4G Wireless Front-Runner Verizon Scooping Up $3.6b in AWS Spectrum

Cable Sellers Get a 57% Premium Over Purchase Price, Plus Agent Arrangement

You have to admit, Verizon Wireless is run by some pretty slick operators. The company is far and away the leader in terms of 4G deployment (while pioneer Clearwire flounders, more on that below) after spending billions in the 2008 auction for 700 MHz licenses. And today, even as rival AT&T struggles to keep its ill-advised T-Mobile acquisition alive, Verizon announced that it will acquire 122 Advanced Wireless Services (AWS) spectrum licenses from the cable consortium that laggard Sprint used to date.  It just goes to show you that not all giants have the same vision, despite their lofty vantage point.

First, the deal details. SpectrumCo, LLC, a joint venture between Comcast, Time Warner Cable and Bright House Networks, will sell its 122 AWS licenses covering 259m POPs to Verizon Wireless for $3.6b. That’s a nearly 57% premium over the $2.3b that SpectrumCo paid for the licenses at the FCC’s auction in 2006, a fact which should cheer the many ILECs nationwide that have owned AWS licenses since the auction.

The FCC’s web site is still using 2000 Census data for POPs, but in the press release announcing the deal SpectrumCo said that there are 259m POPs included. Back when the auction was held in 2006, the FCC said that the subject licenses covered about 253.6m POPs, which implies a 2.1% increase since the auction. Based on 259m POPs, the Verizon Wireless deal implies a weighted average value per MHz POP of $0.706—or 53.5% more than the $0.435/MHz POP that the cable consortium paid in 2006.

Notably, the price per MHz POP isn’t too far below the final average price/MHz POP paid in 2008 for 700 MHz spectrum at auction, which came out at about $0.81/MHz POP. That said, the implication is that spectrum assets are still increasing in value, due to the more attractive propagation characteristics of lower spectrum bands. The AWS licenses lie at 1.7 and 2.1 GHz, which implies that more cell sites are necessary for build out—Verizon is presumably looking to bulk up its capacity in urban markets, which makes sense given the rapid uptake of its 4G service.

As a reference, I've taken the auction price and POPs for each of the 122 markets included in the sale and shown what the implied value/MHz POP is based on my estimated 53.5% premium over Auction 66 prices--some readers who own nearby AWS licenses may be interested in the "comparables," although admittedly there may be few buyers out there willing to pay the kind of premium that Verizon has ponied up.

Beyond the spectrum value implications, this deal highlights the shifting landscape in the wireless—nay, communications—world. AT&T is buying spectrum from Qualcomm in order to increase capacity, but that deal seems like a consolation prize now that the FCC has signaled that it is unlikely to support AT&T’s attempt to acquire T-Mobile (which was also a big AWS spectrum buyer in the 2006 auction).

I think Verizon’s tactics have been far more clever than AT&T’s, and the latter is now wasting vast resources on legal efforts to make the T-Mobile deal happen while Verizon races ahead in terms of 4G coverage nationwide.

And then there’s Sprint, which has tried off and on to work with the major cable players for more than a decade, but been unable to gain traction. Come to think of it, Sprint hasn’t played nice with partner Clearwire either, despite its commitment yesterday to provide up to $1.6b in funding for the floundering WiMax system operator. I would have expected more from Dan Hesse…

The transaction also reiterates what cableco Cox Communications indicated over the past few months when it first abandoned its effort to build and run its own wireless operations and then later shut down its reseller arrangement with Sprint. Running a wireless business isn’t necessarily an easy add-on for other communications providers (ILECs included). But it IS necessary in a competitive sense.

Ironically, Comcast, Time Warner and Brighthouse are now effectively getting in bed with the enemy. (Take it from someone who gleefully cancelled Comcast service just one month ago and is now happily streaming Netflix and Hulu video content over a Verizon 4G connection.) But it’s a smart alliance.

As stated in the press release, “The agreement comes at a time when consumer demand for wireless services and bandwidth is increasing rapidly...[this] is an important step toward ensuring that the needs and desires of consumers for additional mobile services will not be thwarted by the current spectrum shortage. While government action to free more spectrum is expected, this transaction ensures that the spectrum which is already available for mobile services is used effectively to serve customers.”

It’s interesting that the cable companies are the ones to say this now, considering that they were the target of accusations (not untrue) last spring that they were ‘warehousing’ spectrum, in particular, AWS spectrum. NAB head Gordon Smith railed against the cablecos at that time as he resisted efforts on the part of the government to make broadcasters relinquish additional spectrum.

And sure enough, five years after acquiring the licenses, the cablecos are not only making a handsome return on their original investment, but they’ve also leveraged the licenses into a deal with the most powerful wireless operator in the country. The SpectrumCo transaction includes agreements which will allow both the cablecos and Verizon to become agents for the other and the companies have also agreed to form “an innovation technology joint venture for the development of technology to better integrate wireline and wireless products and services.” And that, my friends, is the wave of the future.

Sprint, Clearwire and the Cablecos Dance Around a Deal

Clearwire Shares Double on Word of Renewed Talks

Earlier this month I commented on the untenable situation that has developed between Sprint (NYSE:S) and Clearwire (Nasdaq:CLWR), and also wondered about the wisdom of the announcement Sprint made that it had entered into a nine year, $13.5b network deployment deal with startup LTE wholesaler LightSquared. 

Specifically, I pointed out that if Sprint continues to ignore Clearwire’s financial woes, it stands to lose its nearly 50% ownership position should Clearwire end up restructuring via bankruptcy….I also mentioned the fact that LightSquared’s spectrum is still constrained by interference issues with GPS providers.

Well according to a report published by Bloomberg last Friday, Sprint hasn’t completely lost sight of its investment in, not to mention reliance upon, Clearwire. In fact, the two may be in deal discussions as I write, and their cable step-brothers Time Warner Cable (NYSE:TWC) and Comcast (Nasdaq:CMCSA) may also be seated at the table.

Shares in Clearwire skyrocketed on the rumor last Friday, more than doubling from the sub-$2/share level they had fallen to in the wake of the Sprint/LightSquared announcement.  While Clearwire was trading at present levels (around $3/share) just a month or so ago, after tumbling to a low of $1.32 in early August, $3+ per share suddenly looks a lot better.

But what does it imply in terms of Clearwire’s value?  Back in June I wrote a story on Clearwire’s ongoing struggles to raise capital via a spectrum sale or a broader deal.  At the time, Pardus Capital’s Karim Samii had written a letter to interim ceo John Stanton bemoaning the fact that, at $4.60/share, Clearwire’s massive spectrum holdings were valued at less than $0.20 per MHz POP.  Samii urged Stanton to sell off some of Clearwire’s excess spectrum in order to get the company’s business plan back on track.

After Friday’s run-up, Clearwire appears to trade at an even more discounted $0.15/MHz POP, and at its low two weeks ago, Clearwire’s public market cap indicated a value of just $0.12/MHz POP….But according to the FCC, not to mention AT&T in its T-Mobile lobbying efforts, U.S. wireless carriers are facing a serious spectrum shortage!

I’ve been flummoxed by Sprint’s refusal to step up and support Clearwire for some time now…clearly the company’s bet on WiMax technology has proven to be a misstep in hindsight, but in the meantime Sprint keeps adding 4G customers, to the tune of 1.7m net new 4G customers on the Clearwire network in the second quarter.

Sprint needs every advantage it can get its hands on in the face of the AT&T/Verizon Wireless duopoly.  Why bet billions on LightSquared’s fledgling plan when it already bet billions on Clearwire’s 4G plan years ago?  And why haven’t the cable guys stepped up sooner?  They desperately need a wireless strategy—and that’s what their investments in Clearwire was supposed to be…but the partnerships have floundered in recent years; the vast majority of Clearwire’s wholesale customers have come from Sprint.

Clearwire’s 2.5 GHz spectrum isn’t as desirable as the 700 MHz licenses that Verizon and AT&T will use to deploy their 4G systems on, but it has LOTs of it. Furthermore, the FCC is still considering a proposal to raise the out of band emission limits, which would enable Clearwire to use 20 MHz of spectrum and deliver speeds of 90 Mbps.

It just makes sense for Sprint and the cable players to really get behind Clearwire and make it the basis of their next generation wireless strategies. But after the drubbing the stock has taken this year, due largely to Sprint’s relative lack of support, Clearwire’s existing backers may now be in a position to take over for a much lower price than would have been demanded last winter.  Maybe that was the point?

AT&T, Dish Network and Echostar Deal Speculation

Who Needs Who?

The phoenix has risen again…I’m referring, of course, to the rumor that suggests that AT&T (NYSE:T) should buy out Dish Network (Nasdaq:DISH).  (This bird has a sister, by the way, who insists Verizon (NYSE:VZ) should acquire DirecTV (NYSE:DTV), but I’ll save that story for another day).  This time the speculation also includes Dish Network’s kissing cousin, Echostar (Nasdaq:SATS).

Credit Suisse analyst Jonathan Chaplin released a report on February 10 that suggested talks between AT&T, Dish and Echostar are, if not already ongoing, a real likelihood.  His report was obviously taken seriously—at one point that day shares in Dish were up more than 8%—though disappointing subscriber results in the fourth quarter have since pushed the stock back down. 

Notably, shares in Echostar have been very strong since the Credit Suisse report came out.  SATS is up about 18% compared to its closing price on February 9 and is trading at its highest level since mid-2008.

The rationale behind the speculation, which has surfaced several  times over the years, is that with Dish’s DBS service AT&T can offer a compelling video/wireless bundle nationwide that will lessen churn on the wireless side and provide several billion dollars worth of synergies to improve margins overall.  AT&T Wireless reported an impressive churn metric for the fourth quarter of just 1.32%, but that will no doubt rise some now that rival Verizon Wireless has the iPhone.  It’s also assumed that AT&T would be able to garner more attractive programming rates with the addition of Dish’s 14.1m subscribers. 

A combination of AT&T and Dish would result in a company with around 18m video subscribers, based on fourth quarter results and assuming that about half of AT&T's DBS subs are already Dish customers. By way of comparison, DirecTV had 19.2m subscribers at the end of last year and Comcast (Nasdaq:CMCSA) had 22.8m basic video subs.  #2 cable operator Time Warner Cable ended 2010 with 12.2m video subscribers--but it's worth noting that of the top four video providers (Comcast, DirecTV, Dish and TWC) only DirecTV grew its subscriber base in the fourth quarter.

But even more important, and the real impetus behind the latest resurgence of rumor mongering, are the satellite and 700 MHz spectrum assets that Dish/Echostar chairman Charles Ergen has been maneuvering to acquire.  Through Echostar, which has been acquiring the distressed debt of bankrupt Terrestar, Ergen is attempting to gain control of 20 MHz of S-band satellite spectrum.  Echostar also announced on February 14 a $2b sweetheart deal for Hughes, which offers satellite broadband service in rural markets with poor cable or DSL coverage.  Finally, Echostar also owns a bit of 700 MHz spectrum, which AT&T has been selectively acquiring for the past year.  For its part, Dish made a $1b offer for bankrupt DBSD in early February, which owns another 20 MHz of S-band spectrum. 

Combined, nearly 50 MHz of spectrum is in play, and while all of these deals are works-in-progress and by no means a sure thing, the Hughes deal already has board approval on both sides.  The outcome of the Terrestar and DBSD situations remains murky, however. Harbinger Capital, backer of LightSquared, has reportedly made a competitive offer for DBSD and Terrestar’s other creditors/ hedge fund backers are also said to be unhappy with the idea of an Echostar takeover.

Finally, regulatory approval of an AT&T/Dish combination is also a question mark, but it does seem that the current environment is relatively tolerant of vertical integration—think Comcast/NBCUniversal.  Even combined, AT&T/Dish would only be the third largest video provider.  Given other approvals that have gone through over the past few years, it seems likely to me that the deal, probably with certain concessions (like existing resale arrangements with other ILECs have to be honored), would be given a green light.

But what really caught my eye in the latest round of news was the value applied to Dish and Echostar in the Credit Suisse report, and what the implications might be for both Dish and AT&T. Chaplin suggested in his report that AT&T could acquire the equity of both Dish and Echostar for about $20b, and specifically, he said the target price for a Dish takeover would be in the $39/share range—well above the $22-$23 it's been trading at.

I decided to run discounted future income (DFI) models on Dish and Echostar in order to see what kind of assumptions Chaplin may have been making, and also looked at what current trading prices imply.  While I was at it, I also took a gander at AT&T.

First I ran a DFI looking at Dish and its current trading price.  Based on historic results, I projected net free cash flow for 2011 through 2013, and applied a perpetuity growth rate.  I used the company’s actual cost of debt and then backed into an implied cost of equity to see what investors are currently discounting into the stock price.

Given Dish’s recent subscriber losses—down 157,000 in the fourth quarter—I predicted low single-digit revenue gains for the next three years.  While subs were falling at the end of 2010, the company did post a solid increase in ARPU for the year, reporting $73 in 2010 versus $70 in 2009.  I assumed minimal OIBDA margin improvements and held the capex margin steady at 9%, about where it’s been for the past two years.  Based on the company’s recent trading price of $22.87/share, it appears investors are demanding an 11.3% return on equity.

Next, holding all other assumptions the same, I determined that Chaplin’s $39/share target, if his operational assumptions are similar to my own, implies a cost of equity of just 7.4%.  At that price the enterprise value for Dish would be $23.5b, which translates to 1.8x revenue and 7.5x OIBDA, and $1664/subscriber.  These are actually conservative compared with some recent cable deal multiples we’ve seen, but as I mentioned, Dish has been struggling somewhat competitively in recent quarters.  At this price, the equity would be valued at about $17.3b.

The implied 7.4% cost of equity also makes sense if you think about AT&T’s cost of equity.  As a check, I ran the DFI model for AT&T.  Based on conservative assumptions and AT&T’s capital structure and interest expense, its recent closing price of $28.08/share implied a cost of equity of just 6.1%.  The relatively low return requirement isn’t surprising considering AT&T’s status as one of the two biggest, strongest telecom companies out there, and it also pays a decent dividend, which investors appreciate.

Finally, a quick look at Echostar and its recently higher stock price also indicates a low cost of equity, at just 6% if my forecast is in the ballpark.  The recent trading price values total equity at just under $3b, which when combined with the Credit Suisse Dish value of $17.3b gets us to Chaplin’s $20b+ target should AT&T take the two companies out.

What’s important to note here is that the projections for each company in the DFI analyses are based solely on existing business lines—they don’t include incremental cost or revenue associated with the combination of spectrum assets that AT&T might theoretically get a hold of with a two-way, Dish/Echostar purchase. 

If you believe, like Credit Suisse’s Chaplin does, that the satellite spectrum Dish and Echostar are amassing is worth a good deal more than the companies are offering, it translates to instant equity for AT&T as a buyer. And if you believe that the Dish/wireless bundle that AT&T would then bring to market provides measurable synergies and a reduction in churn, the incremental value created for AT&T investors is even greater.

At the end of the day, I think AT&T is probably watching Ergen’s fancy footwork very closely.  The dance isn’t over yet, though, and while Charlie’s been out trying to buy up airwaves, those left watching the shop back in Colorado have been letting the subscriber base erode.

Still, Ergen’s moves are proving prescient in light of the FCC’s recent waiver grant to LightSquared to allow it to develop a terrestrial-only service using satellite spectrum.  If AT&T thinks it can bully the deals through the FCC and Justice Department, then it could very well step up to the plate.

BlackRock Buying into Satellite TV Providers

Yet Another Signal that the Satellite Space is Heating Up 

We wrote last week about the $1b bet DISH Network (Nasdaq:DISH) is making on DBSD, a bankrupt satellite concern with S-band spectrum holdings, and the speculation that DISH may be going for a mobile video play…Seems DISH’s Charlie Ergen isn’t the only one who likes the prospects for satellite’s role in the burgeoning broadband/ streaming video arena.

In filings with the SEC, money management firm BlackRock, Inc. disclosed that it now owns a 7.52% stake in DISH Network, or about 15.4m shares. BlackRock has also acquired a 5.1% holding in DIRECTV (Nasdaq:DTV), or about 42.5m shares. BlackRock has also reduced its ownership of cable TV giant Comcast (Nasdaq:CMCSA), from nearly 7.4% a year ago to about 7.2% as of February 3, 2011.  The money management firm filed as a passive investor in its DISH and DIRECTV filings.

Clearwire to Sell 2.5 GHz Spectrum

WiMax Service Provider Looking to Raise Up to $5B in Spectrum Auction

According to reports by Bloomberg, The Wall Street Journal and others, 4G wireless service provider Clearwire (Nasdaq:CLWR) is presently in the second round of an auction which will divest up to 40 MHz of its BRS/EBS (2.5-2.6 GHz) spectrum, in an effort to raise several billion dollars.  CLWR, which is majority-owned by Sprint Nextel (NYSE:S, “Sprint”), also counts Google (Nasdaq:GOOG), Time Warner Cable (NYSE:TWC), Comcast (Nasdaq:CMCSA), Bright House Networks and Intel (Nasdaq:INTC) among its investors. 

CLWR was the first to launch 4G services in the U.S., using WiMAX technology, and at the end of the second quarter was serving 55.7m POPs with 4G in markets including Atlanta, Baltimore, Charlotte, Chicago, Dallas, Honolulu, Houston, Kansas City, Las Vegas, Philadelphia, Portland, Oregon, Salt Lake City, San Antonio, Seattle, St. Louis and Washington D.C.  Of its 1.7m subscribers as of June 30, 940k were retail subs and 742k were wholesale subscribers acquired primarily by Sprint, TWC, and CMCSA.  In the second quarter, nearly 600k of 722k net adds were wholesale customers.  When it reported 2Q results, CLWR raised its guidance for year-end subscribers from 2m to 3m. 

Recently, company executives have confirmed that it will also be testing the Long Term Evolution, or LTE, standard that Verizon Wireless (NYSE:VZ, “VzW”), AT&T Mobility (NYSE:T, “AT&T”) and most other U.S. wireless providers have embraced.  Its plans to add LTE technology, along with the need to continue to rapidly deploy WiMAX—CLWR intends to increase its 4G coverage to 120m POPs by year-end—means that it needs additional capital heading into 2011, perhaps as much as $2b. 

The company confirmed recently that it has had talks with Deutsche Telekom’s T-Mobile USA unit, and that a wholesale deal with the rival carrier was possible.  In its latest 10-Q, CLWR said, “Based on our current projections we believe that we will be required to raise additional capital in the near term in order to maintain our current business plans, or we will be required to materially revise our plans for such period. Our need for additional capital is primarily due to additional capital expenditures we expect to make in the near term to increase the capacity of our network in certain markets.”  Sale of spectrum assets was mentioned as one possibility for raising the needed capital. 

CLWR says it has an impressive 46 billion MHz POPs worth of spectrum, or an average of 120 MHz per market—well more than most of its rivals.  Its fat spectrum position means that it is able to deliver higher data speeds in practice than its more spectrum-challenged competitors, although the higher spectrum position is less effective at in-building penetration than the lower 700 MHz spectrum position most major carriers will be using for 4G.  Ceo Bill Morrow said during the company’s second quarter conference call that he expects in LTE tests to get speeds between 20 to 70 mbps vs. the 5 to 12 mbps reported by others. 

The spectrum slices are expected to go for between $0.20 - $0.40 per MHz POP, although analysts are divided over the wisdom of CLWR selling its valuable airwaves.  But, with both Sprint and CMCSA on the record saying they aren’t interested in upping their investment in CLWR at this time, it may not have a choice.  Analyst Monica Paolini said, “Even if the company is wildly successful, it has more spectrum than it will ever need…They have a huge advantage, but they have to be realistic. They have to have the money to continue their plans. They probably looked at the other options, and from a network perspective they can afford to sell spectrum and still have enough for what they plan to do.”