The unexpected success of the Government in wringing top dollar out of its mobile phone license auct...
The unexpected success of the Government in wringing top dollar out of its mobile phone license auction sets officials a tough poser, what to do with the £22.5bn windfall. Moreover, there is a risk the damage wrought by a strong pound on exports will be exacerbated if winning bidders based overseas buy sterling to fund their seats on the internet gravy train. The most obvious use of the auction proceeds would be to repay Government debt by buying gilts. The ruddy health of the UK economy and the corresponding reduction in Government borrowing, however, means pension funds are already scrapping over a dwindling supply of gilts.
Worsening the supply/demand imbalance that has helped drive the yield on gilts maturing in 2028 to 175 basis points below two-year levels would cause uproar among fund managers already hard-pressed to meet the benchmarks set by their trustees. Government finances are already threatening to outpace official forecasts, endangering at least one planned gilt auction.
The money could repay the Government's £17bn overdraft with the Bank of England, known as the Ways and Means Facility. It already intends to trim £2bn off those arrears by year-end; it could pay back even more. That would transfer the problem from the Treasury to the bank. However, the bank would probably invest the cash in the gilt market, distorting the market further.
Given Chancellor Gordon Brown's commitment to use the bonanza to trim borrowing, a move to repay foreign currency debt is more likely. The UK has seven foreign bonds outstanding, three in dollars and four in euros worth a total of $15.6bn and ranging in maturity from E2bn of 4.25% bonds repayable in January 2001 to E2.75bn of 4.75% bonds maturing January 2003.
To repay the holders of those foreign bonds, the Government would have to buy dollars and euros, and sell sterling on the foreign exchange market. So a nice side effect of this might be to push the pound lower while dodging the accusation of trying to dictate currency values.
While the auction was a resounding success, the Government does seem to have made one error. Winning bidders can either pay in full immediately, or half now and the rest in installments from 2005 onwards. But the Government will charge 8.65% interest, making it more likely the companies will settle immediately. Had it charged a negligible rate, the Government might have halved its immediate cashflow problem. The Government would have a tough time if it decided to spend the money on schools and hospitals. It is already under fire from the IMF for loosening the purse strings in the most recent budget. Britain's continental peers will face a similar conundrum. Italy, Germany and France, among others, are planning their own spectrum auctions. The Netherlands reckons to raise E10bn, while Germany could raise more than E50bn as 14 bidders scrap over six licenses in that lucrative market.
So where is the money coming from for this massive one-off transfer of wealth from private companies? The total amount raised by selling spectrum rights to beam video and web content to British mobile phones is split between five companies. Only BT, with a winning bid of £4bn, is almost certain to raise the cash to pay its bill directly in sterling. The other license holders fall into two camps. Two are foreign. They could borrow directly in sterling, though it is not unfair to assume they will raise the bulk of the cash in their home markets. There is £8.4bn of potential sterling purchases from Montreal-based TIW UMTS, whose £4.4bn bid was backed by Hong Kong's Hutchison Whampoa and Deutsche Telekom AG, whose One 2 One unit bid £4bn, enough to drive the pound higher.
The remaining two licensees are Vodafone AirTouch, the world's biggest mobile phone company and the biggest spender in the auction, and its subsidiary Orange. Vodafone has to sell Orange following its purchase of Mannesmann AG. The buyer of Orange will effectively foot the bill for Vodafone's license and will then have to pay for Orange's license. That spin-off also distorts the timing of license payments. Three of the bidders will make their payments by the end of the month. Vodafone and Orange have a grace period to arrange the sale of Orange. Vodafone is to sell $3.5 bn of floating-rate notes repayable in December 2001 to help meet the interim financing costs of its £5.9bn bill. The sale illustrates the likelihood of the winning bidders raising money overseas and becoming huge buyers of sterling to settle at least a chunk of their auction bills - purchases the Government and Bank of England will be keen to neutralise.
Mark Gilbert in the Bloomberg London newsroom