Verizon/SpectrumCo: The Spectrum Concentration Gap v. The Spectrum Crunch (Why VZ’s 700 MHz Divestiture Offer Doesn’t Help) Part I

Verizon has clearly studied everything AT&T did wrong last year when it tried to acquire T-Mobile. That includes staying alert for early signs of trouble and taking preemptive moves to keep the course of approval running smoothly. It also includes showing grace under fire rather than trying to browbeat the FCC into submission. To head off concerns about the growing “spectrum gap” between Verizon (and AT&T) and its competitors, Verizon has offered to sell its Lower 700 MHz A&B block licenses in a private auction if the FCC grants the application to transfer the AWS-1 spectrum to it from Spectrumco.

At the same time, Verizon also insists that it is doing this of its own free will and not because the FCC is making it do so or because it has run into any trouble. As I will explain, I believe Verizon is telling the truth. The 700 MHz A&B block licenses Verizon promises to auction to competitors is not nearly as useful to it as the AWS-1 spectrum it will get from Spectrumco and Cox. Given that everyone has extolled the virtues of the 700 MHz spectrum as the most important, game changing super-duper useful for mobile broadband spectrum in the entire universe, and since the licenses in question do cover some major markets, that no doubt comes as a surprise to many. Indeed, rather like the stereotypical used car salesman offering to swap your beat up lemon for his hardly ever driven luxury cream puff, this offer looks too good to be true. Why would Verizon want to swap Magic Elixir 700 MHz spectrum for Totally Awesome But Not Magic AWS-1 spectrum?

Below, I give a run-down of my guesses as to why Verizon decided to make a preemptive offer to divest when so many experts opined this would sail through without serious problems. I also explain why, despite the real virtues of the 700 MHz spectrum, Verizon has good reason to want to ditch these licenses (and was already starting to sell them off before the Spectrumco deal). Finally, I’ll explain why, IMO, this doesn’t address the fundamental problems of the VZ/Spectrumco deal because (a) it doesn’t address the side agreements that make this look like the formation of a cartel; (b) for reasons I have explained at length before, AT&T is the most likely winner of any “private auction” Verizon will hold; and, (c) even if AT&T were excluded from getting the licenses, the Spectrum Gap will actually be worse, not better, as a result of the transaction.

In chess terms, Verizon is offering to sacrifice two pawns to gain a queen. Hopefully, the FCC will resist the invitation and avoid a Fool’s Mate for competition.

Because this ended up being rather long, I’ve divided it into three parts. Part I explains how the spectrum situation changed dramatically in just a few months, so that concern about the Spectrum Gap, the difference in spectrum between the two largest providers and all other wireless providers, came to have such increased significance in the FCC’s thinking. This prompted Verizon to make public what it already planned to do, ditch the 700 MHz A&B blocks, despite the fact that this leaves them open to accusations of spectrum warehousing during the pendency of the Spectrumco/Cox deal.

In Part II, I explain why AT&T will likely win the licenses (a conclusion others have reached as well), absent some condition by the FCC to keep AT&T out of the private auction (which I consider politically unlikely). Part III explains why, even if AT&T were excluded from the private auction for Verizon’s Lower 700 MHz A&B licenses, it still would aggravate the spectrum gap. Since the transaction would make competition worse off post-transaction (and fail to address the whole ‘cartel’ thing), the FCC should still deny the application for transfer.

More below . . . .

 

Just last month I was telling a conference call of Wall St. analysts that they had seriously underweighted the concerns the FCC had about spectrum concentration and the Spectrum Gap between the top two competitors and everyone else. So it amused me to see one of these Wall St. analysts quoted in BusinessWeek saying: “Investors have underestimated the challenges that Verizon faces at the FCC.” Dude, just read this blog. Did I not totally kill it on AT&T/T-Mo while y’all were still utterly convinced the AT&T juggernaut would bull its way to approval? But Hell, it’s not your personal money you’re losing by believing company press releases and cheerleaders, just your clients’.

OK, enough gloating. On to analysis.

The “Spectrum Crunch” v. the “Spectrum Gap.”

As everyone in telecom land knows, the accepted wisdom for the last few years is that we face a looming “spectrum crunch” or “spectrum crisis” because data traffic carried on wireless networks continues to grow exponentially. Mind you, not everyone believes in the spectrum crunch, but it has become accepted wisdom in DC by both the Administration and members of both parties in Congress, and therefore become a major driver of policy in telecom.

Just as the “energy crisis” can justify anything from drilling in arctic wildlife preserves to approving the XL Pipeline, AT&T and Verizon quickly figured out that could use the “spectrum crisis” as the justification for everything from ridiculously low bandwidth caps on your wireless data plan to buying up all the available spectrum in sight. And while it ultimately did not carry the day, the “we must buy competitor spectrum to meet our needs” argument appeared to get a lot of traction in AT&T/T-Mobile. Since the transfer of licenses from Comcast and the other cablecos that make up Spectrumco did not involve any change in marketshare, and because Comcast said they didn’t have any plans to use this stuff anyway, the “approve this because of the spectrum crunch” argument looked like a real winner.

Most observers missed, however, that in addition to the spectrum crunch, the FCC (and DOJ) has also expressed concern about the “spectrum gap.” Competitive wireless carriers (everyone but AT&T and Verizon) and folks like yr hmbl obdn’t blogger have argued that the “spectrum gap” – the gap between the largest two providers and everyone else in the wireless industry – is more important than the overall industry spectrum crunch because the spectrum gap makes effective competition impossible. Assuming the spectrum crunch is real, it is an industry problem that all carriers must meet by cooperating through data roaming agreements, increasing network efficiency, and other clever ways. Pumping up the two largest carriers while letting the rest of the industry stay spectrum starved not only kills competition, it encourages Verizon and AT&T to warehouse spectrum they already have and to maintain inefficient older technology rather than invest in network upgrades.

So while the FCC needs to solve the spectrum crunch for everyone in the long term, it also wants to avoid any  increase the spectrum gap. (Ideally, the FCC would like to reduce the spectrum gap, but will settle for not making things worse.) Increasing the spectrum gap makes everyone ultimately worse off, because it actually delays finding a real solution to the spectrum crunch (by killing the incentive of the industry leaders to do roaming agreements with competitors or upgrade their systems). Along the way, it makes it harder for anyone to compete with AT&T or Verizon. If spectrum is a zero-sum game, which is what the spectrum crunch argument means, giving more to the biggest players automatically makes things worse for all the other competing players.

For the last few years, the FCC has signaled in the annual Wireless Competition Report that the growing spectrum gap could become a major competition issue. In the order approving AT&T’s acquisition of Qualcomm’s 700 MHz licenses, the FCC reiterated its concern about the growing spectrum gap. But it limited its analysis to the 700 MHz spectrum at issue, so Verizon could reasonably conclude that just buying AWS spectrum (which is still awesomely good, but not super awesomely good like 700 MHz spectrum) wouldn’t raise too many concerns.

No New Spectrum Anytime Soon Means The Spectrum Gap Trumps The Spectrum Crunch.

In the last three months, it has become increasingly clear to those of us in Policyland who follow the FCC that the expectation of freeing up spectrum for auction to wireless carriers will take longer – and yield much less spectrum – than the FCC hoped. In 2010, when the FCC released the National Broadband Plan and set a goal of finding another 500 MHz for mobile broadband (mostly in the form of exclusive licenses, but with a nod to unlicensed use like the TV white spaces) it pointed to a bunch of places it expected to get spectrum for auction: The 10 MHz D Block left over from the 700 MHz auction, freeing up the 1755-1780 MHz block of fed spectrum to pair with the existing AWS-3 block, converting satellite “ancillary terrestrial component” (ATC), freeing up more federal spectrum beyond 1755-1780 and, the biggest prize, getting Congress to approve incentive auctions for broadcasters.

In the last three months, pretty much everyone of these potential sources of auctionable, exclusively licensed spectrum of the kind carriers want has faced a major set-back, or been taken off the table altogether.  The Spectrum JOBS Act in February reallocated the D Block to public safety. Last month, NTIA released a report indicating that it would take a minimum of 5 years to clear the 1755-1780 MHz band for auction, and the cost might well exceed the expected auction revenue. While LightSquared is not officially dead yet, not even the most optimistic true believers claim it will bring 40 MHz of wholesale spectrum to market any time soon.  And while the proposal to make DISH’s 40 MHz of S Band satellite spectrum available for terrestrial use appears to be cruising along, DISH has made it clear it has no intention to offer that capacity on a wholesale basis (assuming it doesn’t flip the spectrum to AT&T, as Wall St analysts keep hoping). That means no help for existing competitors, and no entry of DISH as a new competitor until the rulemaking is complete and DISH can do some build out.

Yes, the FCC did get authorization for incentive auctions to reclaim broadcast spectrum. But most people failed to appreciate how hard and complicated designing and implementing the incentive auctions will be.  We are talking years before the incentive auctions can happen. Worse, broadcasters continue to send mixed signals on how many will want to cash out, so there remains an overall possibility that the incentive auction, however well designed, may ultimately yield little or no spectrum. But even in the best case scenario, most folks agree we’re looking at 3 years minimum before  an auction could occur, followed by some unknown period of time afterward to repack and reshuffle everyone so the spectrum can be used for broadband.

Finally, the recent spectrum legislation also took away the ability of the FCC to keep AT&T and Verizon out of any future auction. Yes, the FCC can still set a hard ‘spectrum cap’ or take some other steps to keep AT&T and Verizon from winning the bulk of the licenses, as happened in the 700 MHz Auction in 2008. But the easiest thing to do politically, require AT&T and Verizon to sit out a round so that competitors can get a bunch of licenses to close the spectrum gap, is now prohibited by law.

In other words, between the time VZ and the cablecos announced the spectrum deal and now, the expectations about the ability of competitors to find new spectrum changed radically. So if we believe in the Spectrum Gap as a competition problem, and the FCC has made it clear for the last few years it does, then the Spectrum Gap crisis far, far outweighs the Spectrum Crunch crisis here. Because while Verizon still has some spectrum in its back pocket and can invest in network upgrades to meet its Spectrum Crunch, there is no new spectrum ANYWHERE for Sprint or MetroPCS or anyone else to make up the Spectrum Gap.

As I discuss in Part II, Verizon did not spend their time moping or trying to bully their way past the FCC’s concerns. Instead, they considered how they could redirect that negative energy and concern around the spectrum gap into something more positive, and without forcing them to do anything they weren’t already planning to do.

Stay tuned . . . .


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