The 700 MHz Auction Pre-Show: Live from the AT&T/Aloha Bowl!

The pre-game show for the 700 MHz auction has definitely gone into full swing. Lets ignore for the moment the purely regulatory shenanigans such as Verizon’s war of litigation and regulatory maneuver. Let’s pause for a moment to consider some of the player training and pre-game jockeying for position. Notably, today’s big announcement that AT&T will buy Aloha Partners 700 MHz licenses.

“Whoa!” I hear you cry. “How did Aloha Partners (or anyone else) get 700 MHz licenses? I thought the auction wasn’t until January!” Well, for reasons I will address below, the FCC actually auctioned some of these licenses back in 2002 and 2003. Aloha Partners won a fair number of them dirt cheap (since at the time no one knew if the broadcasters would ever finish the digital transition and get off the spectrum), and then began a steady stream of acquisitions, culminating in the purchase last month of Lin TV’s 700 MHz licenses, giving them a total of 270 licenses overall and healthy coverage in the major markets of the southwest, south, east coast, and portions of the midwest. (You can see and old map of the major coverage areas here.)

And now, in what has become the all too familiar paradigm for the telecom world, AT&T has turned around and swallowed Aloha Partners 700 MHz licenses. What does this mean? What impact for the auction? For other deals? Will this impact the regulatory end game?

My speculations are even wilder-ass than usual, given the utter lack of real data. But if you’re up for a walk through the entrails with me, see below . . . .

As usual in the build up to a major auction, we see potential bidders jockeying for position while simultaneously trying to mislead opponents and keep their real bidding strategy secret. Because the deadline for FCC short forms is now December 3, any deals, consortia, bidding agreements, or other such arrangements must get worked out by then because of the FCC’s anti-collusion rules.

Already we have seen Sprint divorce the cable cos and potentially run off with Google. MetroPCS and Leap Wireless, the largest “second tier” wireless providers are circling each other with merger in their eyes. But this deal, at a stroke, radically alters the balance of power in the 700 MHz and spectrum circles.

The problem is, it is damn hard to tell what it actually means.

So Where’d These Licenses Come From? The Auction Hasn’t Even Happened Yet?

Actually, when Congress set up this whole transition to digital TV and subsequent auction of returned spectrum as part of the Telecom Act of 1996, it required the FCC to auction the spectrum by 2002. But the broadcasters dragged things out, making it very unclear if they would ever get off the spectrum. Michael Powell, as part of his overall agenda of turning licenses into property and to chivvy things along, set up an auction in 2001 under which bidders could bribe the broadcasters with the auction proceeds rather than turn them over to the U.S. Treasury.

Fortunately, through the phenomenal work of Michael Calabrese over at New America Foundation, Congress passed a law canceling the proposed auction. As a sop to folks who wanted to see some progress made, Congress did require the FCC to auction off some of the licenses in 2002 and 2003 (but with the proceeds deposited in the Treasury, as required by law). So the FCC went ahead and auctioned a bunch of the licenses. You can see details here and here.

One fact that will leap out at folks, given that we expect at least $10 billion from the upcoming auction, is how amazingly cheap the licenses went. Thats in part because we were post internet bubble, but also because no one in 2003 knew if the broadcasters would ever get off the spectrum. For all anyone knew, it could take a decade or more before anyone actually got to use the stuff they won. So it went cheap. And Aloha, following up on its superior position, kept gobbling up the other license winners.

It also didn’t help that the rules for service in the band encouraged applications like mobile television, rather than mobile broadband (although they permit that as well). So Aloha and others have been playing with various mobile television technologies which, while nice, do not have the same value as wireless broadband. Or so goes the conventional wisdom.

O.K., Now We know How This Stuff Is Out There. But What Does AT&T’s Purchase Mean?

That’s a damn good question. AT&T paid $2.5 billion, which gives them a substantial footprint at a price of about $1.06 MHz/pop (a standard valuation). That value is high compared with the AWS auction average, but not far off what folks have been paying in the secondary market by acquisitions (NB: this difference between the auction MHz/pop valuation and what parties negotiate when they merge was one of our proofs that incumbents routinely rig the auctions, then settle up for fair market value later). So AT&T may be overpaying or getting a bargain, depending on people’s expectations for the auction.

OK, but whether they overpaid or underpaid, why buy from Aloha instead of waiting. There are two strong possibilities that go in opposite directions. Either AT&T doesn’t want to play heavily in the auction — in which case they are getting themselves a good national footprint and can cover the existing holes with their other spectrum holdings or with the cheaper A & B block licenses in the lower 700 MHz (the ones being sold on an EA or CMA basis). That means they won’t bid for C Block or D Block, avoiding a possible costly bidding war with Verizon or whoever else might show up. They also avoid either the devie open access rules or the D Block public safety rules — neither of which fits with their existing business model.

Alternatively, they may be trying to bulk up on spectrum. In which case this is an effort to generate as large a footprint and as great a depth in this band as possible and we can expect AT&T to bid aggressively for C Block and D Block.

Finally, it is vaguely possible that AT&T wants this for the purpose Aloha used it for, mobile television to compliment their competitive offering and fight cable. I assign that a very low probability, but can’t eliminate it altogether.

One thing is certain. Aloha had been a likely bidder for the A & B Block licenses. It was even possible (although unlikely) that they might make a play for C Block licenses, given how aggressively they were building their footprint. This eliminates them from the auction altogether. That has to worry Martin and everyone else who wants to see the competition maximized to drive up auction revenue.

Is the Sale a Done Deal?

And now we get to the interesting part. The transfer of licenses must get approval from the Department of Justice and the FCC. We can expect Justice to whip out the ‘ole rubber stamp and roll over like a good industry lap dog. But the FCC may present sme unexpected difficulties. Although the FCC has abolished an official spectrum cap, it has maintained an “unoffocial” cap and forced regional divestitures when it concluded that a wireless acquisition eliminated too much competition and put too much spectrum in the hands of one provider.

Both Frontline and PISC pressed the FCC to adopt a spectrum cap for the 700 MHz auction. Although the FCC rejected this proposal, both Frontline and PISC raised variations on the idea in their respective Petitions for Recon. AT&T’s actions will certainly add fuel to the fire. Furthermore, because AT&T must file an application with the FCC, Frontline and other AT&T opponents will have the opportunity to press the Commission for conditions and divestitures. In addition, Martin or other FCC Commissioners may have informal discussions with AT&T to see how this is likely to impact AT&T’s bidding behavior.

It is likely that the FCC will not decide the applications until after the auction occurs. A license transfer of this size would be expected to take 4-6 months. But that puts AT&T in an awkward position. If it bids strongly and wins significant licenses, the Commission may reject the transfer or force divestitures where AT&T has acquired significant spectrum blocks. OTOH, if AT&T sits the auction out, it may find its spectrum advantage compromised by ceding the field to Verizon or some other bidder. Alternatively, AT&T can hold off filing the application until after the auction, although this raises potential problems with the Commission’s anti-collusion rules. But these problems are manageable and waiting until after the auction to file the transfer application woul give AT&T flexibility to propose divestitures (if necessary) based on its actual acquisitions rather than try to shape a strategy for moving the license transfer through while everyone is still uncertain about the ultimate outcome of the auction.

Final Thoughts?

Not really. There are a lot of potential warm ups and side games yet to come. SpectrumCo, the cable consortium, has not signaled whether it will try to bid in this auction. Given that anonymous bidding makes blocking impossible, the incentive to show up and bid is greatly reduced — especially when they still can’t figure out how to use the spectrum they bought last time. Google and other Silicon Valley folks have yet to make clear whether they will try to bid themselves or back a more experienced/pre-existing wireless player, or whether they play at all. A lot also depends on whether the credit crisis is really over or whether the would be bidders like Frontline will find it hard to scare up the billions needed to bid. We can expect a lot of lawyers to work this Thanksgiving holiday, however, because all these deals and agreements need to get resolved by December 3. Makes me rather glad I’m no longer in private practice.

Stay tuned . . . .

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