Are Spectrum Prices Out of Whack?

Equity valuations of Sprint, T-Mobile US and Dish Network seem out of line with the theoretical value of their spectrum holdings. Something does not seem right. Either the market is mispricing those firms, or the market is overvaluing spectrum assets.

It seems like the spectrum valuation is the mistake.

U.S. mobile service provider Dish Network Dish Network is gambling in a big way with its spectrum strategy, assuming it can monetize its mobile spectrum assets in some way.

The fact that some analysts believe 80 percent of the company’s equity value now rests on the deployment of that spectrum for commercial purposes illustrates the magnitude of the gamble.

Dish has assembled a portfolio of about 55 MHz of spectrum to support Long Term Evolution networks, but faces a 2017 deadline to get 40 percent of that spectrum activated, allowing mobile customers to buy service.

If it misses that deadline, Dish Network must deploy enough of its spectrum to reach 70 percent of U.S. consumers by 2020.

If not, Dish loses the spectrum, and possibly 56 percent to 80 percent of its market value.

Dish Network assumes it can either sell its spectrum for $25 billion to $45 billion, create a wholesale mobile business using the spectrum, or perhaps buy one of the U.S. mobile operators.

Dish will get no help from AT&T or Verizon. Sprint and T-Mobile US are viewed as possible partners. But Sprint, T-Mobile US and Verizon are viewed as the likely actors, for any Dish move.

T-Mobile US has been viewed as an acquisition target for Dish Network. Sprint has been viewed as a partner, leasing network facilities to Dish Network so spectrum can be converted into retail capacity.

Verizon has been seen as a buyer of Dish Network Spectrum.

There is a potential obstacle, though. The value of Dish Network’s spectrum, in the wake of prices paid in the recent AWS-3 spectrum auction, are high enough to make any purchase transaction for Dish Network spectrum very costly.

In fact, that auction featured the highest prices ever paid for mobile spectrum. Based on those recent precedents, some expect the 2016 auction for 84 megahertz worth of 600 MHz spectrum

could cost between $15 billion and $30 billion.

That upcoming auction is a part of the very-complicated spectrum acquisition picture. AT&T spent $18 billion in the AWS-3 auction; Verizon about $10 billion. A 2016 auction would require each firm to raise more debt, something neither is keen to do, and which neither Sprint nor T-Mobile US can afford, either.

But other spectrum conceivably will be made available. Shared spectrum in the 3.5 GHz band, new Wi-Fi spectrum in the 5-GHz band and then additional spectrum in the millimeter bands all are expected to be made available for commercial use, at some point.

Also, some spectrum presently not considered available for sale, including low power TV spectrum, could be considered for auction as well. In light of the AWS-3 auction prices and the upcoming 600-MHz broadcast TV spectrum auction, some within the low power TV business think they should have the ability to sell their TV spectrum as well.

There are, in 210 TV markets, 2,650 low-power TV licenses, representing an aggregate 15,900 MHz of spectrum, according to Mike Gravino, LPTV Spectrum Rights Coalition director.

Based on the AWS-3 auction prices, that spectrum might be worth $50 billion dollars, Gravino said.

There are lots of moving parts.

So one way of looking at matters is that, were Dish Network to sell, at AWS-3 prices, that spectrum might cost  $56 billion to $80 billion. The 600-MHz auction might add another $15 billion to $30 billion.

Sprint has talked about selling some of its excess 2.5-GHz spectrum. At AWS-3 prices, that implies a possible value of $155 billion, far in excess of the current market value for all of Sprint, about $21.3 billion.

Also, consider that T-Mobile US just spent $10 billion on AWS-3 spectrum. T-Mobile US current market capitalization is about $26.5 billion.

A rational person might conclude that something is out of whack, and that the likely problem is spectrum valuations, which are too high.

Spectrum valuations might be so costly, in fact, that many conceivable options for buying or selling spectrum might be beyond reach.

Will FiOS Ever Pay Off for Verizon?

Exhaustion of the older revenue models and products means firms such as Verizon increasingly will rely on new services to drive revenue growth in the future, Verizon CFO seems to agree.

With the caveat that AT&T arguably is far more exposed to consumer revenues in it fixed network segment, Verizon’s earnings from its fixed networks show why Verizon was not keen to expand its FiOS deployment.

About 40 percent of fixed network  revenue comes from the residential market, notes Michael Hodel, Morningstar analyst. So an important observation is that Verizon makes its money in the fixed network segment from business customers.

The reason Verizon only earns 40 percent from consumers is that it faces ferocious and successful competition from cable operators. “We estimate Verizon now serves less than 40 percent of the households in its territory, down from nearly 60 percent five years ago,” Hodel says.

In other words, where it has built FiOS networks, 60 percent of the access investment is stranded and does not earn a return. That also means full recovery of invested capital has to be carried by the 40 percent of actual customers.

“We believe that losing customers will make it difficult for Verizon to earn a solid return on FiOS network spending or justify network upgrade spending beyond where FiOS already exists,” Hodel argues.

Verizon's network is future-proof. “But returns on this investment have been poor, as we calculate fixed-line asset turnover and margins trail most peers,” said Hodel.

On the other hand, Verizon generates about 70 percent of its total revenue from its mobile segment.

Verizon Wireless of course is working on new sources of revenue, “but the revenue opportunity in these areas may not prove adequate to maintain the current rate of growth across the industry,” Hodel said.

Irrational pricing by Sprint or T-Mobile US or both could threaten Verizon’s mobile cash flow, as could heavy new spending on spectrum.

If consumer revenue growth stalls or if the enterprise market continues to struggle, Verizon may have trouble expanding fixed-line margins as planned.

And Verizon’s cash flow is not what it once was.  Free cash flow of $13 billion in 2014 was 36.5 percent less than in 2013.

Since the $130 billion acquisition of Wireless from Vodafone in 2013, Verizon's debt has more than doubled to $113 billion, while its shares outstanding has increased almost 40 percent.

That limits both borrowing and equity issuance as avenues to raise capital. For that reason, some might doubt Verizon has the ability to buy Dish Network’s spectrum, and Verizon likely has no interest in acquiring Dish Network’s video business.

Might Verizon be better able to augment its spectrum position by buying excess Sprint spectrum? That might seem more reasonable.

Market Power Issues Lie in High Speed Access, Not Linear Video

Beyond looking at traditional market share and competitive impacts of the AT&T acquisition of DirecTV, and the Comcast acquisition of Time Warner Cable, regulators and antitrust officials also might consider the relative fortunes of the video and high speed access markets as well.

Simply, the high speed access market is growing, while the linear video market has begun declining. It might not be part of the formal mathematical screening, but it arguably makes good sense not to regulate declining markets in the same way as growing markets are regulated.

Virtually all observers believe linear video is a product that already has entered the declining part of its lifecycle, while high speed access arguably remains short of a peak.

Also, few might disagree that the most-important consumer service now is Internet access. That is why U.S. universal service funding now centers on Internet access, not voice.

The 17 largest U.S. cable and telephone providers in the United States acquired three million net additional high-speed high speed access subscribers in 2014.

By way of contrast, the 13 largest linear video providers in the United States lost about 125,000 net video subscribers in 2014. That is about a two orders of magnitude difference in growth rates.

At the same time, cable companies had  51.9 million broadband subscribers while telephone companies had 35.4 million subscribers. In other words, the leading cable companies had 59 percent high speed access market share.

The top cable companies gained 89 percent of the net additions in 2014, and 82 percent of the broadband additions in 2013.

In other words, in addition to commanding market share position, the cable industry seems to be accelerating its market share gains.

At the same time, cable companies continued to lead in video market share.

The top 13 linear video providers had 95.2 million subscribers. The two satellite TV companies had 34.3 million subscribers, while the two top telephone companies had 11.6 million subscribers.

Both AT&T and Verizon had fewer than six million video subscribers each.

The point is that the market concentration problems are in the high speed access area, not video.

Will AT&T Become the Biggest Wireless ISP?

Assuming the AT&T bid to buy DirecTV is approved by regulators and antitrust authorities, AT&T plans to launch a rural areas bundle based on Internet access and TV including Internet access, using fixed wireless technology.

The original plan called for access up to 15 Mbps or perhaps 20 Mbps. That might change now that the Federal Communications Commission has revised the definition of “high speed” to reflect a minimum of 25 Mbps.

Some think the odds of approval are about 50-50. At least so far, public opposition has been fairly muted, compared to the heat the proposed Comcast acquisition of Comcast has generated.

Perhaps that is because the key service, with the greatest strategic implications, is high speed access, not video, in the same way that voice services no longer are the strategic service for other fixed or mobile service providers.

Comcast has argued, with some reason, that video service competition would not be harmed by its acquisition of Time Warner Cable. Many do not agree, but it is true that the two firms actually do not compete head to head very much.

Comcast also has agreed to divest enough video accounts to keep its video market share below 30 percent.

On the other hand, many warn that Comcast’s share of high speed access would climb beyond 50 percent, with a disproportionate share of access at speeds above 25 Mbps.

Perhaps significantly, 63 percent of U.S. homes would have only one provider capable of providing 25 Mbps speeds, and Comcast would provide that access. Historically, antitrust scrutiny has been high whenever a single provider reaches 30 percent share of the market.

AT&T earlier had said it would provide service to about 13 million rural locations using fixed wireless.

Such a development would make AT&T the largest wireless Internet service provider (WISP) in the United States. Up to this point, only Clearwire had tried to build a big business using fixed wireless technology, and even Clearwire had switched emphasis to mobile broadband.

Presumably linear video entertainment would be provided by the DirecTV network.

Device Boundaries (PC, Tablet, Smartphone) Blur

With tablet sales down as much as 30 percent in some instances, Apple appears to be getting ready to enhance tablet attractiveness for business customers, planning a device with a 12.9-inch screen, possibly outfitted with USB 3.0 ports useful for direct offline data backups, as well as keyboard and mouse ports.

Among the problems is an apparent consumer preference for larger-screen phones as an alternative to tablets.

Tablets were supposed to replace personal computers. It now looks like larger-screen smartphones are displacing tablets.

The differences between PCs, tablets and smartphones are blurring.

Softcard Mobile Payments Venture Closes

It’s official. After selling core technology to Google, and agreeing to pre-install Google Wallet on their smartphones, AT&T, Verizon and T-Mobile US are formally closing the Softcard mobile payments service.

Instead, customers are directed to Google Wallet as an alternative. The end of the Softcard business is not the first time a mobile operator consortium has closed.

ABN Amro, ING, KPN, Rabobank, Vodafone and T-Mobile abandoned their planned mobile payments  venture in 2012, for example.

In the United Kingdom, O2 has shuttered its mobile wallet application, while France’s Bouygues Telecom apparently has ended its NFC program as well.

It probably is notable that those failures affect ventures aimed at retail payments. Services focused on mobile banking services, or money transfer services, seem to be doing much better.

Globally, 255 mobile money ventures are operating in 89 countries, according to the GSM Association. Those services include remittances (sending money to another person or entity), insurance, credit or savings services.

Mobile money is generating substantial revenues for a growing number of mobile service providers, GSMA says. At least 11 providers reported generating more than US$1 million in revenues during the month of June 2014, and all but one of these providers were mobile operators.

HBO Now Readying April 2015 Launch?

Time Warner appears to readying an April 2015 launch of its new “HBO Now” streaming video service, at a price of $15 a month. That will mean the first time the full HBO service has been made available directly to U.S. consumers, without the need to buy a linear video subscription first.

That means a new set of distributors (Apple TV, Roku, Xbox, PlayStation, Amazon) will be engaged to sell the product to end users, though some U.S. cable TV operators have expressed interest in retailing the product as well.

HBO claims the HBO Now service will be marketed primarily to the 10 million U.S. high speed access subscribers who do not buy a linear video subscription.

But consumers themselves will decide how the demand shapes up. Linear video distributors will be watching closely to see whether there is an upsurge in HBO churn, as well as the degree of demand from consumers who do not want to buy a linear video service.

CBS and Starz already have committed to launching an over the top product, and NBCUniversal is launching a new comedy-focused niche service as well.

At some point, linear video distributors are going to have to make a hard choice about whether to compete with Verizon Communications, Amazon, Apple TV, Roku, Xbox, Playstation and others.

Verizon, among the larger U.S. linear video distributors, has been most supportive of the notion that over the top entertainment video, especially delivered to mobile devices, was a significant opportunity.