Today’s announcement that SoftBank is investing $1.7B in Intelsat as part of a merger between Intelsat and OneWeb is eerily reminiscent of SoftBank’s investment in Sprint and subsequent purchase of Clearwire back in 2012-13. Then the motivation was acquisition of large amounts of 2.5GHz spectrum to be used with innovative small cells to revolutionize the cellular market. Today the motivation is acquisition of large amounts of NGSO spectrum to be used with innovative small satellites to revolutionize the satellite market.
There are certainly many synergies between Intelsat and OneWeb: Intelsat needs a next generation plan beyond Epic, to lower the cost of its capacity, and hamstrung by debt, it could not have afforded to build a new system on its own. OneWeb needs distribution and market access, as well as interim capacity so that it does not have to wait until the LEO system is fully deployed. So this deal makes a lot of sense, if you believe, as Masa clearly does, that new constellations will dramatically boost the future prospects for the satellite industry. On the other hand, if it doesn’t work out, would SoftBank get to the point where it is prepared to sell the assets and not even mention them in its vision of the future?
However, another potential parallel is that back in 2013, SoftBank faced a lengthy challenge from DISH, which mounted a bid for Clearwire and later made an offer for all of Sprint, and ultimately forced Masa to pay far more for Clearwire than he had hoped. Now EchoStar, which had made a $50M investment in OneWeb (then WorldVu) back in 2015, but has been far less prominently involved in OneWeb’s development efforts compared to Qualcomm (with DISH even objecting to OneWeb’s use of the MVDDS spectrum), has apparently seen its mooted partnership with SES put on hold.
Clearly Charlie Ergen needs to find a way forward for EchoStar to compete in the satellite broadband market on a global basis, building on the successful launch (and market lead) of Jupiter-2. Some analysts have been reiterating that this could involve a bid for Inmarsat, as I mentioned last summer, but the time for that has probably passed. So does Ergen use this development to revive the mooted SES deal, because SES will now need to compete more aggressively with Intelsat? Or does he want to be more actively engaged with OneWeb and get a larger slice of that development effort (and potentially use its capacity in the longer term)?
Either way it would not be surprising if DISH or EchoStar already holds some of Intelsat’s debt, and Ergen could even seek to maximize his leverage by acquiring a larger position in the company. Does Masa want a cooperative relationship with Ergen going forward (perhaps even with a view to collaboration between DISH and Sprint in the wireless sector), or is he still upset over what happened in 2013? And returning to the theme of Groundhog Day, will this movie end with the two protagonists eventually falling in love, or will we see a repeat of 2013, with yet another battle between Masa and Charlie?
Back in December, I suggested that AT&T could end up being the winner of the FCC’s incentive auction, by “dropping the licenses it held at the end of Stage 1 until broadcasters are forced to accept a tiny fraction of their originally expected receipts, leave T-Mobile (plus a bunch of spectrum speculators in various DEs) holding most of the spectrum…and screw DISH by setting a new national benchmark of ~$0.90/MHzPOP for low band spectrum.”
Broadcasters were certainly forced to accept a tiny fraction of their originally expected receipts, when the reverse auction ended Stage 4 with a total clearing cost of only $12B, and the auction has concluded with a national average price of just over $0.90/MHzPOP. However, by the beginning of this month, the clues to the incentive auction outcome derived from the splitting of reserved and unreserved licenses also suggested that T-Mobile might not have bid as aggressively as expected on licenses such as Los Angeles and San Diego, because only 1 license in these areas was classified as reserved.
Despite this, AT&T’s recently filed 10-K confirms that:
“In February 2017, aggregate bids exceeded the level required to clear Auction 1000. This auction, including the assignment phase, is expected to conclude in the first half of 2017. Our commitment to purchase 600 MHz spectrum licenses for which we submitted bids is expected to be more than satisfied by the deposits made to the FCC in the third quarter of 2016.”
The deposits made by AT&T totaled $2.4B, and commitments below this level indicate that AT&T has purchased no more than 5x5MHz on average across the US. That also suggests that AT&T very likely was responsible for dropping bids in Stages 2, 3 and 4, as I guessed back in December. But if both AT&T and T-Mobile did not bid as aggressively as expected in the auction, Verizon did not put down any material deposit and Sprint did not show up at all, that certainly raises the question of who is left standing as a winning bidder for over $19B of spectrum?
T-Mobile could well have bid somewhat more aggressively outside the southwestern US, and therefore may still be holding $5B-$8B of bids in total. It was also clear from the auction results that one or more designated entities are holding just over $2B of spectrum. But Comcast must certainly have winning bids for upwards of $5B, likely in the form of a national 10x10MHz license (and perhaps more in some markets), and it is even conceivable that DISH is still holding some licenses, despite the bidding patterns suggesting that DISH most likely dropped out in Stage 1.
But taken as a whole, the limited participation by AT&T and the lack of interest shown by Verizon could well have serious implications for the prospects of a rapid standardization and transition in this band. As I noted in December, AT&T could strand T-Mobile, Comcast and the various spectrum speculators by supporting the broadcasters in their efforts to delay the transition and ensuring that this spectrum remains non-standard because AT&T and Verizon won’t bother supporting the band any time soon.
Moreover, this outcome once again raises the question of how much AT&T and Verizon really need spectrum in the near term, or if they can instead make do with their current holdings until small cell networks based on 3.5GHz, 5GHz LTE-U and eventually mmWave spectrum create a new era of spectrum abundance and support vast increases in network capacity. Thus its somewhat ironic to see analysts speculating that Verizon is now more likely to buy DISH.
In fact, Charlie Ergen seemed to be hinting on DISH’s Q4 results call that Verizon and AT&T are no longer the most plausible partner when he stated that “I’m sure there will be discussions among any number of parties that are in the wireless business today and people who maybe are not in the wireless business today. And, I would imagine that – we’re not the biggest company, we’re not going to drive that process, but obviously, many of the assets that we hold could be involved in that mix.” However, it remains to be seen if any Silicon Valley companies are still interested in getting into the wireless business (most plausibly via the renewal of DISH’s previously mooted tie-up with Google and T-Mobile) or if something even more surprising like a reconciliation with Sprint and Softbank could be a possibility.
As the FCC’s incentive auction draws to a close, some further clues emerged about the bidding when the FCC split licenses between reserved and unreserved spectrum. What stood out was that in Los Angeles, San Diego and another 10 smaller licenses (incidentally all located in the southwestern US), only 1 license is classified as reserved. That means there is only 1 bidder that has designated itself as reserve-eligible when bidding for these licenses and that bidder only wants a single 5x5MHz block of spectrum. In contrast, in LA there are five 5x5MHz blocks going to non-reserved bidders (and 1 block spare).
This leads me to believe that T-Mobile may not be holding quite as much spectrum as anticipated, at least in that part of the country, while some potentially reserve-eligible bidders (i.e. entities other than Verizon and AT&T) have not designated themselves as reserve-eligible. That election can be made on a PEA-by-PEA basis, but it would be very odd for a major bidder like Comcast not to designate itself as reserve-eligible. On the other hand, speculators whose intention is to sell their spectrum to Verizon or AT&T, very likely would not want to be reserve-eligible, since that could cause additional problems in a future sale transaction.
A plausible conclusion is that if T-Mobile’s bidding is more constrained, then Comcast may be bidding more aggressively than expected, but is primarily focused on areas where it already has cable infrastructure (i.e. not Los Angeles, San Diego, etc.), and T-Mobile, AT&T and Comcast may all end up with an average of roughly 10x10MHz of spectrum on a near-national basis. We already know that one or more speculators are bidding aggressively, due to the gap between gross and net bids (note that the FCC reports this gap without regard to the $150M cap on DE discounts so it could be a single aggressive player with $2B+ in exposure) and thus the balance of the 70MHz of spectrum being sold would then be held by other players (but with these holdings likely skewed towards more saleable larger markets, including Los Angeles).
Its interesting to note that speculation is now revving up about the transactions to come after the auction is complete, with most attention focused on whether Verizon is serious about a bid for Charter, or if this is a head fake to bring DISH to the table for a spectrum-focused deal, after Verizon apparently sat out the incentive auction. Incidentally, Verizon’s expressed interest in Charter would also tend to support the notion that Verizon believes Comcast may want to play a bigger role in the wireless market, by acquiring a significant amount of spectrum in the incentive auction and perhaps even buying a wireless operator at a later date.
However, when you look at Sprint’s recent spectrum sale-leaseback deal, which was widely highlighted for the extraordinarily high valuation that it put on the 2.5GHz spectrum band, Verizon’s need for a near term spectrum transaction is far from compelling. I’m told that the appraisal analysis estimated the cost of new cellsites that Verizon would need to build with and without additional 2.5GHz spectrum, but that either way, there is no need for Verizon to engage in an effort to add substantial numbers of macrocells until 2020 or beyond, given its current spectrum holdings and the efficiency benefits accruing from the latest LTE technology. And if mmWave spectrum and massive MIMO are successful, then Verizon’s need for spectrum declines considerably.
So it seems there is little reason for Verizon to cave now, and pay Ergen’s (presumably high) asking price, when it does not need to start building until after the March 2020 buildout deadline for DISH’s AWS-4 licenses. It would not be a surprise if Verizon were willing to pay the same price as is achieved in the incentive auction (i.e. less than $1/MHzPOP), but the question is whether Ergen will be prepared to accept that.
Of course, DISH bulls suggest that the FCC will be happy to simply extend this deadline indefinitely, even if DISH makes little or no effort to offer a commercial service before 2020. The most important data point on that issue will come in early March 2017, when DISH passes its initial 4 year buildout deadline without making any effort to build out a network. Will the FCC take this opportunity to highlight the need for a large scale buildout that DISH promised in 2012 and the FCC noted in its AWS-4 order? Certainly that would appear to be good politics at this point in time.
“…we observe that the incumbent 2 GHz MSS licensees generally support our seven year end-of-term build-out benchmark and have committed to “aggressively build-out a broadband network” if they receives terrestrial authority to operate in the AWS-4 band. We expect this commitment to be met and, to ensure that it is, adopt performance requirements and associated penalties for failure to build-out, specifically designed to result in the spectrum being put to use for the benefit of the public interest.”
“In the event a licensee fails to meet the AWS-4 Final Build-out Requirement in any EA, we adopt the proposal in the AWS-4 NPRM that the licensee’s terrestrial authority for each such area shall terminate automatically without Commission action…We believe these penalties are necessary to ensure that licensees utilize the spectrum in the public interest. As explained above, the Nation needs additional spectrum supply. Failure by licensees to meet the build-out requirements would not address this need.”
I’ve been thinking a lot about the failure of Google Fiber and if there are any wider lessons about whether Silicon Valley will ever be able to compete effectively as an owner and builder of telecom networks, or indeed in other large scale capex intensive businesses (such as cars).
One conclusion I’ve come to is that there may be a fundamental incompatibility between the planning horizon (and deployment capabilities) of Silicon Valley companies and what is needed to be a successful operator of national or multinational telecom networks (whether fiber, wireless or satellite). The image above is taken from Facebook’s so-called “Little Red Book” and summarizes pretty well what I’ve experienced living and working in Silicon Valley, namely that the prevailing attitude is “There is no point having a 5-year plan in this industry” and instead you should think just about what you will achieve in the next 6 months and where you want to be in 30 years.
In software that makes a lot of sense – you can iterate fast and solve problems incrementally, and scaling up (at least nowadays) is relatively easy if you can find and keep the customers. In contrast, building a telecom network (or a new car design) is at least two or three year effort, and by the time you are fully rolled out in the market, its four or five years since you started. So when you start, you need to have a pretty good plan for what you’ll be delivering (and how its going to be operated at scale) five years down the road.
For an existing wireless operator or car company that planning and implementation is obviously helped by years of experience in operating networks or manufacturing facilities at scale. But a new entrant has to learn all of that from scratch. And its not like technology is transforming the job of deploying celltowers, trenching fiber or running a vehicle manufacturing line. Software might change the service that the end customer is buying, but its crazy to think that “if tech companies build cars and car companies hire developers, the former will win.”
Of course self-driving cars will drastically change what people do with vehicles in the future. But those vehicles still have to be made on a production line, efficiently and with high quality. Mobile has changed the world dramatically over the last 30 years, but AT&T, Deutsche Telekom, BT, etc. are still around and absorbed some of the most successful wireless startups.
Moreover, Silicon Valley companies simply don’t spend capex on anything like the scale of telcos or car companies. In 2015 Alphabet/Google’s total capex for all of its activities worldwide was $9.9B and Facebook’s capex was only $2.5B (surprisingly, at least to me, Amazon only spent $4.6B, though Apple spent $11.2B and anticipated spending $15B in 2016).
But the US wireless industry alone invested $32B in capex in 2015, which is more than Facebook, Google, Amazon and Apple put together, and that excludes the $40B+ spent on spectrum in the AWS-3 auction last year. In the car industry, GM and Ford each spent more than $7B on capex in 2015. So in round numbers, total wireless industry and car industry capex on a global basis are both of order $100B+ every year, a sum that simply can’t be matched by Silicon Valley.
So when Silicon Valley companies aren’t used to either planning for or spending tens of billions of dollars on multi-year infrastructure developments, why are people surprised when it turns out Google can’t support the investment needed to build a competitive national fiber network? (Indeed its not been widely reported, but I’m told that earlier this year Google’s board also turned down a $15B+ partnership with DISH to build a new national wireless network.) Or when it appears “The Apple dream car might not happen” and “Google’s Self-Driving Car Project Is Losing Out to Rivals“?
Instead it appears that we may be shifting towards a model where the leading Silicon Valley companies work on new technology development and “give away the blueprints…so that anyone from local governments to Internet service providers can construct a new way to get Internet signals into hard-to-reach places“. Similar Google could “enable [rather] than do” in the field of self-driving cars. Whether that will lead to these technologies being commercialized remains to be seen, but it does mean that Facebook and Google won’t have to change their existing ways of working or radically increase their capital expenditures.
Undoubtedly some other Silicon Valley companies will end up try to build their own self-driving cars. But after the (continuing) struggles of Tesla to ramp up, it seems more likely that most startups will end up partnering with or selling their technology to existing manufacturers instead. And similarly, in the telecom world, does anyone believe Google (or any other Silicon Valley company) is going to build a new national wireless broadband network that is competitive with AT&T, Verizon and Comcast?
It seems to me that about the best we could hope for is for Google to push forward the commercialization of new shared access/low cost frequency bands like 3.5GHz (e.g. as part of an MVNO deal with an existing operator) so that the wireless industry no longer has to spend as much on spectrum in the future and can deliver more data at lower cost.
However, that’s not necessarily all bad news. It seems almost quaint to look back a year or two at how wireless operators were reportedly “terrified” of Facebook and concerned about how Project Loon could “hand Google an effective monopoly over the Internet in developing countries.”
If Facebook and Google are now simply going to come up with clever technology to reduce network costs (rather than building rival networks) or even just act as a source of incremental demand for mobile data services, then that will be good for mobile operators. Those operators may just be “dumb pipes,” but realistically, despite Verizon’s (flailing) efforts, that’s pretty much all they could hope for anyway.
Back in November 2014, I published my analysis of what was happening in the AWS-3 spectrum auction to scorn from other analysts, who apparently couldn’t believe that Charlie Ergen would bid through multiple entities to push up the price of paired spectrum. Now we’re seeing relatively little speculation about who is doing what in the incentive auction (other than an apparently mystifying consensus that it will take until at least the end of September to complete Stage 1), so I thought it would be useful to give my views about what is happening.
The most important factor to observe in analyzing the auction is that overall demand relative to the amount of spectrum available (calculated as first round bidding units placed divided by total available supply measured in bidding units) has been considerably lower than in previous large auctions (AWS-1, 700MHz) and far short of the aggressive bidding seen in the AWS-3 auction.
That’s attributable partly to the absence of Social Capital, but much more to the 100MHz of spectrum on offer, compared to the likelihood that of the five remaining potential national bidders (Verizon, AT&T, T-Mobile, DISH and Comcast), none of them are likely to need more than about 30MHz on a national basis.
What’s become clear so far over the course of the auction is that most license areas (Partial Economic Areas) are not attracting much excess demand, apart from the top PEAs (namely New York, Los Angeles and Chicago) in the first few rounds. I said before the auction that DISH’s best strategy would probably be to bid for a large amount of spectrum in a handful of top markets, in order to drive up the price, and that appears to be exactly what happened.
However, it now appears we are very close to reaching the end of Stage 1, after excess eligibility dropped dramatically (by ~44% in terms of bidding units) in Round 24. In fact a bidder dropped 2 blocks in New York and 3 blocks in Los Angeles, without moving this eligibility elsewhere, somewhat similar to what happened on Friday, when one or more bidders dropped 5 blocks in Chicago, 3 blocks in New York and 1 block in Los Angeles during Round 20.
However, a key difference is that a significant fraction of the bidding eligibility that moved out of NY/LA/Chicago during Round 20, ended up being reallocated to other second and third tier markets, whereas in Round 24, total eligibility dropped by more than the reduction in eligibility in New York and Los Angeles. It is natural that a bidder such as T-Mobile (or Comcast) would want licenses elsewhere in the country if the top markets became too expensive, whereas if DISH’s objective is simply to push up the price, then DISH wouldn’t necessarily want to bid elsewhere and end up owning second and third tier markets.
This suggests that DISH has been reducing its exposure in the top three markets, in order to prevent itself from becoming stranded with too much exposure there. My guess is that DISH exited completely from Chicago in Round 20 and is now reducing exposure in New York and Los Angeles after bidding initially for a full complement of licenses there (i.e. 10 blocks in New York and Chicago and 5 blocks in Los Angeles).
If DISH is now down to about 8 blocks in New York and only 2 blocks in Los Angeles, then its maximum current exposure (if all other bidders dropped out) would be $4.52B, keeping DISH’s exposure under what is probably a roughly $5B budget. Of course DISH could potentially drop out of Los Angeles completely and let others fight it out (for the limited allocation of 5 blocks), if its objective is simply to maximize the end price, but this may not be possible in New York, because there are 10 license blocks available, which could give Verizon, AT&T, T-Mobile and Comcast enough to share between them.
Regardless, with the price increasing by 10% in each round, the price per MHzPOP in New York and Los Angeles would exceed that in the AWS-3 auction before the end of this week, implying that a resolution has to be reached very soon. If DISH is the one to exit, then it looks like Ergen will not be reallocating eligibility elsewhere, and DISH’s current eligibility (256,000 bidding units if it is bidding on 8 blocks in New York and 2 in Los Angeles) is likely higher than the excess eligibility total of all the remaining bidders combined (~182,000 bidding units at the end of Round 24 if all the available licenses were sold). This implies that a rapid end to Stage 1 of the auction is now likely, perhaps even this week and almost certainly before the end of next week, with total proceeds in the region of $30B.
Of course we will then need to go back to the next round of the reverse auction, but it looks plausible that convergence may be achieved at roughly $35B-$40B, potentially with as much as 80-90MHz sold (i.e. an average price of ~$1.50/MHzPOP). If DISH is forced out in Stage 1, then prices in key markets would probably not go much higher in future rounds of the forward auction, so the main question will be how quickly the reverse auction payments decline and whether this takes 1, 2 or 3 more rounds.
Also, based on the bidding patterns to date, it seems likely that Comcast may well emerge from the auction with a significant national footprint of roughly 20MHz of spectrum, potentially spending $7B-$10B. In addition, unless the forward auction drops to only 70MHz being sold, all four national bidders could largely achieve their goals, spending fairly similar amounts except in New York and Los Angeles, where one or two of these players are likely to miss out. In those circumstances, it will be interesting to see who would feel the need to pay Ergen’s asking price of at least $1.50/MHzPOP (and quite possibly a lot more) for his AWS-3 and AWS-4 spectrum licenses.
UPDATE (8/30): Bidding levels in New York and Los Angeles dropped dramatically in Round 25 (to 10 and 8 blocks respectively), with total bidding units placed (2.096M) now below the supply of licenses (2.177M) in Stage 1. This very likely means that DISH has given up and Stage 1 will close this week at an even lower price of ~$25B, with convergence of the forward and reverse auction values probably not achieved until the $30B-$35B range. This lower level of bidding activity increases the probability that 4 stages will now be required, with only 70MHz being sold in the forward auction at the end of the day.
Its been interesting to see the various reactions to today’s announcement from the FCC that Stage 1 of the Reverse Auction concluded with a total clearing cost of $86.4B (apparently excluding nearly $2B for the $1.75B relocation fund and other auction costs).
Most opinions, including my own, were that this amount is laughable in view of how much wireless operators have available to spend on buying spectrum. Some have suggested this means that broadcasters are pricing themselves out of the auction by asking for an excessive amount of money. But the reality is that the FCC set the initial prices (of up to $1B per station) and all broadcasters had to decide was whether or not to participate and if so, at what point to drop out.
Importantly, if the FCC had no excess supply of TV stations willing to offer their spectrum in the auction, then it was obligated to freeze the bids at the opening price. It seems very unlikely that if a broadcaster was willing to participate at an opening bid of say $900M (in New York) then it would decide to drop out at $800M or even $500M. And notably the total opening bids if the FCC moved every single station off-air would be only $342B.
So even though the FCC has described broadcaster participation in the auction as “strong”, it seems that this statement may be code for “somewhat disappointing” because it has proved impossible to obtain sufficient participation to lower the opening bids in a number of key markets, if the full 126MHz target set by the FCC is to be cleared.
Of course the FCC would have been criticized if it had set a lower initial clearance target and it subsequently became evident that sufficient participation existed to reach the maximum. However, it now seems plausible that Round 1 of the forward auction could go nowhere, because there is little reason for participants to reveal their bidding strategies if it is essentially impossible for the clearing costs to be covered. That will probably also lead to criticism of the FCC for miscalculating the level of demand for spectrum, and certainly broadcasters will be highlighting that they apparently value spectrum more highly than the wireless carriers.
As a result, we are likely to see multiple rounds of the reverse auction, in which the clearing target is gradually reduced, until a more reasonable level of clearing costs (perhaps $30B or so) is reached. Although we could see quite a sharp reduction in clearing costs in Round 2 once more markets are unfrozen, it may need as many as 3 more rounds, with 84MHz cleared (representing 70MHz of spectrum to be auctioned), assuming the FCC incrementally reduces the target from 100MHz auctioned to 90MHz to 80MHz to 70MHz. At that point DISH could have even more reason to bid up the prices aggressively, because less spectrum will be available to its competitors, especially T-Mobile, so we might actually end up with the final forward auction bids exceeding the clearing costs by $10B+.
But for now, speculation as to which broadcasters declined to participate is likely to intensify. My suspicion is that fewer of the small and non-commercial broadcasters than expected might have decided to participate. After all as one station in Pennsylvania told the WSJ back in January, “it won’t consider going off the air…because it would lose its PBS affiliation and go against the station’s stated mission of serving the public”. That would mean more of the reverse auction proceeds potentially going to commercial ventures, especially those that were bought up by investment firms with the explicit aim of selling their licenses.
Moreover, it may even be reasonable to guess at some of the markets which may have been frozen at the opening bids: for example, it seems likely that this must include some of the biggest cities, such as New York or Chicago, for such a high total clearing cost to have been reached. No doubt investors will be contemplating what that might mean for those companies that own broadcast licenses in these areas, especially if they have indicated their willingness to participate.
So now the Kerrisdale report has been released, along with a prebuttal from Citigroup, claiming that Kerrisdale is “Absolutely Not a Thesis Changer”. However, as I noted last week, the biggest issue in thinking about the future for DISH is likely its capital structure, which neither of the reports address at all.
I also wish that both of them were better at math, when they try to assess whether today’s wireless networks are operating at capacity (though perhaps its hardly surprising when these calculations have been a recurring problem for New Street Research, CTIA, the FCC, Ofcom and even the ITU). Citi criticize Kerrisdale for considering New Albany, Ohio as a representative location, given its lower than average population density amongst US metropolitan areas (suggesting that 1000 people per sq km is more representative than 258 people per sq km), and also allege that Kerrisdale “ignores the variance in usage during the day” (suggesting that 40% of traffic needs to be accommodated in each of the 2 hour long morning and evening rush hours).
By making these adjustments, Citi claims that average utilization with a 25MHz downlink spectrum allocation would be 280% in the morning and evening peaks, compared to the 15% daily average estimated by Kerrisdale. Of course Citi exaggerate on the upside and Kerrisdale exaggerate on the downside.
The correct calculation for a “typical” situation should take the average number of subscribers per cellsite (144M subs on 48.6K cellsites for Verizon, according to Citi’s own report, or 2965 subs/site, compared to 1773 in Kerrisdale’s report and 7092 subs/site in Citi’s report) and the average busy hour ratio for mobile traffic (6.9% according to Cisco’s Feb 2016 VNI report which says the busy hour has 66% more traffic than average, although carriers typically build to around an 8% busy hour, perhaps 9%-10% in very peaky locations) and should also derate by the share of traffic carried on the downlink (around 87% in the US according to Sandvine), which neither report takes into consideration.
That would result in a daily downlink traffic of around 258GB per site (vs 177GB for Kerrisdale and 709GB for Citi) and a busy hour traffic of 17.8GB rather than the 142GB estimated by Citi. Then, using their own assumptions about capacity per site, each site would see a busy hour utilization of 35%, not 15% and certainly not 280%, suggesting that there is some headroom on most cellsites, just as you would expect, but that carriers will need to continue to upgrade their networks in years to come, to cope with future traffic growth, especially in peak locations.
That brings us back to my original thesis: Verizon might find DISH’s spectrum useful, but its network is not in danger of imminent collapse without it. Instead Verizon might prioritize increased use of small cells, sectorization and beamforming, and treat buying spectrum as the last thing to do, as Bob Azzi (former Sprint CTO) suggested on today’s Tegus call that I participated in.
This is a poker game, and if Ergen can prolong his license term (by building out fixed wireless broadband, as all of the call participants agreed would be logical) then he may be able to wait for Verizon to come to the table. If DISH can push up the price of spectrum in the incentive auction and prevent LightSquared/Ligado from offering a midband alternative then Ergen will be in a stronger position. So it seems more logical to me to talk about where that money will come from over the next couple of years, and not whether DISH will be forced to sell at a discounted price or Verizon will be forced to pay whatever DISH demands.
Its interesting to hear that Kerrisdale is apparently raising $100M to short DISH stock, after its previous attacks on Globalstar and Straight Path. As I said back in October 2014 when Kerrisdale mounted its attack on Globalstar, all spectrum (even that owned by Globalstar) does have value, its just a question of what someone will pay for it.
The spectrum bubble has clearly deflated considerably since late 2014 (despite DISH’s successful efforts to push up the price of the paired spectrum sold in the AWS-3 auction) with DISH’s share price roughly halving since that time, and other spectrum plays (like LightSquared/Ligado) also trading at much lower price levels.
This reduction in valuation clearly seems be the result of lower anticipated prices in the upcoming incentive auction, and last week’s FCC announcement that the initial clearing target will be at the maximum level of 126MHz, allowing 100MHz to be auctioned in most of the country (other than close to the Mexican border), will reduce the initial reserve price from $1.25/MHzPOP to $0.875/MHzPOP (although that could rise if broadcasters bid too much in the reverse auction to give up their spectrum).
However, arguments that DISH’s share price will fall much further seem to rely on DISH being forced to sell its spectrum at an even more discounted price due to impending buildout deadlines, competition (not least from Ligado, which secured a Public Notice from the FCC on its revised spectrum plans a couple of weeks ago) and very low prices in the incentive auction. Its useful to look back at what has happened previously, when operators have overpaid for spectrum, notably Verizon’s lower A and B block purchases in the 700MHz auction in 2008. In that case Verizon simply waited until someone (T-Mobile and AT&T respectively for those blocks) was prepared to pay the same as Verizon had paid (plus its cost of capital over the holding period).
If DISH is not under time or competitive pressure, then Ergen could also potentially wait to realize a reasonable price, at least in line with what DISH has already invested in its spectrum holdings (including the $10B spent on AWS-3 spectrum). Verizon might even decide to do a deal to buy spectrum from DISH sooner rather than later if it believes Ergen can wait indefinitely. And all of these problems can be addressed by spending money: bidding up the prices in the incentive auction this year, outbidding Ligado for the 1675-80MHz spectrum next year, and building out a fixed broadband network in the 1695-1710/1995-2020MHz band (as I suggested in November) to meet its FCC buildout deadlines.
Those three items could represent a sizable amount of money: perhaps $3B-$5B in the incentive auction (something that does not appear to be contemplated by most of the analysts covering the auction), $1B-$2B for 1675-80MHz and $2B-$3B for a fixed wireless broadband network, for a total of $6B-$10B over the next couple of years. And at first blush many would view that as another negative for DISH’s equity.
But the key issue here is to understand DISH’s capital structure and how the money flows around. DISH has raised its existing debt in the form of unsecured bonds at the DBS subsidiary, with no recourse to the parent entity which holds DISH spectrum assets. And the DBS bonds are not protected from being structurally subordinated to new bank debt at DBS (indeed part of the plan to fund a bid for T-Mobile last year was to raise $10B-$15B of new bank debt at DBS).
So if Ergen agrees with his kids, that its crazy to be in the pay TV business long term, then it makes absolute sense to raise say $6B+ of bank debt at DBS, flow that up to the parent company to support its spectrum plans, and (depending on how quickly the pay TV business declines and if a spectrum deal can be done in the interim) eventually file Chapter 11 for the DBS subsidiary (but not the DISH parent company). In fact raising that money sooner rather than later would make sense – DISH would have to convince the bankruptcy court that the subsidiary was not insolvent at the time of the transfer, unless that transfer happened several years before the filing. Note also that DISH has no need to spin off a spectrum holdco – the parent is exactly that, once it has extracted all of the equity value from the DBS subsidiary via this bank debt.
What does all this mean? All of the upside from any spectrum deal flows to DISH’s equity, but relatively little of the downside from no deal being struck: that downside is much more likely to be a problem for the DBS bonds. So if Kerrisdale’s plan is to short the equity, then it may face an asymmetric exposure risk. In fact, some people taking the other side of Kerrisdale’s trade might even decide to be long DISH equity and buy credit default swaps on the DBS bonds. That would create the possibility that they could win from a spectrum deal taking place, but also win if DISH can’t do a deal this year and has to raise money to wait out Verizon and/or AT&T.
In conclusion, remember what DISH said in response to rumors of the Kerrisdale report: “We will continue to manage the business for the long-term benefit of our shareholders as we have done over the last 35 years.” After all, Charlie Ergen’s a shareholder, with much of his wealth tied up in DISH stock, but as far as I know he’s not a DBS bondholder.
I woke up this morning to read New Street Research’s latest 3Q2015 Wireless Trends Review, subtitled “Competition Gets Ugly: The Big Guys Have A Problem” and while I agree that competitive pressures in the US wireless market are getting ugly, I’m afraid it is the analysts rather the “Big Guys” that have a problem. In particular, New Street’s “network capacity framework” that suggests Verizon “have half the capacity they will need by 2020 to maintain current network quality” is based on a completely flawed premise, just like most other pronouncements of an imminent spectrum crisis.
This network capacity framework calculates the number of “MHz-sites” that Verizon has for LTE in the top 25 markets and assumes that data demand will grow at 30% from 2015 to 2020 (reaching 10GB/LTE sub per month by then). Ignoring the fact that New St doesn’t know its Petabytes (1 million Gbytes) from its Exabytes (1 billion Gbytes), Verizon’s “aggregate LTE data demand” is projected to increase five fold between 2015 and 2020, while Verizon is expected to increase its deployed LTE spectrum from 68 to 138MHz and its number of LTE macrosites in these markets from 21K to 27.2K over the period, which supposedly will result in 2.5 times growth in network capacity. Thus New St concludes that Verizon will have only half the capacity needed to meet demand, without buying more spectrum from DISH.
This thesis is even more flawed than the Brattle Group study for CTIA back in June, because it completely fails to consider the potential for improvements in network efficiency over the period as LTE-Advanced technologies are deployed. Even Brattle Group acknowledges that “LTE+” will carry over 70% more bps per Hz than 4G LTE, based on a move from 2×2 MIMO to 4×4 MIMO, and the original source for these estimates (Rysavy Research’s August 2014 paper on “Beyond LTE: Enabling the Mobile Broadband Explosion“) acknowledges that many additional improvements are feasible.
Correcting for this error alone, and assuming capacity constrained locations are upgraded to LTE-Advanced by 2020, New Street’s supposed capacity shortfall is reduced from 50% to 14%, and so the number of additional macro sites that Verizon would need to build is reduced from 26.7K to only 4.5K (which based on the FCC’s October 2010 estimate of $550K per cellsite would cost only $2.5B in incremental capex). That hardly seems to justify Verizon spending tens of billions of dollars to buy DISH’s spectrum.
New Street also ignore other sources of incremental capacity (such as LTE-U) and reject small cells as infeasible because they have supposedly only 1/3 the capacity of macro sites (Rysavy in fact points out in Figure 68 of his report that through careful placement to meet hotspot demand, four picocells per macrocell could produce roughly a 10x increase in capacity).
Its hardly surprising that New Street conclude Verizon’s behavior is “perplexing” and suggest that rather than “discounting to hang onto subs” Verizon “should be taking up price to shed subs faster in congested markets to preserve superior network performance for their most valuable subs.” But perhaps Verizon do actually understand network engineering and the potential for network capacity enhancements better than analysts with a simplistic, erroneous spreadsheet model?
In these circumstances Verizon would also feel happy to say no to Ergen’s blackmail and refuse to pay more than their previous offer for DISH’s spectrum (which I guess is around $1/MHzPOP). In fact, it would seem likely that Verizon don’t want a deal at any price ahead of the incentive auction, if that would enable Ergen to bid up the price of spectrum once again. On the other hand, Ergen is undoubtedly keen to find a partner to endorse the value of his spectrum holdings and force Verizon back to the table. As part of that effort, I’m told he has been visiting Google again recently, just as he did back in 2012 when he was trying to pressure AT&T to do a spectrum deal.
One possibility for such a partnership would be to reinvigorate DISH’s rooftop small cell deployment plan, and meet Ergen’s AWS-4 buildout requirements, using the AWS-4 uplinks (2000-2020MHz) as downlinks in conjunction with his 1695-1710MHz uplink spectrum. Remember that Google has backed similar efforts in the past, when it funded Clearwire (rather than LightSquared) in 2008, in order to get a competitive 4G network built out quickly, and push Verizon and AT&T to do the same. However, Ergen has little more than a month left to get a deal done before the auction restrictions kick in, so time is not on his side.
Charlie Ergen’s atypical absence from the Paris satellite conference this week was not the only pointer that something is happening at DISH which could lead to a spectrum spinoff being announced imminently. On Wednesday Northstar and SNR asked for and were granted a two week extension to the September 17 deadline to provide an irrevocable standby letter of credit for the $3.3B DE discount that the Commission has ordered to be repaid.
This move signals that DISH is close to a deal to restructure its spectrum holdings and presumably announce the spinoff of a spectrum leasing company before October 1. However, the question is who would be the anchor leasing tenant for that entity, which would enable it to raise tens of billions of dollars of debt in its own right, and allow the Spinco to pass the proceeds back to DISH and/or to fund a bid for additional spectrum in the upcoming incentive auction.
Back in August I speculated that Sprint was a potential wild card partner for DISH, but Verizon has always been the more attractive option, given its greater financial resources and that it bid against DISH in the AWS-3 auction earlier this year and will soon be deploying AWS-3 to supplement its existing AWS-1 network. Its therefore hardly a coincidence that Verizon was openly discussing on Thursday its interest in a deal with DISH, including that “we’ve had discussions about how we could provide [Dish Network Chairman and CEO Charlie Ergen] with megabytes and how he could pay for it with spectrum.”
It seems clear that Verizon would be interested in gaining access to both DISH’s AWS-3 winnings and the adjacent AWS-4 downlink through a leasing deal. However, by advertising its bottom line in public, and in particular that Verizon is not willing to pay DISH’s asking price in cash to lease this spectrum, it seems that Verizon has presented Ergen with a take it or leave it proposition, calculating that DISH has no other options.
If DISH really is serious about entering the wireless business, then it could use the “megabytes” offered by Verizon (which would presumably not be limited to being provided on the spectrum under lease) to set up an MVNO business, and the price established by Verizon could then serve as a benchmark for cash deals with other parties (i.e. a 700MHz E block deal with AT&T and an H-block/AWS-3 uplink deal with Sprint). Theoretically Verizon could offer quite a high price, especially if it calculated that DISH might not succeed in the MVNO business and would therefore leave most of the megabytes unused.
However, this outcome would leave DISH without the ability to raise substantial debt at the Spinco, unless and until further cash deals were struck. That’s likely a wise move for Verizon, since it would prevent DISH from bidding aggressively in the incentive auction, and potentially result in lower prices in that auction and a correspondingly lower benchmark for future spectrum transactions.
So now we’ll see if Ergen accepts Verizon’s offer or if he can come up with an alternative leasing partner in the next week and a half. Alternatively, and perhaps even more likely, is that no deal will be struck now. Then Ergen might have to wait for a long time for the next opening, as operators focus their attention on the incentive auction next spring and beyond that on the possibility that a change of administration in November 2016 could result in a different regulatory climate for deals that are impossible today (such as a Sprint/T-Mobile merger).
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