Spectrum Caps To Hurt Verizon And AT&T

Includes: S, T, VZ
by: Bidness Etc

Efforts to free up more airwaves through the auctions of spectrum by TV broadcasters took an interesting twist after the FCC recently voted to begin reviewing its rules for how much spectrum a telecom operator would be allowed to hold. The FCC voted 5-0 for the review of the rules, which will have a significant impact on how operators approach acquisitions of spectrum, as well as how much they can hold. Sprint's (NYSE:S) Dan Hesse and AT&T's (NYSE:T) Randall Stephenson welcomed the proposed changes, emphasizing that a more transparent process will benefit the industry. Despite telecom operators welcoming the proposed changes, we believe the latest developments will have an adverse impact on Verizon Wireless (NYSE:VZ) and AT&T, as their ability to accumulate more spectrum will be limited. However, other telecom operators (the smaller ones) like Sprint will benefit from it.

The telecom regulator last reviewed its policies regarding spectrum holdings almost a decade ago, when it removed spectrum caps. Now, the rule making will also look into the regulator's spectrum screen, which is used to review spectrum transactions. If, for example, a telecom carrier violates the screen by acquiring too much spectrum, the deal is scrutinized more. Currently, there is no set rule for setting the screen; rather, it varies from transaction to transaction. But now, with the proposed changes, those rules might also be revisited. The new rule making will also aim to examine which spectrum bands need to be included in the review as well as how various geographic areas would be considered going forward.

The decision to introduce spectrum caps for telecom carriers has largely been welcomed by the industry, as well as the carriers themselves. However, some have opposed the concept. One of the Republicans on the commission has expressed his fears that spectrum caps could harm the mobile market by creating unnecessary market uncertainty. Another Republican said that the proposed rules affecting the spectrum screen are likely to discourage participation by telecom operators in the upcoming auction of TV spectrum.

However, the majority has welcomed the FCC's recent decision to review the spectrum screens and caps, as it would be a step in the right direction to counter AT&T's and Verizon's monopoly. Smaller carriers have repeatedly stated that both telecom giants own too much spectrum. Verizon has recently acquired $3.9 billion spectrum, which will be used to supplement its LTE network, while AT&T is also looking for more airwaves after its proposed T-Mobile acquisition was rejected by the Justice Department and the FCC. Looking at AT&T's recent filings, its need for more airwaves becomes apparent. The company recently announced its plans to acquire Nextwave Wireless for over $600 million, which will supply it with spectrum in the 1.7/2.1 and 2.3 GHz bands.

Overall, the proposed changes to spectrum caps are positive steps, which will help smaller telecom carriers in the long run. Allowing larger carriers to obtain unlimited spectrum could be detrimental for healthy competition. However, if the $7 billion auctions do go ahead as planned in 2014, it could also lead to AT&T and Verizon acquiring more airwaves, further strengthening their monopoly.

For telecom players like Verizon and AT&T, it is all about spectrum and radio waves, which are needed by both carriers to attract customers. Both companies have been actively involved in rolling out their respective 4G LTE networks. However, Verizon still has the lead when it comes to market coverage. Currently, Verizon's 4G network covers around 400 markets and is expected to cover more by the end of the year. With the availability of smartphones with LTE technology, though, it seems likely that the battle for spectrum will become even fiercer.

The idea behind the T-Mobile deal, which failed to go through, was that AT&T wanted more spectrum to become an even stronger carrier, which was exactly why the deal did not get the green signal from regulatory authorities. Had it been allowed, the deal would have put too much spectrum in the hands of a few carriers. However, Verizon is playing it smarter by not trying to take out a direct competitor; instead, it is acquiring cable spectrum. Both Verizon and AT&T are on a constant lookout for more spectrum, and even though both carriers' management has welcomed the FCC's decision to introduce spectrum caps and make changes to the procedures regarding spectrum screens, these changes would benefit smaller telecom operators more than they would benefit Verizon and AT&T.

Both AT&T and Verizon are trading near their 52-week highs, and based on their high valuations the stocks have limited upside potential. Verizon and AT&T are trading at 16 and 15 times their forward earnings, respectively. On a P/S basis, Verizon and AT&T trade at 160% and 285% premiums to Sprint, respectively. Both Verizon and AT&T remain attractive, however, from a dividend perspective as they are currently yielding 4.5% and 4.7%, respectively.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Telecom Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.