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U.K. prices: Up, up and away

Bidders in the U.K. third-generation license auction appeared to exceed their budgets last week. Bidding for the five licenses totaled an eye-popping $35 billion, and the auction will linger on into this week.

The auction seems eerily reminiscent of the U.S. personal communications services C-block auction in 1996, when the top bidders overstepped their budgets and later couldn’t get financing. Level-headed bidders like cellular-phone mogul Craig McCaw dropped out when the stakes were getting too high.

Likewise, companies like Spain’s Telefonica and Finnish operator Sonera have already dropped out, acknowledging that the heat is becoming unbearable. Despite Telefonica’s strong desire to obtain UMTS licenses across Europe, with the U.K. market a key one, the stakes were too high, the company said.

“With the UMTS licenses in the United Kingdom at these price levels, Telefonica believes it would be difficult to make such an investment profitable and therefore regards other growth opportunities more attractive and creating more value for its shareholders,” Telefonica said.

Sonera’s shares on the Helsinki stock market rebounded once it withdrew from the auction. Another dropout, MCI WorldCom is looking for an alternative way to enter the U.K. market, with an eye likely on Orange plc, a U.K. carrier also bidding in the auction that Vodafone AirTouch must divest. Telefonica also is said to be preparing a bid for Orange.

But the United Kingdom’s four incumbents must win a license at any cost. If they lose, they face destroyed business cases that call for huge returns on more advanced Universal Mobile Telecommunications System networks. If they win, they must finance the cost of paying for the license and more expensive network infrastructure.

Thirteen bidders began the auction. Six companies, which include the country’s four incumbents, remain. The contest will end if one more company withdraws. Bidding resumes Tuesday.

By the end of round 145 last Thursday, Canada-based Telesystem International Wireless Inc. led the race for the A license, which is reserved for new entrants, with its $6.9 billion bid. Incumbent Vodafone AirTouch plc held onto the B license, which has the most spectrum, at $9.3 billion, while NTL Mobile submitted the top bid for license C with $6.27 billion. British Telecommunications plc’s BT3G topped bids for the D license with a $6.2-billion bid, and Orange ended with a $6.2-billion offer on the E license. Incumbent One 2 One had battled with NTL Mobile, a consortium jointly owned by France Telecom and U.K. cable operator NTL, for license D.

Unlike the companies that bid in the U.S. entrepreneurial C-block auction, the winners that emerge from the U.K. auction are leveraged and experienced operators. But some are beginning to feel the pressure.

Credit rating agency Standard & Poor’s downgraded Vodafone AirTouch to A- and said the need to fund 3G licenses across Europe would make it difficult for the company to return to its single A credit rating in the near term. Most analysts believe that the majority of license costs will be debt-financed, putting credit-ratings under pressure. Under the U.K. auction rules, winners can pay the full license fee upfront, or pay half this year and the rest in deferred payments at an annual interest rate of 8.65 percent.

Other European countries planning auctions include Austria, Germany, the Netherlands and Switzerland. Still other countries either are undecided or plan to award licenses based on a selective tender. France and Italy, which are planning to grant licenses based on a selective tender, have indicated they are rethinking how much they will charge for the licenses in light of the high bids in the United Kingdom. Those companies looking for a pan-European 3G play will have some critical decisions to make, say analysts.

Jane Zweig, executive vice president with Herschel Shosteck Associates Ltd., estimates spending on fully constructed 3G networks worldwide, including spectrum costs, will exceed the total spending on first- and second-generation systems to date-close to $300 billion.

“At such costs, any business case for 3G is unclear,” said Zweig. “Nonetheless, many operators will continue to pursue 3G, if only to maintain market parity with their competitors.”

The costs then are likely to roll to consumers and retard the growth of 3G services, say analysts.

“The biggest problem is that the auction is inflating the cost of delivering service,” said Jeffrey Schlesinger, analyst with Warburg Dillon Read. “Someone has to pay, and it’s going to be the consumer. When the costs are higher, the penetration will take longer.”

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