As of October 21, 2011, the stock of Alaska Communications (ALSK) is down -43.3% YTD. It is amazing that it has not fallen further given the significant amount of negative sentiment investors have towards it. Four of the five Wall Street analysts that cover the stock rate it as a hold (which is usually a thinly disguised sell recommendation). The internet is littered with postings that question whether the dividend will continue to be paid at the current level, and the message boards on Yahoo Finance even have some people trying to start a “countdown to delisting.” Not surprisingly, the company has one of the highest short interests of stocks traded on the NASDAQ. As of September 30, 2011, more than 12 million shares were sold short; that is 28.1% of the outstanding float. Other than those excited about a +13% dividend yield, it would seem that virtually no one likes this company and perhaps rightfully so.
The analysis of most people tends to dig into the balance sheet and cash flow statements and uncovers a somewhat large amount of debt and an unsustainable source of funding for the high dividend. Alaska Communications is a small company based in a far off land and not that many people talk about it, so information can be hard to come by. Based strictly upon the quarterly statements and the guidance by management, the outlook for this company is by all accounts troubling. However, spending too much time focused on the fundamental numbers inside those quarterly filings has caused most to not even notice the 800 lb. gorilla that is sitting right next to Alaska Communications (more on this later, but it is quite literally right next to them).
The gorilla is Verizon (VZ). Verizon does not currently offer any service in Alaska whatsoever. When Verizon Wireless subscribers travel to the 49th state, their phones operate under a roaming agreement between Verizon Wireless and Alaska Communications. The exact financial terms of this agreement are unknown and governed by a non-disclosure agreement, but it is fair to assume that the vast majority of the $32 million in roaming revenue that Alaska Communications collected in the last 12 months was a result of its agreement with Verizon Wireless. Alaska Communications has been providing roaming services to Verizon for roughly the past decade. So far this agreement has worked out well for both parties. Verizon does not need its own network in the state but can still claim nationwide coverage. On the other side, Alaska Communications is taking in a handsome amount of roaming revenue. Despite this seemingly synergetic relationship, over the past year Verizon has stated its intentions to develop its own network in Alaska. The detailed account of the events over the past year makes for a very long story. In the interest of brevity and clarity the following is a brief summary of the pertinent events of the two companies over the past 14 months.
In August of 2010, Verizon Wireless filed paperwork with the FCC to acquire spectrum covering the entire state of Alaska. Verizon does not currently offer coverage in Alaska, but as of November 2010 when the deal was officially approved, it has the right to operate in the 700 MHz band (this is the same band where Verizon Wireless is currently deploying its new 4G network in the rest of the United States). The call sign for the spectrum Verizon Wireless acquired is WQJU651. The purchase price that Verizon Wireless paid is unknown; however the company that sold the spectrum to Verizon Wireless originally paid $1.8 million for it at an FCC auction. Based on this, it is not unrealistic to expect Verizon bought it at a premium.
On March 15, 2011 Verizon spokesperson Scott Charleston made a statement to the Anchorage Daily News indicating that the company intends to offer service in Alaska and that “we'll announce details as we get closer.”
On June 22, 2011 Alaska Communications issued a press release announcing its intent to spend a total of $32 million to upgrade its existing network so that it can support 4G LTE. These upgrades would include linking cell towers with fiber optic cable to support the high bandwidth requirements of a 4G network.
In its second quarter 2011 10Q filing, Alaska Communications indicated that it expects little competition with Verizon until 2013 at the earliest. This date coincides with the build out requirements for the 700 MHz Alaska spectrum that Verizon acquired. Similar comments were made on the investor conference call by the CEO of Alaska Communications, Anand Vadapalli. ALSK’s local competitor, General Communications Inc. ("GCI") (GNCMA), made a similar assessment as to its estimate of Verizon’s arrival in Alaska.
So a quick recap:
- Verizon Wireless purchased spectrum covering Alaska in the fall of 2010.
- Verizon Wireless stated in the spring of 2011 that it plans to provide service in Alaska at a future date.
- Alaska Communications is upgrading its network to support 4G LTE.
- Both Alaska Communications and GCI expect Verizon to enter the Alaska market sometime in 2013.
That brings us to the fall of 2011. Both Alaska Communications and Verizon have been very quiet about their activities in Alaska over the past few months. Alaska Communications has been virtually silent on the new 4G network it is building, and Verizon has been absolutely mute. Though, a closer examination of public records and databases which are available from the Municipality of Anchorage and the State of Alaska indicate a fair amount of recent activity between these two companies.
First off, the Municipality of Anchorage allows anyone with an internet connection to search its property tax assessment database. A simple name search for Verizon in that database yields nothing, however Verizon Wireless has a different legal name. Verizon Wireless is actually a partnership that is 55% owned by Verizon Communications and 45% owned by European telecom giant Vodafone Plc. (VOD). This entity is called Cellco Partnership and does business as Verizon Wireless. Search the Anchorage database for “Cellco” and you find an ownership record for a four acre parcel of land in midtown Anchorage. The exact location is the most interesting part, as it is directly behind the headquarters of Alaska Communications.
The Municipality of Anchorage identifies the land as parcel # 009-082-23-000 and assesses the value of the empty lot at approximately $1.9 million. The record indicates that ownership of the parcel was last transferred on August 9, 2011. Visiting the website of the State of Alaska Recorder’s Office shows that the land was in fact sold by Alaska Communications to Verizon Wireless, as a Statutory Warranty Deed is on file and signed by Anand Vadapalli (Alaska Communications’ CEO). Also on file with the State Recorder’s Office is a Common Maintenance Access Agreement that allows access from the parcel of land Verizon Wireless purchased to an adjacent parcel owned by Alaska Communications.
Any long-term Anchorage resident can attest that the parcel purchased by Verizon Wireless has been an empty lot covered in trees for years. Images from Google Maps can also verify this as the last photo capture (done sometime in Spring 2011) shows a wooded lot. Beginning in September, the site has seen a recent flurry of activity. What was once land filled with trees has now been completely cleared and a large amount of dirt has been hauled away. A building permit is posted at the site that indicates Verizon Wireless is the site owner/permit applicant, but it lists Alaska Communications as well. The adjacent public road was closed for approximately 10 days as wastewater connections were made. Additionally there have been a lot of pipes buried in the ground around the site, likely a combination of drainage and electrical conduit. Elements of an actual building have not yet materialized, but recently trenches have appeared at the site which could certainly be the location for foundation footings. Searching the Municipality of Anchorage’s building permit activity records shows that two permits were issued in September 2011 for the site. The permits are for a new building and the work is valued at a combined total of $4.4 million. Furthermore, the Muni tax assessment database has been updated to indicate a building on the site that was “built” in 2011. It is listed as a single story “Telephone Equipment Bldg” and has a size of 21,870 square feet. Obviously the building has not yet been built, but it is planned for the site.
So, again another quick summary:
- In August 2011 Alaska Communications sold the land directly behind its headquarters to Verizon Wireless (hello 800 lb. gorilla!).
- The two companies have been working together to develop the site (as evidenced by posted building permits).
- The land was likely purchased for at least $2 million and building permits indicate approximately $4.5 million of planned work. Therefore, the current level of Verizon’s investment in Alaska likely stands between $8 and $10 million (including the purchase price of the 700 MHz spectrum).
Now what does this all mean?
It is the personal opinion of the author that Verizon (either the parent company Verizon Communications or the subsidiary Verizon Wireless) will make a tender offer to acquire Alaska Communications. Again this is a personal opinion based upon the information collected through various public records that pertain to both companies. This acquisition makes sense not only because of the construction taking place behind Alaska Communications’ headquarters, but also due to the information below.
Verizon is obviously coming to Alaska in one form or another. The company has stated it publicly and is in the process of building infrastructure privately. However, one of the many hurdles it faces is that the telecommunications industry is regulated and it currently does not have the necessary spectrum to provide any meaningful level of service in Alaska. The only spectrum Verizon Wireless currently owns in Alaska is in the 700 MHz band. This is prime spectrum that has excellent propagation, but it currently only serves one purpose for Verizon and that is providing high speed 4G LTE internet service. Currently subscribers to Verizon’s 4G LTE network utilize the 700 MHz band for data transfer, but calls are still routed through the older 2G/3G network in the 850 MHz and 1900 MHz bands. Eventually Verizon intends to implement VoLTE (Voice over LTE), where phone calls will be sent through the 700 MHz band. However this technology is still in early development and is slated for an estimated initial rollout of sometime in 2012 (at the earliest). Furthermore, it will be a long time before all subscribers of Verizon are using 4G VoLTE. If Verizon wants to offer a meaningful level of service in Alaska in the near future they need 2G/3G CDMA spectrum. Who owns such spectrum? Alaska Communications.
Looking past the spectrum requirements and complications that the FCC introduces, the challenge of physically building a network in Alaska is another significant hurdle. Alaska is not like the rest of the continental United States. Alaskans like to say this a lot, and it is absolutely true. Alaska is the combination of some of the greatest geographic and meteorological extremes America has to offer. There are annual temperature swings that rival the Midwest and Northern Plain States. The tallest peak on the North American continent lies in Alaska, as wells as a collection of smaller mountains, glaciers, lakes, and rivers that no other state can come close to matching. Just below the surface, the ground in many parts of the state is perpetually frozen. Alaska lies along the Pacific Ocean’s “Ring of Fire” which contains fault lines and active volcanoes. The state is subject to almost constant (albeit small) earthquakes. It places in a degree of remoteness that only Hawaii can compete with, while being the size of 20% of the land mass of the continental United States. That is over twice the size of Texas. To say that building in Alaska is difficult is an understatement. It is also not cheap.
For the reasons mentioned above, building a network from scratch in Alaska is likely not economically feasible. Furthermore, upon completion of such a network there would be the problem of connecting it to the rest of the world. The two main local telecom companies (Alaska Communications and GCI) own four different fiber optic cables that connect Alaska to the continental United States. If Verizon were to build its own network, it would either have to lay another line or lease bandwidth on an existing one.
If you are not convinced yet and want to look past the difficulties presented by a lack of spectrum and remote geographic location, then let’s look at population. Despite being massively huge in physical size, not very many people live in Alaska. The 2010 census puts the number at just above 700,000 people. That is roughly the population equivalent of Columbus, OH spread out over an area double the size of Texas. Furthermore, not all of those 700,000 residents have a cell phone. Currently there are approximately 400,000 wireless subscribers in Alaska (AT&T (T) is estimated to have 150,000, GCI has 126,400 (pdf file), and ALSK has 116,679.) So, if Verizon Wireless is to build its own network and enters the Alaska market on its own, it would be competing against three other established carriers for an absolute maximum number of subscribers that equals 0.4% of its existing customer base.
It could be argued that Verizon Wireless should not even be interested in a market that consists of 0.4% of its current subscribers spread out over mostly uninhabitable land. But, the company does have several reasons to offer service in Alaska (as it has stated it would). First off, AT&T (its biggest competitor) has offered service (including the iPhone) in Alaska since the buyout of Dobson Communications in 2007. Alaskans have a higher disposable income and spend more on communications services then the average American. That means more people (on a percentage basis) can buy smartphones with big data plans, and phone companies love this. Alaska’s economy is based upon three things: oil, the federal government, and tourism. Oil companies and the federal government have deep pockets, something Verizon Wireless would obviously love to tap (as well as Verizon the parent company at the enterprise level). Alaska houses a large population of military service members, and Verizon likely loses subscribers when people are transferred there. The tourism component of Alaska’s economy brings over one million people to the state annually, and undoubtedly many of them are Verizon Wireless subscribers.
Now let’s discuss Alaska Communications’ new 4G network. In the first half of 2011, ALSK committed $12 million for upgrades to its network so that it will be able to offer 4G services. In June 2011 the company increased that capital expenditure to $32 million. Upon completion of these upgrades its cell sites will be linked with fiber optic cable, massively increasing the amount and speed at which data can travel on its network. Alaska Communications has provided basic cost figures for this new network, but has otherwise been conspicuously quiet as to any other important details. The company has stated in quarterly filings its intentions to turn the network on sometime around the end of 2011 or beginning of 2012. More recently, when asked by a reporter who was covering GCI’s recent 4G (HSPA+) rollout, ALSK’s spokeswoman said that the company expects to provide 4G before the end of 2011. At the Oppenheimer Technology and Telecommunications Conference on August 9, 2011, ALSK’s CEO provided one bit of additional information by saying that 4G service will be rolled out using the AWS spectrum the company already owns. AWS stands for Advanced Wireless Services and is a band of spectrum that is constituted of two separate segments in the 1700 MHz (uplink) and 2100 MHz (downlink) ranges. The thing about AWS is that while it can technically support 4G LTE, almost nobody currently uses it for that purpose. The only carrier in the nation who currently has a large scale deployment of LTE service in the AWS band is MetroPCS (PCS), and its 4G service only achieves data speeds similar to the Verizon 3G network. (This difference in speed is possibly caused less by the difference in frequency, but rather because MetroPCS uses only a 5MHz channel, whereas Verizon 4G LTE uses a 20 MHz channel.) The 700 MHz band offers far better propagation and penetration characteristics than radio waves in the AWS band, and without getting too far off in the weeds the bottom line from this is that better coverage is provided from fewer cell towers.
The specific frequency used also dictates which phones can be offered. According to phonescoop.com there are currently 10 LTE cell phones on the market in the U.S. Seven of them are only compatible with 700 MHz LTE. Of the remaining three phones that work with AWS LTE, only two of them are Android powered smartphones. Bottom line, were ALSK to deploy 4G in the AWS spectrum it would be spending lots of money to provide a service that ultimately will not be as good as what Verizon can offer (both in the phones and the quality of transmission).
So, back to how this relates to Verizon buying ALSK. If it is not clear, let’s do another recap:
- ALSK has said they are going to build a 4G network. They have the towers and backhaul infrastructure, but do not have the best spectrum to do it in.
- Verizon owns the best spectrum and said they want to provide service in Alaska. Alas, they have no infrastructure, only spectrum. By making a substantial capital expenditure to upgrade its network, ALSK becomes very attractive to Verizon as upon acquiring the physical assets Verizon can offer 4G service immediately.
- Everything about ALSK’s 2G/3G network is directly compatible with Verizon. The two companies go together like peanut butter and jelly.
- Building a new network in Alaska is costly, difficult, and time consuming. Also, a new network would be the fourth overlapping network in a small population. Four different networks may make economic sense in Los Angeles or New York, but not Alaska.
It is amazing how well these two companies fit together and yet a deal has not been announced. People have proposed the idea before, but are usually shot down by naysayers who argue that Verizon would never want to buy an unprofitable and poorly managed company. However, one of the biggest weights around ALSK’s neck is also one of its most attractive qualities. By committing to spend a significant amount of cash (almost a full year of dividend payments) to be 4G ready, the company may have decreased its financial position but it just became a lot more attractive to Verizon. Furthermore, the company may report negative earnings per share, but when adjusted for dividends the company is a profitable enterprise. In buying the company, Verizon would free itself of roaming fees and essentially pick up the dividend that ALSK offers. The construction that is taking place behind Alaska Communications is a clear indication that Verizon sees this value. At this point we can also be sure that the management at Alaska Communications has certainly looked out their windows and seen the 800 lb. gorilla in their back yard. It is about time investors do the same.
There have been some other events over the past year that relate to the situation, but are not presented in the narrative above.
Alaska Communications' employee stock incentive and compensation plan was amended and now requires double triggers for automatic vesting to occur. Previously only a single trigger was required. Before it was amended, if a “change in control” event (i.e. Verizon buying ALSK) were to occur, all options and stock grants of current employees would immediately vest. Under the new plan, a double trigger requires a “change in control” event and an employee to be terminated “without cause” for options/stock grants to vest.
Alaska Communications refinanced its debt maturing in 2013 with new debt that matures in 2018. Both the new and old debts were convertible offerings, but the 2018 issue has a significantly lower buyout adjustment. This ultimately would save the acquiring company money as it does not have to pay as large a premium to the convertible debt holders.
The company has had a significant shakeup in management over the past year. Roughly half of the board has turned over, and a handful of top executives have resigned (including the CEO). What this means in relation to a buyout remains unclear.
For approximately 90 days (from July 13, 2011 to October 13, 2011), Verizon had a single job posting in Alaska. It was placed under the Verizon Business and Residential section and was for the position of “Field Service Technician.” It was a very general posting, but indicated Verizon was looking for a few people in Alaska with a strong technical knowledge.
Alaska Communications has made a series of adjustments to the services it offers. These include changes to its prepaid plans and introducing tiered data plans for smartphones. Alaska Communications now offers fleet services (vehicle tracking) for businesses. Also, the company has opened a series of standalone retail stores throughout Alaska (previously it had relied heavily on mall kiosks and a store in the corporate headquarters building). All of these changes align nicely with the way Verizon operates.
For the picturebook version of what is presented above, see below [click images to enlarge]:
This is an aerial shot showing the land that Verizon Wireless acquired in relation to the headquarters of Alaska Communications.
Work being done to clear the site Verizon Wireless purchased from Alaska Communications. The building in the background is the headquarters of Alaska Communications.
A more recent picture of work being done at the site.
This is the building permit posted at the site. Note both Verizon Wirless and Alaska Communications are printed on it.
This is the tax assessment description page for the parcel of land Verizon Wireless acquired from Alaska Communications.
Disclosure: I am long ALSK.