New Questions Arising About Likely Success of Incentive, AWS-3 Auctions

In a recent research report, analyst Craig Moffett of MoffettNathanson said the four major carriers could face constraints in how they bid based on how much free cash flow they have to dedicate to spectrum. AT&T said in its recent earnings report that 2014 free cash flow would be $11 billion, or more than 20 percent less than some expected. By some estimates, the two big auctions plus the sale of 1695 MHz spectrum could raise $50 billion, the report said: That “amounts to the next two years’ worth of free cash flow for all four of the Big Four combined ... before dividends.” Moffett said $50 billion is enough to buy a new iPhone 5S for all of AT&T’s 80 million subscribers, the same cost “as four of the U.S. Navy’s brand new Gerald R. Ford-class nuclear powered aircraft carriers."

"While we have no way of forecasting the end result with any real precision, and while the incentive auction could still face further delays because of its sheer complexity, in all likelihood both auctions should be blockbusters,” Moffett wrote. “But allow us to ask an uncomfortable question: can the industry afford it? ... Spectrum may be a valuable asset, but the industry may not have enough money to bid it up to the levels everyone seems to think. And if it does, the bottom line financial consequences of doing so won’t be pretty."

Industry asset valuation firm Summit Ridge Group said in a recent report that the “spectrum crunch” is not turning out to be as severe as once feared (http://bit.ly/1eYA78f). “Large swaths of mobile spectrum remain undeveloped -- including prime sub-1 GHz spectrum in the 700 MHz band auctioned over six years ago,” Summit Ridge said. The firm cited increased Wi-Fi offloading and the phasing out of unlimited data plans as key factors in reducing demand.

Industry observers disagree whether the outlook seems less rosy than in the past for the upcoming auctions. Several analysts noted that last week Cisco’s latest projections showed wireless broadband usage continues to grow at a rapid rate, with global mobile data traffic up 81 percent in 2013 over 2012 (CD Feb 6 p13).

"As something moves closer to reality, you start to get a more realistic look at it than when it’s just an idea on a piece of paper,” said a former FCC legal adviser. “AT&T and Verizon are awash in spectrum at the moment. ... There really isn’t a spectrum crunch at this point."

No ‘Bottomless Pockets'

"It’s very sensible to point out that even the largest operators don’t have bottomless pockets,” said Paul Gallant, analyst with Guggenheim Partners. “But the carriers do say they'll need more spectrum around 2017, and the pipeline after broadcast is basically empty. So I suspect they'll be creative in pulling together the financing needed to bid aggressively."

BTIG Analyst Walter Piecyk said carriers will have to pay now, or pay later, for more spectrum. “The belief that wireless operators would make spectrum purchase decisions based on impact to dividends is ridiculous,” Piecyk told us. “Spectrum is the finite asset that enables revenue, cash flow and dividend growth. If they don’t buy it now they will end up paying much more later."

"Wireless carriers know that spectrum is a finite resource and that if they don’t buy it sooner, they will have to spend more later,” agreed Roger Entner, lead analyst at Recon Analytics. “The reason why AT&T’s free cash flow is ‘only’ $11 billion is because the company is heavily investing in building out the spectrum it already has and 2014 will be their peak year of that three-year accelerated build-out,” he said. “Isn’t it a wonderful coincidence that the auctions will be under way in 2015? Maybe not. The AWS3-band will be the only LTE global roaming band. To think carriers will not be keen on owning it and bidding aggressively on it would be counter-intuitive. The broadcaster spectrum is also prime real estate of the first order. The carriers will do their best to win these licenses, even if it means that they will have to go in debt. The less the government interferes with the auction the higher the proceeds for the government will be, and as history has shown us both consumers and carriers will prosper as a result.”

Entner said anemic bidding in the underway H-block auction has few implications for the upcoming auctions. “The reason why there is such limited interest in Auction 96 with 10 MHz is that technology has moved on and demands wider channels than what the FCC can offer,” he said. “Any carrier would want 20 MHz contiguous spectrum. The G block which is owned by Sprint nationwide makes the H block an orphan and for anyone but Sprint non-contiguous."

Carriers can’t afford to blow off the upcoming auctions, said Jeff Silva, analyst at Medley Global Advisors. “While the incentive auction faces a range of challenges due to inherent design complexities, voluntary broadcaster participation uncertainty and other factors, my sense is that pushing the start-date back to mid-2015 will enable the FCC to overcome many of these obstacles if the agency pursues a smart strategy, conducts thorough testing and plans for contingencies,” Silva said. “Targeted broadcaster outreach and education ... could prove effective. The FCC needs to acknowledge a number of broadcasters will not be incented to return airwaves and build that likelihood into its model.” But Silva predicted carriers will “find the financial wherewithal” to actively bid in the auctions. “Though broadcast spectrum will likely carry a high price tag, wireless operators simply cannot afford to hold back in bidding,” he said. “The spectrum opportunities offered by upcoming auctions -- especially the incentive auction -- cannot be overstated. The essential input for carriers, spectrum, is dwindling and more cannot be manufactured."

"Certainly Sprint and T-Mobile are both in a far stronger position to bid for spectrum than they were one or two years ago,” said Michael Calabrese, director of the Wireless Future Project, which is part of New America’s Open Technology Institute. “Sprint’s new owner SoftBank has deep pockets and they're extremely committed to making Sprint capable of competing head-to-head with AT&T and Verizon,” Calabrese said. “And T-Mobile is rapidly gaining subscribers and market share thanks to its ‘Uncarrier’ campaign and its very innovative new pricing program.” All four national carriers should be able to pick up the spectrum they feel they need in the auction, he said. “Some of the smaller carriers will be going to the capital markets and interest rates remain near historic lows and it appears they will be bidders as well."

But Calabrese agreed that Wi-Fi offloading is limiting demand. “Somewhere between 40 and 50 percent of mobile device data traffic is being redirected over Wi-Fi,” he said. The European Commission projected last year that in Western Europe 80 percent of mobile data will be offloaded by the end of 2016, he noted. “There is no spectrum crisis thanks to Wi-Fi and unlicensed.”

"Congress correctly recognized that unless it gives the commission an actual deadline, there’s a historic tendency toward inertia,” said a former FCC spectrum official. “On the other hand, spectrum values tend to rise and fall due to many different and unpredictable factors. At this point, the commission is on the hook for the AWS-3 auction; however, it can, and I expect it will, slow the self-imposed race to hold the incentive auction. I haven’t heard any sector -- wireless or broadcast -- clamoring for the commission to get on with that auction."

'Essential’ Auctions

Former U.S. Rep. Rick Boucher, a Virginia Democrat who chaired the Communications Subcommittee, told us the upcoming auctions remain “essential” for carriers. More Wi-Fi offloading “doesn’t say the crunch is lessening, it just says they're trying to find new ways to address it until new spectrum can become available,” he said.

A wireless infrastructure executive said his main concern is that the FCC not impose rules designed to help small carriers that would keep AT&T and Verizon Wireless from fully taking part in the auctions. “There’s not enough money floating around that the FCC can afford to put too many restrictions on this,” the executive said. Some broadcasters are already starting to question whether they will take part in the incentive auction, “and if the FCC starts putting too many conditions on and basically precludes people from bidding it’s just going to depress prices and depress participation. ... The whole thing can go south.”

The FCC should be leery of speeding up or slowing down an auction based on “crystal ball projections concerning future demand,” said Free State Foundation President Randolph May. “The principal purpose of auctions is to get spectrum into the hands of private sector service providers in an expeditious manner through an unencumbered auction process that allows the market to value the spectrum,” May said. “It’s not for the government to second-guess the market. Then, once spectrum is auctioned, it is important to have the secondary market function on a free market basis so spectrum can be transferred to those who value it most as business models, technology, and consumer behavior change."

"There is definitely a need for more internationally harmonized licensed spectrum for carriers and their customers in the U.S. and other countries in the Americas as a spectrum shortage is on the horizon,” said Chris Pearson, president of 4G Americas. The organization “and the wireless industry are working diligently to evolve LTE and encourage regulatory innovation, but it is critical to have more licensed spectrum auctioned such as the AWS-3 extended band and TV bands."

"Spectrum auction revenues are always a crap shoot,” said Public Knowledge Senior Vice President Harold Feld. “This is why policies to ‘maximize revenue’ are so stupid. For some reason, people who in every other circumstance talk about how no one can predict the market hold forth with great authority about how much money the market will pay for spectrum. We are much better off when we follow the Communications Act and focus less on revenue and more on [the] public interest."

"Carriers desperately need access to additional low-band spectrum, and with the right framework in place a successful incentive auction is achievable,” said Steve Berry, president of the Competitive Carriers Association. “The 600 MHz auction, the first low-band spectrum auction in eight years, is critical for every competitive carrier. The FCC must ensure that all carriers, both large and small, have meaningful opportunities to bid on and win spectrum at the auction, and no one carrier should be able to walk away with the entire lot. Providing the right incentives for broadcasters to participate, a smart band plan and clear, up-front auction rules will get competitive carriers to participate, which will result in higher revenues. The big question is, ‘How do you get the broadcasters to show up for the auction?’ Spectrum is the lifeblood of the wireless industry, and competitive carriers can’t afford to let an opportunity to acquire more spectrum pass them by.”