Who Is Going To Help Sprint And T-Mobile Get Their Deal Done?

According to press reports this week, there are three contenders. The WSJ pegs DISH as the front runner (LINK), with discussions also continuing with the cable companies. And Adderton, Boost’s founder, perhaps backed by private equity, has expressed interest (LINK). There was early talk that Amazon might be interested, but that seems to have faded.

It isn’t surprising that all these characters might want to take advantage of the situation to capture assets, or access to assets, at below market prices. New Street would be in the bidding too, if the companies (and the DOJ) would only willing to consider a layaway payment plan. They may not all solve the DOJ and the companies’ problems though.

In this edition of the weekly review we explore how each of these companies might stand to benefit from the process, what they might be looking for, and how their participation might help cure the competitive harms caused by the deal.

The DOJ Needs A Fourth

It seems, based on reports, that the DOJ is looking to preserve a four-carrier market. Sprint and T-Mobile can merge, if they divest assets that help establish an alternate fourth carrier. In the AT&T / T-Mobile case from 2011, the DOJ outlined what is required for a company to a credible competitor in the national wireless market:

1. Nationwide spectrum,
2. A national network,
3. Scale economics that arise from having tens of millions of customers, and
4. A strong brand, as well as other valued characteristics.

Cable provides the easiest path to a deal…

If Cable purchased nationwide spectrum, they would check all the DOJ’s boxes. Collectively, they have a national broadband network that can be used to deploy the spectrum. The cable networks already carry most of the market’s wireless traffic on unlicensed spectrum. There is nothing preventing them from deploying licensed spectrum alongside the unlicensed.

Collectively, the Cable companies have 50MM broadband customers. They have just 2MM wireless customers; however, the scale economics Cable has in broadband carries over to wireless. Comcast and Charter have said they will make money in wireless at low single digit penetration, which wouldn’t be possible if this weren’t true.

Finally, Cable has a strong enough brand, and whatever other valued characteristics the DOJ might seek.

…and the spectrum would be valuable to Cable…

We have written before that spectrum between 2.5GHz and 5GHz is ideal for deploying 5G (LINK), and the US is starved of this spectrum[fnote]The US wireless industry is starved of mid-band spectrum that can be used to deploy 5G. Most developed countries have released 200MHz around 2.5GHz and 400MHz around 3.5GHz. We have laid out in a prior report why this spectrum is ideal for 5G (LINK). The US carriers have nothing at 3.5GHz today (CBRS is coming but this won’t work for the carriers). The FCC is trying hard to release spectrum at 3.7GHz, but it will take at least three years to clear. Moreover, there is only a plan to clear 200MHz, which is half of what other markets have. The US does have close to 200MHz of 2.5GHz; however most of it is with Sprint, who has never had the means to deploy it.[/fnote]. The cable companies have a shot of getting perhaps 40MHz of a scarce, strategic asset in a transaction in which AT&T and Verizon can’t compete against them and bid up the price. This would seem a great opportunity, even if they had no need for it.

But they will have a need for it. The Cable companies will eventually deploy licensed spectrum with 5G across their wireless access points, improving the experience of wireless and broadband customers, and transforming the economics of their wireless business. Charter has been trialing CBRS and C-Band spectrum for this purpose. Sprint’s 2.5GHz doesn’t have the power limits of CBRS and it can be deployed today, while C-Band may not be available for years.

...but Comcast doesn’t seem to want to play ball with assets…

Comcast announced that they have no interest in buying spectrum or other assets from the wireless carriers. We can think of four reasons why they would pass up an opportunity to acquire a valuable, strategic asset at a discount:

First, Comcast has prioritized returning leverage to its target range, which we now believe to be somewhere between 2.2x and 2.5x. A spectrum acquisition, no matter how opportune, would arrest the process, potentially requiring forbearance from rating agencies and bond investors. Comcast would have no interest in risking their debt rating.

Second, and relatedly, equity investors want to see leverage returned to its target range so that the company can resume repurchasing shares. The cost of the spectrum could push repurchases off by another year or more, and investors would fear that the investment required to deploy the spectrum might delay repurchases further still.

Third, T-Mobile has been threatening to use the abundance of capacity they would secure through this deal to go after the home broadband market. We don’t think this is a material threat (LINK), and we doubt Comcast does either, but why help them. Comcast might believe, as we do, that if the deal is blocked Sprint will be in distress soon enough and the Cable companies will get another crack at this spectrum in a couple of years.

Finally, while it might be nice to get great spectrum at a discount, the Cable companies don’t need it now. They are probably a year or two away from deploying a 5G network of their own and there are other bands coming available next year or the year after (CBRS; C-Band).

Even that may be too soon. Ideally, the cable companies would buy spectrum at a point when they can demonstrate a very quick return from the elimination of MVNO costs. We estimate that these will grow from ~$0.5BN in 2019 to $3BN five years out between them. We estimate they could save at least 75% of these costs by deploying 5G on licensed spectrum. Spending $10BN on spectrum to save $2.5BN annually in MVNO costs will be a no-brainer eventually, but “eventually” is still a few years off.

…and other Cable companies may be of the same mind

Charter has been more focused on the opportunity from deploying spectrum than Comcast has. Altice is farther along still, having deployed close to 20,000 small cells across their plant in conjunction with Sprint to give themselves access to a much better network and much lower MVNO costs. These companies may be more interested in acquiring spectrum than Comcast, thought it would be difficult for them to proceed without Comcast participating[fnote] If Charter and Comcast were to buy spectrum it would have to come with a deep MVNO that would give them SIM control, at a minimum.  We think they can circumvent SIM control with dual SIMs; however, this hasn’t been tested in a commercial setting, and an MVNO with SIM control would be a simpler solution.[/fnote].

We suspect the timing will be an issue for both Charter and Altice too. Investors want them to repurchase shares. The equities of both companies may be punished even more harshly than Comcast, if they diverted capital to a spectrum acquisition now.

Interestingly, if we are wrong, and at least Charter decides to pick up spectrum now, they may be able to meet the DOJ’s requirements without Comcast’s participation. Comcast already owns 600MHz spectrum covering their footprint. If Charter acquired 2.5GHz covering the rest of the country, between them they would have nationwide spectrum. It would be far better if it were the same band, and Comcast’s 600MHz isn’t particularly good for 5G or for deploying on a dense grid. Nevertheless, an accommodating DOJ and a deferent judge might deem this enough to let the deal through.

For what it is worth (which is very little), we think it would be crazy for the cable companies to pass up the opportunity to acquire valuable spectrum. We believe they could create far more value with it than they can with Sky and a host of other investments they have made. The equity markets would eventually thank them for it, no matter how much they stomp their feet and sulk in the near-term. But it is easy for us to say; we don’t have to manage a business in a capricious public market. 2018 wasn’t much fun for the management teams of any of the public cable companies.

…though we have no doubt they would take a better MVNO

All three cable companies would take a better MVNO than the one they have now. Comcast and Charter would want SIM control. They would undoubtedly also like a better rate. Though they may find it hard to get T-Mobile to match the other elements of their deal with Verizon, which is a perpetual, technology agnostic deal with the wholesale price indexed to retail rates.

Altice would like a perpetual deal (their current one has a five-year term), and if they can’t get that, at least another 5-10 years on the deal they have. Altice says they already have SIM control, though there is some debate around this topic (LINK). Altice has managed to extract a commitment from T-Mobile to take on the Sprint deal and to negotiate with them in good faith when it comes time to renew, but they would be better off locking in terms now.

It is unlikely that better MVNO terms on their own would be enough to establish Cable as a fourth wireless carrier, and so if they aren’t willing to acquire assets, they may not have much leverage to get anything else out of the deal either (perhaps, except for Altice). If this proves true, it would be a pity. A new MVNO, on what will rapidly become the most robust 5G network in the US, would be valuable. A new MVNO with SIM control and spectrum could be transformative.

DISH may be the best alternative

DISH meet the first and last points on the DOJ’s list; however, they don’t have a network and they don’t have wireless subscribers. Unlike broadband subscribers, we don’t think satellite pay-tv subscribers would confer much in the way of scale economies to a wireless business. DISH could acquire Boost and whatever other subscribers the carriers are required to divest, solving the subscriber problem. We can think of two ways they could solve the network problem[fnote]There has been talk of DISH acquiring network assets which could also help solve the network element; however, we will argue below that we doubt they would be interested.[/fnote]:

First, DISH is building out an internet-of-things network, and they have promised to build out a 5G network in time. Perhaps, if they committed to building the 5G network within a certain timeframe this would be enough to satisfy the DOJ. It might also get the FCC off their back, which could be of tremendous value to them (more on that below).

Second, and much more interestingly, DISH could secure a network sharing deal from T-Mobile. If T-Mobile agreed to deploy DISH’s spectrum alongside their own, this could be transformative for DISH. It would enable the Company to deploy their spectrum quickly and inexpensively. They would have to pay T-Mobile to have access to their infrastructure, but this would likely be far cheaper than the cost of maintaining an independent network.

The DOJ and FCC should love this. With the spectrum they have today, DISH could be truly disruptive to the US wireless market if they could find the means to deploy it. If DISH got even more spectrum spectrum and a network sharing deal, the agencies would undoubtedly be able to deliver more competition and lower prices to consumers. Companies that rely on networks for the delivery of their products would love this too.

This would probably be a step too far for T-Mobile though. The company may be happy to sell DISH subscribers and some more spectrum, but a network sharing deal that helped them disrupt the market may put more value at risk than they hope to glean from acquiring Sprint. But it might not be. If T-Mobile believes that DISH will deploy their spectrum and disrupt the market anyway, they are better off facing that threat with the spectrum and scale they would acquire through the merger than without.

DISH doesn’t need spectrum, network assets, or subscribers…

There are three sets of assets that the wireless carriers could sell: spectrum, network assets and subscribers. DISH doesn’t really need any of these. But by taking them, they might get something of far greater value.

DISH is always interested in spectrum; however, another 40MHz wouldn’t be transformative to their value or their strategic position. They need capital and a deployment partner far more than they need spectrum. Still, some mid-band to deploy alongside their low-band would certainly be nice, and keeping the spectrum out of the hands of others has value to them.

Network assets can’t be of any value. DISH is entranced by the idea of gaining disruptive unit costs by deploying all their spectrum with brand new 5G equipment. They are hoping to virtualize many of the network functions, driving costs down further. This would give them a much lower cost per gigabyte than the wireless carriers, who must maintain layer upon layer of inefficient legacy equipment in their networks. Buying Sprint’s cast-off network assets, with its ancient legacy equipment, is the last thing DISH needs.

Prepaid subscribers can’t be of much interest to DISH either, though DISH may be interested in the cash flow they generate, if they can acquire them cheaply enough. And DISH would value the MVNO that those subscribers come with, if it is struck on the right terms.

…nevertheless, the deal could be transformative for DISH

Assuming a network sharing deal is not on offer, what does DISH have to gain from the process, given that they don’t really need anything the wireless carriers have to sell? A lot.

The market recognizes that DISH is sitting on valuable spectrum that, whatever it is worth, is worth a good deal more than is currently reflected in DISH’s stock price. The stock price reflects some probability that the spectrum value is realized and some probability that it is not. There are two ways DISH could fail to capture the value of the spectrum: they could run out of money and they could lose the spectrum to the FCC.

The market isn’t too worried about the first risk. It is true that DISH’s pay-tv business is losing subscribers and cash flow. But the spectrum is in a separate entity from the pay-tv business and all the debt. If the pay-tv business fails, the spectrum can be salvaged, and DISH can easily raise debt against the spectrum to fund strategic initiatives.

The second risk is graver. DISH must meet build-out requirements to keep its AWS-4 licenses by March 2020. They are hoping to meet this obligation with the deployment of a narrow-band internet-of-things network. We think the IOT network meets the license requirements, but the FCC hasn’t confirmed this, and the market is rightly nervous.

If DISH can get the FCC off their back in this deal process, it would provide a huge boost to their equity value for three reasons. The first is obvious: if you eliminate the prospect of DISH losing the spectrum, or at least buy them more time, then the equity is worth more. Perhaps more importantly though, it would enable DISH to find the capital and partners they need to deploy the spectrum. It must be hard for DISH to secure either when there is a chance they could lose the spectrum. Finally, a lift in the equity from the two factors above would improve DISH’s direct access to the capital markets and so improve their strategic options.

Some speculate that DISH may just want to sell the spectrum; that all talk of a Jio / Rakutan type network deployment is a ruse. Perhaps. But eliminating the risk of losing the spectrum would make it much easier to have discussions with potential buyers of the spectrum too. If DISH does play a role in this process, the terms they accept may well provide the best evidence we have ever had of whether they plan to build or sell. We could envisage terms that would make it hard, or impossible, for DISH to sell the spectrum to the most obvious bidders.

And finally, the Others

Peter Adderton has shown interest in acquiring Boost and establishing it as the fourth carrier. We think it would be much tougher to meet the DOJ’s requirements with this construct, though perhaps not impossible. If they got somewhere between 10 million and 20 million subs, and 40MHz of spectrum, and a network sharing deal so that the spectrum could be deployed, and a killer MVNO, it might work.

The challenge would be establishing New Boost as a viable competitor with less scale than Sprint, when Sprint wasn’t really a viable competitor. This would be difficult, but not impossible with the right kind of network sharing deal. It may be preferable to T-Mobile than deals with Cable or DISH that could help enable new entrants with disruptive potential.

Making the DOJ happy is important, but it may not be enough

We believe the companies face a real challenge from the state AGs. If they secure DOJ approval for a deal that doesn’t address the competitive harms raised by the DOJ staff, the companies could very well lose in court. The support of two expert agencies doesn’t confer the guarantee of a pliant court that many of the clients we have spoken to in the last week seem to think (see Blair’s writing on this: LINK).

We think there are deals with Cable and DISH that would genuinely cure the harms and so more or less guarantee the companies victory, if the AGs still pursue their suit. The same may be true of a deal that centers on some entity other than Cable and DISH, though this would be far harder to construct.

Finally, we would note that the DOJ and the parties involved can’t be having a pleasant weekend. This will be an extremely challenging deal to construct given the sheer number of parties, and their competing interests. We look forward to seeing what they manage to construct, perhaps as early as next week.