AT&T And Verizon Are Killing Each Other

Summary

• Stock markets are racing to records every day. Records are also set at a different place with dire potential consequences for dividend stars AT&T and Verizon.
• The ongoing FCC Auction 107 for 5G spectrum has smashed expectations and a real bidding war has ensued.
• Although it is not yet clear which of the big players is bidding what amount, it is highly likely that AT&T and Verizon are virtually killing each other.
• The big question is, which currently remains unanswered, if this unprecedented spending on 5G spectrum which is double what was expected will have any impact on future revenue forecasts and prices for 5G plans.

Asset prices are at record levels across the board, be it stocks, cryptocurrencies or home prices. A staggering influx of cheap money, fiscal stimulus and pure greed in my view has poured obscene amounts of cash into the system, and with markets cheering every bit of good news and bad news, it is no surprise (but deeply alarming) that favorite stocks like EV mothership Tesla (NASDAQ:TSLA) are now adding tens of billions in market cap each and every day.

Records are also set at a different place with dire potential consequences for dividend stars AT&T (NYSE:T) and Verizon (NYSE:VZ). I am referring to the ongoing FCC Auction 107 which offers 280 megahertz of mid-band spectrum (aka "C-band) in the 3.7-3.98 GHz band for flexible use including 5G.

(Source: AT&T Investor Relations)

The auction will end next week, but already the total gross proceeds bid far exceed even the loftiest expectations. Although it is not yet clear which of the big players is bidding what amount, it is highly likely that AT&T and Verizon are virtually killing each other in order to compete with T-Mobile's (NASDAQ:TMUS) dominant C-band exposure.

While I don't see any risk to AT&T's or Verizon's dividend from this auction, the whole auction itself should be critically evaluated and record capex expenses from both carriers could be a further burden to their stock prices.

What exactly is going on at the FCC Auction 107?

The C-band auction for 5G spectrum started December 8, 2020, and is scheduled to be completed on January 12, 2021. Currently, with one day to go and 64 rounds passed, gross proceeds have reached a breathtaking $80.5B. This almost doubled the previous record set at an FCC auction, the AWS-3 spectrum auction in 2015, which raked in $45B in the end.

The $80B is gross proceeds is a staggering number and needs to put into perspective even more. Not only is it far higher than the record 2015 auction, but it is also miles away from what was expected and thereby raising serious questions about the auction itself and its ramifications. As a German this reminds me of the epic failure and collective mess that was created in the early 2000s when European operators spent almost $130B on 3G spectrum licenses. Now, 20 years later, it might be that these massive investments are paying off given the explosive usage of wireless data mostly due to streaming, but this investment required a lot of patience from investors.

As with every auction where demand exceeds supply, it is easy for the bid to race away as no carrier want to concede defeat in the bidding war for an asset they absolutely need for their 5G offerings.

Although the entities bidding are not yet disclosed, it is widely expected that the big bidders are AT&T, Verizon, Comcast (NASDAQ:CMCSA)/Charter (NASDAQ:CHTR), T-Mobile/Sprint and DISH Network (DISH).

Latest analysis suggests the following spend levels in the C-band auction right now with analysts at Cowen projecting total gross proceeds between $81B to $83B:

• Verizon: $35B
• AT&T: $20B
• Cable: $10-15B
• T-Mobile: $10-15B
• DISH: $0-5B

With 64 rounds of bidding passed, the majority of spending occurred between rounds 23 and 50, as it currently looks as if demand is flattening out. Still, with 16 rounds left, that does not mean that the bidding has stopped albeit it is unlikely that we'll see any further dramatic moves.

Source: sashajavid.com

What is behind the record bidding?

While there may be different reasons as to why the running C-band spectrum auction is surpassing even the wildest expectations, I believe that the most likely one is T-Mobile, and ironically months before the action started in September, T-Mobile CEO Mike Sievert himself described as to how the auction is going develop:

AT&T and Verizon are absolutely going to kill each other over C-band. I think they're going to spend tens of billions of dollars they don't have, stress out their balance sheets, put at risk their share buyback and dividend plans in order to not be left outside the party on 5G because they're stuck and they got themselves stuck and they're way behind us and they can't stand it.

Source: fiercewireless.com

Well, it looks like he absolutely nailed it with some bidders, most likely AT&T and Verizon, doing uneconomic things. For T-Mobile, this is an absolute dream scenario. With the successful combination of Sprint, the company inherited a great set of assets it can leverage to build its 5G network. T-Mobile holds the largest amount of sub-6 GHz spectrum and thus does not have to go big in the ongoing C-band auction.

AT&T and Verizon were obviously aware of that as they already complained prior to the 107 auction in September that T-Mobile should be stopped from getting even more 5G spectrum. Their line of argumentation was that T-Mobile already owns a lot of low- and mid-band spectrum and that its latest "spectrum-leasing deal will push its overall spectrum holdings over the FCC's spectrum screen". This raises serious competitive concerns and can threaten the "health and competitiveness of the wireless market" as Verizon argued.

Back then AT&T and Verizon were concerned that T-Mobile will dominate the C-band battle at the current 107 auction. They were right but likely not in the sense that T-Mobile goes into the auction with a real intention to scoop up even more C-band spectrum but rather make others overpay by artificially overcalling the big operators.

For T-Mobile it is a win-win situation. It can aggressively bid for C-band spectrum assets it knows AT&T and Verizon want to have and thereby stretch its competitors' finances to the limit and at the same time attempt to scoop up bargains at different places in a disciplined way as both AT&T and Verizon carry heavy debt loads and need to think more than twice about how and where to spend their money or raise even more debt.

We're interested in it. But we're coming from a position of strength and a tradition of being disciplined

Source: fiercewireless.com

So, while T-Mobile can be opportunistic, its competitors have to be very aggressive and apparently they are. For both AT&T and Verizon, 5G will play a crucial role in their future business, and in order to succeed, they need to secure licenses where most of the U.S. population is rather than rural areas and as early as possible. This is raising the prices to astronomical heights, and I will fully review all the auction once the FCC announces the official results some time in February or March.

What does this mean for AT&T and Verizon financially?

While we can't say for sure how much AT&T and Verizon have already committed to spend during the auction, we can put the most recent estimates into perspective and discuss them against the background of the companies' balance sheets.

Both AT&T and Verizon have levered balance sheets with Verizon's net debt EBITDA ratio around 2.2 and AT&T's around 2.6. Both numbers are not bad per se, but given the high absolute debt numbers at both companies (AT&T's long-term debt is at $164B and Verizon's at around $110B with both figures excluding any pension-related liabilities). Right now, even during the pandemic, both companies can comfortably service their debt and have made varied use of refinancing large portions of long-term debt at historically low rates.

In terms of dividend coverage, AT&T is boasting a comfortable mid-50% payout ratio which can be seen as a position of strength albeit the company recently opted not to hike its dividend at the usual December slot. Instead of raising the dividend, AT&T stated that it expects financial flexibility and debt reduction to play a key role in 2021 while remaining strongly committed to its dividend.

Beyond that, I can think of three reasons why AT&T decided not to raise the dividend this time around: 1) it wants to get a better sense of the COVID-19 impact in 2021 and 2) it needs to keep its cash together to pay for the ultra-expensive C-band auction, and 3) why even raise the dividend when the yield is already at 7% and a paltry 2% raise wouldn't make any meaningful difference in the first place. With early 2021 guidance calling for $26B in FCF AT&T certainly enjoys a lot of financial flexibility and thanks to its aggressive debt repayment path in the past years, its balance sheet is in much stronger condition now even though it is still weaker than Verizon's.

As far as Verizon is concerned, its dividend payout ratio is in the high 60% range right now and Verizon's most recent capex spend for 2020 called for $18.5B. Neither AT&T's nor Verizon's dividends are at any risk but significantly overspending in the current C-band auction could be costly for shareholders, especially Verizon's shareholders.

The very latest projections even speculate that Verizon could spend double or triple the amount of the $15B originally estimated. Verizon already delayed its stock repurchase program amidst the corona crisis and preserve cash for the auction, but this is unlikely to be enough to pay for its costly auction endeavors. According to Craig Moffett from MoffettNathanson the situation is as follows:

Verizon's balance sheet will be more heavily burdened, which in turn means they will appear more richly valued than we had previously assumed. More of Verizon's future cash flows will be diverted to debt service, and their future returns will be lower.

Source: MoffettNathanson Research

Since the auction started in early December, Verizon's stock price initially performed slightly better than AT&T's, but thanks to a recent rally in January, they are more neck-and-neck now with AT&T holding a slight edge.

Data by YCharts

Going forward, though, once the winners of the respective licenses are unveiled in the coming weeks, I think AT&T has a much better chance to outperform Verizon than the other way round. Verizon's valuation at 12 times earnings is significantly higher than AT&T's 9 times earnings valuation, and I prefer AT&T's superior cash flow.

Investor Takeaway

It looks like the two leading U.S. wireless operators, AT&T and Verizon, are absolutely killing each other financially at the ongoing FCC 107 auction. While it is not clear yet who is spending how much and on what, two points appear to be clear:

1) The industry is spending at least twice as much as expected to buy 5G spectrum.

2) T-Mobile is largely the leading force driving up prices and is very likely to emerge as the winner since it already holds a great amount of 5G assets and is not forced to spend heavily in the current record auction.

I am focusing on AT&T and Verizon as they are the leading and biggest wireless carriers in the U.S. and also the ones most likely to spend big but that shouldn't distract from the fact that also Comcast/Charter and DISH could be spending heavily.

In the end, while I am very disappointed about the nosebleed bidding levels, none of that jeopardizes the dividends of AT&T and Verizon in any way.

The big question is, which currently remains unanswered, if this unprecedented spending on 5G spectrum which is double what was expected will have any impact on future revenue forecasts and prices for 5G plans.

In the meantime, I keep all my shares in AT&T and Verizon while running automated biweekly savings plan on AT&T. I will wait for the final results of the auction to assess what exact financial implications this will have on AT&T and Verizon.

One final word

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Disclosure: I am/we are long T, VZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.