What The U.S. Wireless Spectrum Auction Means For The Telecom Industry
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April 29, 2008 Credit FAQ: What The U.S. Wireless Spectrum Auction Means For The Telecom Industry Primary Credit Analyst: Catherine Cosentino, New York (1) 212-438-7828; catherine_cosentino@standardandpoors.com Table Of Contents Frequently Asked Questions www.standardandpoors.com/ratingsdirect 1 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of 645389 | 300321569 Use/Disclaimer on the last page.
Credit FAQ: What The U.S. Wireless Spectrum Auction Means For The Telecom Industry Many U.S. telecommunications companies expect to use the 700 MHz wireless spectrum acquired in the Federal Communications Commission's (FCC) Auction 73 to roll out next generation broadband wireless services and eventually move to a fourth generation Internet platform. The spectrum, currently used for broadcast television, will become available early next year. Diversified telecommunications carriers Verizon Communications Inc. (A/Stable/ A-1) and AT&T Inc. (A/Stable/A-1) were the two high bidders in the auction, which was completed in March and raised $18.96 billion, net of discounts allotted for qualified small businesses (designated entities). These license awards included 12 Rural Economic Area groupings throughout the U.S. and related territories, (C-block), 174 Economic Areas for the A-block, 176 Economic Areas for the E-block, and 728 Cellular Market Areas (B-block). The D-block license, which required the licensee to coordinate its operations with public safety entities, was removed from the auction when it failed to receive the minimum required auction reserve price. In addressing some of the questions the spectrum auction purchases raise, Standard & Poor's Ratings Services aims to sort through the details and shed light on the implications for the companies involved and the industry as a whole. Frequently Asked Questions Why is the 700 MHz wireless spectrum important to the industry? The 700 MHz spectrum has very good transmission and in-building coverage characteristics. The additional capacity will be used by many of the carriers to roll out next generation technology to support advanced services, including broadband applications. Verizon and AT&T, in particular, have noted that the new spectrum will be integral in upgrading their networks to next generation wireless broadband technologies, including the long-term evolution (LTE) platform. For AT&T, the migration will initially be to high-speed packet access plus (HSPA+). In both cases, the companies will ultimately migrate to a common fourth generation Internet protocol-based platform that will support high-speed data applications. How soon would a broadband network based on the new spectrum be available? Because the incumbent broadcast TV licensees remain on this spectrum until the digital TV transition on Feb. 17, 2009, the carriers are not expected to deploy their networks until 2009, with commercial launch not expected until 2010 or beyond for many of them. Verizon has said it will begin field trials this year, conduct advanced device trials and select vendors in 2009, and then quickly begin network launches thereafter. We note that while the spectrum has phase one and phase two minimum build-out requirements, these are very manageable, at 40% of the population no later than Feb. 17, 2013 and 75% of the population by the end of the 10-year initial license term. In addition, either one party, or those working together that serve the geographic areas covered by the licenses can satisfy the minimum construction benchmarks. Standard & Poor’s RatingsDirect | April 29, 2008 2 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page. 645389 | 300321569
Credit FAQ: What The U.S. Wireless Spectrum Auction Means For The Telecom Industry What is Standard & Poor's Ratings Services assessment of the winning bids in the wireless spectrum auction? Verizon and AT&T were the top performers in the spectrum auction in terms of price paid ($9.4 billion and $6.6 billion, respectively), MHz population equivalents (pops) (8.5 billion and 2.1 billion, respectively) and number of licenses (109 and 227, respectively). These two companies' spectrum acquisitions represent nearly three quarters of the total megahertz pops (population equivalents) awarded. However, AT&T was the high bidder only in the 12 MHz B-block spectrum in a broad swatch of markets across the U.S. Verizon chose to bid high in the 22 MHz C-block for all six mainland U.S. licenses, as well as Hawaii, giving it a seamless national footprint in the C-block, but also exposing it to "open access" requirements associated with this spectrum. Other large auction winners were: • Frontier Wireless, a wholly-owned subsidiary of DISH Network Corp. (BB-/Stable/--), which won licenses totaling $712 million; • Qualcomm Inc., which paid $558 million; • MetroPCS Communications Inc. (B-/Positive/--); $313 million; • Cox Enterprises Inc. (BBB-/Positive/A-3); $305 million; • King Street Wireless L.P., which qualified as a designated entity (DE) under the FCC's small business rules, obtained licenses for $300 million, net of DE discounts; a subsidiary of United States Cellular Corp. (BBB-/Positive/--) is a limited partner in King Street Wireless L.P. • Cellular South Licenses Inc. ($192 million); and • CenturyTel Inc. (BBB/Negative/A-3); $149 million. While DISH has not made any public statements about its strategy regarding the licenses won by Frontier Wireless, this spectrum could potentially be used by DISH to provide either a wireless video or broadband service. Cox has likewise not commented on its spectrum use. However, given press reports in late April that Cox, Time Warner Cable Inc. and Comcast Cable Communications Inc. have decided to end their Sprint Nextel Corp. wireless joint venture, Pivot, and the fact this joint venture has not gotten very much traction to date, Cox may opt to use this spectrum, which covers about 21 million pops, to provide a wireless voice product to its cable subscribers. CenturyTel has indicated it will use its spectrum to provide wireless voice and broadband services to a significant percentage of its current customer base, since the spectrum overlaps from about 25% to 100% of its access line base in its various markets. Among the technologies we think CenturyTel may adopt to implement these services is either wireless fidelity (Wi-Fi) or wireless interoperability for microwave access (WiMAX). The license awards that Telephone & Data Systems Inc.'s majority-owned United States Cellular Corp. subsidiary will have access to via its limited partnership interest in King Street Wireless L.P. cover areas that overlap or are contiguous and/or in near proximity to Midwestern wireless markets in which United States Cellular currently has licenses and/or operates. As such, these licenses are likely to be used to augment and supplement United States Cellular's existing markets. MetroPCS's license, which covers the Boston-Worcester, Massachusetts/New Hampshire/Rhode Island/Vermont Economic Area, supplements the company's existing 10 MHz spectrum for this same market, which was previously acquired in Auction 66. The company is building out its network in the Boston region and plans to launch service there in the first quarter of 2009. www.standardandpoors.com/ratingsdirect 3 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page. 645389 | 300321569
Credit FAQ: What The U.S. Wireless Spectrum Auction Means For The Telecom Industry What are the ratings implications of these purchases? None of the rated companies' ratings or outlooks are affected by their license awards given the timeframe required for buildout and cash resources available to each of these companies to fund the initial license awards, which were paid to the FCC on April 17, 2008. Most notably, the 'A' rating and stable outlook for both Verizon and AT&T incorporate our expectation that the requirements for these spectrum purchases will be funded largely with cash on hand from recent significant debt issuances, coupled with cash flow generated after capital expenditures and dividends. For Verizon, additional funding is also expected to come from proceeds from a recently completed transaction with Fairpoint Communications. Debt to EBITDA is expected to modestly increase to the 2x range for both Verizon and AT&T, and this leverage increase uses much of the debt capacity at both companies' current stable outlooks. For the other three investment-grade winners in the auction, CenturyTel, Cox Enterprises and Telephone & Data Systems' majority-owned United States Cellular subsidiary, the cash requirements for the spectrum purchase and buildout are manageable at their respective 'BBB', 'BBB-' and 'BBB-' corporate credit ratings, given their cash generating abilities. Telephone & Data Systems in particular is very conservatively leveraged for its current rating, at around 1.7x. DISH Network is also lightly leveraged for its 'BB-' rating, at about 2.1x, and therefore its ratings can tolerate the near-term requirements for the spectrum. However, future buildout needs could have a longer term affect on the company's ratings and/or outlook, especially if its financial policy becomes more aggressive in the interim. Conversely, MetroPCS's 'B-' corporate credit rating already incorporates the company's ongoing significant capital requirements for the newer market builds. In addition, as cited above, their Auction 73 spectrum is for a market which is already under development. Its positive outlook is also tied to the fact it has lowered leverage over the last year to 5.2x in 2007 from 7.4x in 2006, and has good prospects to further improve its financial profile over the next few years, given ongoing healthy subscriber growth and manageable churn. What are some of the obstacles and opportunities that carriers face in building out and operating these networks? In winning the C-block spectrum, Verizon faces the challenge of providing open access to other devices, applications and content, a condition not required of the other spectrum winners in the 700 MHz auction. The open access rules require a successful bidder to allow any handset to work on its cellular network and enable customers to download any applications to their phones. The FCC has always been a proponent of open access in wireless communications, although it has been reluctant to impose significant regulations on carriers, especially pertaining to Internet services. To foster competition, the FCC ruled in 2007 that it would award the C-block as a nationwide 22 MHz-paired spectrum license that would be subject to open access. This enables consumers to have access to the device, applications, and services of their choice in keeping with the FCC's stance on network neutrality. The ruling also encourages the C-block winner to engage in commercial arrangements with content, device, and applications providers, fostering the development of what the FCC deems innovative products and services. However, these rules don't appear to be intended to impose undue regulation on the network carriers. Verizon has presented this as an opportunity to provide wholesale services to alternative operators at very cost-effective prices. This may prove a better cost model for competitors than the mobile virtual network operator (MVNO) model used by Sprint Nextel. MVNOs are mobile operators that don't own their own spectrum. They buy minutes of use (MOU) from traditional mobile operators to sell to their customers. In fact, Qwest Communications International Inc. (BB/Stable/--) has already indicated that its MVNO arrangement with Sprint Nextel Corp. (BBB-/Watch Negative/A-3) has not achieved targeted results, and is seeking a better wireless partnership to provide Standard & Poor’s RatingsDirect | April 29, 2008 4 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page. 645389 | 300321569
Credit FAQ: What The U.S. Wireless Spectrum Auction Means For The Telecom Industry
it with converged wireline/wireless applications, high-bandwidth offerings and better economics. This may suggest
that carriers will increasingly look at partnerships with Verizon to develop services that would run over the C-block
network.
While AT&T does not have a similar open access requirement, it has indicated it will provide such access by
allowing any unlocked GSM device that operates on the 850 MHz or the 1900 MHz frequency onto its network
with no required minimum term commitment. Given that the open access rules will not require the C-block winners
to reconfigure their existing networks to accommodate non-compatible technologies, we don't envision the rules
having ratings implications for Verizon.
What impact could the open access requirement have on the industry?
The FCC could potentially extend the mandate to other license holders. However, this is unlikely to occur for at
least the next few years. Yet, if the outgrowth of mandated open access in this limited C-block arena is the creation
of financially successfully partnerships, then it is conceivable that more voluntary commercial arrangements may
emerge sooner rather than later in the wireless sector.
What are the implications of spectrum pricing for the industry?
The overall price of the Auction 73 spectrum was $1.33 per MHz pop, on a weighted average basis, using year 2000
census data. This is higher than the values associated with either Auction 58 ($1.09) or Auction 66 ($0.55). In large
part, this is due to the higher value ascribable to the 700 MHz spectrum, versus the higher frequency spectrum of
the other two auctions, at 1900 MHz. However, the value within Auction 73 varied significantly, from a high of
$2.69 per MHz pop for the B-block, to a low of $0.74 for the E-block, and $0.76 for the C-block. The C-block
values were likely adversely affected by open access requirements. Similarly, a nationwide D-block license, which
would have required the licensee to coordinate its network with public safety entities and address interoperability
problems, was de-linked from the auction when it failed to receive the minimum required $1.3 billion auction
reserve price, which equated to about $0.46 per MHz pop. The E-block licenses were valued low relative to the
average due to the limited spectrum provided, at only 6 MHz of unpaired spectrum. Frontier Wireless, the DISH
Network entity, was the winner of most of this spectrum, and is unlikely to use this for a voice product, given the
limited capacity provided and one-way nature of the licenses received.
Table 1
Top 10 Auction Winners In Auction 73
Weighted average
Winning net bid MHz pops price per MHz pop ($) Number of
Companies Ratings* amount ($ Mil.) (million) ¶ licenses
Cellco Partnership (d/b/a Verizon Wireless) A/Stable/A-1 9,363 8,508 1.26 109
(Verizon Communications Inc.)
AT&T Mobility Spectrum LLC (AT&T Inc.) A/Stable/A-1 6,637 2,098 3.16 227
Frontier Wireless LLC (DISH Network Corp.) BB-/Stable/-- 712 1,303 0.55 168
Qualcomm Inc. N/R 558 413 1.35 8
MetroPCS 700 MHz LLC (MetroPCS B-/Positive/-- 313 95 3.28 1
Communications Inc.)
Cox Wireless Inc. (Cox Enterprises Inc.) BBB-/Positive/A-3 305 248 1.23 22
King Street Wireless L.P. (United States BBB-/Positive/-- 300 486 0.82 152
Cellular Corp.; parent is Telephone & Data
Systems Inc.)
Cellular South Licenses Inc. N/R 192 180 1.06 24
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Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page. 645389 | 300321569Credit FAQ: What The U.S. Wireless Spectrum Auction Means For The Telecom Industry
Table 1
Top 10 Auction Winners In Auction 73(cont.)
CenturyTel Broadband Wireless LLC BBB/Negative/A-3 149 212 0.70 69
(CenturyTel Inc.)
Vulcan Spectrum LLC N/R 113 84 1.34 2
*Represents ratings of primary entities listed in parenthesis, including partners in designated entities. ¶Pops based on year 2000 census data, calculation based on gross
winning bid amount. Auction data is from Federal Communications Commission reports.
Table 2
FCC Spectrum Auction Data
Weighted average price per MHz pop ($) * Winning net bid amount for Auction 73 ($ Mil.)
Auction 73 - Band A 1.16 3,876
Auction 73 - Band B 2.69 9,068
Auction 73 - Band C 0.76 4,747
Auction 73 - Band E 0.74 1,267
Overall Auction 73 1.33 18,958
Overall Auction 58 1.09
Overall Auction 66 0.55
*Pops based on year 2000 census data. Auction data is from Federal Communications Commission reports.
Standard & Poor’s RatingsDirect | April 29, 2008 6
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