Last year Ottawa relaxed its foreign telecommunications investment rules so outside investors could bring more money into the industry and increase competition.

But in its first decision dealing with a foreign acquisition the Harper government has turned down an attempt by Egyptian telecom mogul Naguib Sawiris’ to buy the Allstream division of Manitoba Telecom Services, apparently because Allstream is Ottawa’s data services carrier.

It’s a move that may have implications for the future of cellular startup Wind Mobile.

The decision by Industry Minister James Moore was announced late Monday in a from Moore who said the proposed acquisition “will not proceed.”

“MTS Allstream operates a national fibre optic network that provides critical telecommunications services to businesses and governments,” Moore added, “including the government of Canada.”

Last December Shared Services Canada signed a multi-year contract with MTS to provide IP and switched Ethernet services over the Allstream network to almost all of the federal government. Apparently Ottawa will not allow that network to be in the hands of a foreign company.

MTS wants to sell Allstream so it can concentrate on providing wired and wireless services in its home province.

Last May Accelero Capital Holdings, which was founded by Sawiris, offered $520 million plus the assumption of debt for Allstream. By itself, the deal would have met the investment rules, which allow a foreign company to buy all of a Canadian carrier with less than 10 per cent of the market. However, the deal had to pass the Investment Canada Act’s national security provisions.

According to Moore, it didn’t.

MTS CEO Pierre Blouin said in a statement his company is “extremely surprised and disappointed.”

“We pursued this transaction, with Accelero as our partner, in direct response to the federal government’s stated policy objectives of increasing foreign investment and driving greater competition in Canada’s telecommunications sector, so this result is very difficult to understand or accept,” he said.

MTS [TSX: MBT] and Accelero “responded openly and constructively” to Industry Canada’s requests for information, the statement said. Accelero “has proposed far-reaching, comprehensive and binding undertakings to the Canadian government, including a commitment to invest $300 million over three years to pursue Allstream’s capital plans.”

Sawiris used to head Orascom Telecom Holdings, which backed Wind Mobile in 2008 with hundreds of millions of dollars so it could buy spectrum and launch its network. He since sold control of it to Amsterdam-based VimpelCom Ltd.

In 2008 the Telecommunications Act limited foreign telecom ownership of a Canadian carrier to just under 50 per cent and made it clear that Canadians had to be in control of the company.

Although Orascom’s equity investment was over 60 per cent, the Harper government at the time stood stoutly behind Wind’s management, fighting a decision by the Canadian Radio-television and Telecommunications Commission that Wind was not Canadian controlled through the courts until the cabinet had to make a final decision.

This time, however, Sawiris didn’t get the benefit of the doubt.

Meanwhile, VimpelCom is talking to other companies about selling its share of Wind Mobile chair and CEO Anthony Lacavera has talked about teaming with Sawiris to take control of the Canadian carrier, and it has been thought that Accelero’s offer for Allstream was the first step. If Wind gained a fibre network it would go some way to putting it on a more solid footing to compete against incumbent carriers.

That option now may be out.

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