It was announced today that Verizon (NYSE:VZ) is acquiring a big chunk of wireless spectrum from SpectrumCo., a consortium of cable companies (including Comcast (NASDAQ:CMCSA) and Time Warner Cable (TXC)), for $3.6 billion (here). The spectrum that Verizon is acquiring has only a fraction (roughly 11.5%) of the bandwidth capacity that Clearwire (CLWR) owns.
Verizon is paying approximately $0.68 per MHz-Pop, which is roughly 50% more than SpectrumCo. paid at auction during the go-go days of 2006 (as reported by Arlington Economics, SpectrumCo.’s auction consultant: details here. This demonstrates that spectrum continues to grow in value, as it has consistently over the past 25 years.
Applying this new data point to CLWR’s spectrum position (approximately 46 billion MHz-Pops) yields an enterprise value of over $31 billion and an implied equity value of approximately $30 per share. CLWR is currently trading at roughly $2 per share, or about $0.13 per MHz-Pop.
How Is This Possible?
For an explanation of why CLWR is trading well below its break-up value, please see my recent post here.
What Is Spectrum Worth?
Like any asset, spectrum is worth what the market will pay for it. In this case the market includes wireless carriers (both established carriers and potential new entrants) and financial players who believe that spectrum will continue to increase in value as it is a scarce resource and demand for wireless bandwidth is growing rapidly (see this link to Cisco’s bandwidth demand forecast, which is widely cited by industry analysts). Cisco points out that global mobile data traffic grew by 2.6x in 2010, and expects it to grow 26-fold from 2010 to 2015.
All wireless communications spectrum is highly regulated by the FCC to prevent interference between bands (i.e. frequencies) that would render your iPhone useless. This is why spectrum will always be a scarce resource, which is a critical factor in estimating its value. The major spectrum bands allocated by the FCC to mobile voice and data include (but are not limited to) the following:
- 700 MHz (auctioned by the FCC in 2008 for $1.29 per MHz-Pop)
- 800 MHz (given away by the FCC in the 1980s – the original cellular phone spectrum)
- 1900 MHZ (“PCS” spectrum auctioned by the FCC in stages – most recent was in 2005 for $0.98 per MHz-Pop)
- 1700/2100 MHz (“AWS” spectrum auctioned by the FCC in 2006 for $0.54 per MHz-Pop , a portion of which was just acquired by Verizon for $0.68 per MHz-Pop)
- 2500 MHz – Owned primarily by CLWR and valued at an estimated $0.35 per MHz-Pop by Comcast, Time Warner Cable, Intel (NASDAQ:INTC) and Google (NASDAQ:GOOG) when they invested $3.2 billion in CLWR in 2008
Does Clearwire Have Inferior Spectrum?
All else equal, the lower spectrum bands are considered more valuable because at lower frequencies the signal travels farther and penetrates buildings more easily – this is basic physics and will always be true. This makes it cheaper and easier to provide strong network coverage at lower frequencies. This helps explain why 700 MHz spectrum went for $1.29/MHz-Pop versus the 1700/2100 spectrum that Verizon just bought for $0.68.
This concern, however, is at least partially offset by several important factors:
- CLWR’s 2500 MHz spectrum is not so far from the PCS spectrum at 1900 or the AWS spectrum at 1700/2100 – so the basic physics are not all that different – all three bands face challenges relative to 700 MHz spectrum. CLWR’s spectrum is still more expensive to build out, but not dramatically so.
- CLWR’s spectrum is actually better than the other bands for satisfying the growing demand for bandwidth. As management has explained repeatedly, the higher frequencies actually permit more efficient use of spectrum for high-volume data applications (which is where the industry is rapidly moving).
- CLWR has wider bands of contiguous spectrum than any other player – in other words they have several very fat pipes versus the several narrow pipes that Verizon and AT&T (NYSE:T) must use. As a subscriber, this means you’re much less likely see slower speeds when the network is busy. From CLWR’s standpoint, this means they can load a lot more customers onto their network and provide each of them with higher bandwidth applications such as streaming video. These fat pipes have tremendous value in today’s “everything, everywhere” world.
Sounds Interesting, But What Is Clearwire’s Spectrum Actually Worth?
It’s impossible to answer definitively, but the comparable spectrum valuations are good data points (and recent data points are always the best). I’ve taken a conservative approach and simply taken a 50% haircut to the lower end of management’s suggested range of valuation (they have suggested $0.50-$1.00 per MHz-Pop), to arrive at roughly $8 per share. Taking a 50% haircut to the recent Verizon deal gets us to about $13 per share.
I believe that AT&T or Verizon would easily pay $11.5B for CLWR’s spectrum in a bankruptcy auction, as it would give the winning bidder the dominant spectrum position in the industry and a huge strategic advantage. This would leave shareholders with $7.5 billion (or roughly $8/share) after paying off creditors (the lenders only get their money back in bankruptcy – the shareholders get the rest).
Please note that AT&T just took a $4 billion write-off to account for a potential break-up fee for the T-Mobile deal. If AT&T is willing to risk $4 billion just for the potential opportunity to buy T-Mobile for $39 billion (with the stated primary motivation that they need more spectrum), they would almost certainly pay $11.5B to actually complete an acquisition of CLWR (which has 2.5x the spectrum that T-Mobile owns).
Verizon just paid $3.6 billion for 20MHz of spectrum covering most of the U.S. It stands to reason that that they would pay 3x that amount for nearly 9x the spectrum if CLWR was for sale.
Then Why Not Sell Clearwire To The Highest Bidder?
Sprint is the 50% owner of CLWR and is not going to allow anyone (especially AT&T or Verizon) to buy it. But this means that Sprint must keep CLWR out of bankruptcy, which means they must agree to pay CLWR enough for the use of its spectrum so that the CLWR Board of Directors (which is not controlled by Sprint) believes that it’s a better deal for shareholders than a bankruptcy auction.
So How Does This All Play Out?
CLWR’s leverage with Sprint is that they don’t have to agree to Sprint’s pricing proposals because the shareholders would still do well in bankruptcy, while Sprint would lose its most valuable strategic asset. This is why CLWR’s CEO stated publicly that they might skip the December 1 interest payment, which forced Sprint to come to the table and cut a reasonable deal.
The Chairman of the Board is John Stanton (who built what is now T-Mobile from the ground up), which should give shareholders a great deal of comfort that the pricing agreement announced on December 1 is favorable to CLWR shareholders (see the announcement here).
Implications For Shareholders
So while CLWR is not getting sold anytime soon, the breakup value should provide a comfortable floor on the stock even in the unlikely event of a bankruptcy filing. Assuming the company executes their business plan, the upside should be far greater.
Disclosure: I am long CLWR.