. "If carriers were to get their customers to pay more for communications services, investors would flock here."

---

VC watch
Company	Amount	Lead investor(s)	Purpose
T-Networks Optical component maker	$12.5 million	Sequoia Capital	Product development and deployment
Ikanos Communications Silicon broadband chipset maker	$25 million	Walden International	R&D, sales and marketing
Q-Optics Optical provisioning equipment developer	$11 million	Warburg Pincus	R&D, expansion of technology team, deployment of alpha product
UshaComm Billing and customer care software provider	$8 million	Carlyle Asia Venture Partners	Marketing, international expansion
LightCross Optical component maker	$30 million	UMC Capital	Staff expansion, operations
Crosslayer Networks Switching and routing chip maker	$6 million	Alliance Ventures IV	R&D, operations
Compiled by Toby Weber return to top