Analysts: Dish could strike a spectrum deal with Verizon or a perpetual leasing agreement

Dish Network (NASDAQ: DISH) remains in the driver's seat in terms of options for its spectrum, which could include a sale to Verizon (NYSE: VZ), some kind of wholesale agreement with multiple carriers or a perpetual lease. Meanwhile, AT&T (NYSE: T) sharply criticized Dish over its "selective default" on AWS-3 spectrum licenses two of its affiliates bid on following the FCC's decision to not award those companies a 25 percent discount.

In a research note, Deutsche Bank analysts Bryan Kraft, Clay Griffin and Sunny Kwak said that even though Dish and its designated entity partners drove up prices during the AWS-3 auction, which ended in January, "the major carriers, had they not had a significant need for more spectrum, could have opted to stay on the sidelines in an effort to cast doubt on spectrum demand/pricing ahead of future auctions and spectrum acquisitions. Instead, they paid what they had to in order to win some of the licenses they sought. We find it hard to believe that they're now 'all set' as far as spectrum, even with additional licenses they might acquire in the broadcast incentive auction."

Outside of the AWS-3 licenses, Dish's spectrum includes 40 MHz of mid-band AWS-4 spectrum, 10 MHz of 1900 PCS H Block spectrum and 6 MHz of 700 MHz spectrum. Dish's AWS-4 spectrum runs from 2000-2020 MHz (for uplink operations) and 2180-2200 MHz (for the downlink). However, Dish has the option, until June 2016, to decide whether to convert its uplink spectrum into downlink spectrum, which it is likely to do.

"The size of Dish's spectrum holdings has caused some to take a view that a single carrier is not likely to acquire it all, and that even the industry as a whole might find it difficult to buy it at a meaningful premium," the analysts said.

They don't buy into that view because the airwaves represent around 12 percent of the industry's spectrum and because it is a long-term asset, and "comparisons to current year free cash flow or EBITDA are inappropriate." They also think the spectrum could be sold or leased to more than one bidder, "which we think would lead to a higher aggregate sale/lease price and, in the case of a lease, would be tax efficient." Further, the long-term cost of allowing another carrier to buy Dish's spectrum "could be significant in terms of market share losses and relative network advantage."

"We think we can say with a high degree of confidence that, at some point, Dish's spectrum question will be deployed by a wireless operator. The FCC ensures that through build-out requirements, lest the rights be revoked (an unlikely outcome)," the analysts said. "We just don't know when or by whom."

Dish is required to build out 40 percent of its coverage on its AWS-4 licenses by 2017 and at least 70 percent by 2021. If Dish fails to meet the initial buildout requirements, the penalty is a one-year acceleration of the second (and final) buildout date. "Therefore, while there is a shot clock in place, the time table still affords Dish a reasonable amount of time to execute a plan to sell or lease the spectrum," the analysts said.

So what are Dish's main options? The most compelling is a sale to Verizon, which has said it would be interested in some kind of commercial deal for Dish's airwaves. "Many in the industry consider Verizon to have legitimate capacity concerns given its leading market share of subscribers, but fourth place position in terms of spectrum holdings," the Deutsche Bank analysts said. "Furthermore, Verizon has by, a considerable degree, the most profitable wireless business. By buying Dish, Verizon can address its network capacity needs and, at the same time, prevent a competitor from obtaining incremental capacity that one day could be used to overcome Verizon's network advantage."

The problem, the analysts said, is that they think Dish Chairman and CEO Charlie Ergen "would prefer a sale of the entire company (i.e. Dish's equity), as opposed to a sale of Dish's spectrum," but Verizon has said it is not interested in buying the company. The analysts think that for Ergen, a sale of the spectrum would result in a capital gains tax for Dish at the full corporate tax rate and Dish's legacy satellite TV business "would then be left in a strategically challenged position as the only traditional pay-TV operator without a broadband or wireless connectivity business."

Merger talks between Dish and T-Mobile US (NYSE:TMUS) apparently ended this summer and the analysts don't think Sprint (NYSE: S) would make a move because it doesn't need mid-band or high-band spectrum and doesn't have the money.  

So what's left? One option would be a wholesale deal, but the analysts said "it is difficult to imagine an operator being comfortable with anything less than a perpetual lease; effectively a sale of the spectrum with full control over network engineering, construction, and management." However, a perpetual leasing deal with Verizon might work, because "Verizon could probably avoid some of the earnings dilution associated with acquiring spectrum, particularly if Verizon only leases a portion of the spectrum, rather than all of it."

In any event, AT&T is still smarting over the decision last week by Dish's DEs, in which Dish holds an 85 percent economic stake, to give up around a third of the paired AWS-3 spectrum licenses they won earlier this year in the AWS-3 auction -- mostly spectrum licenses covering New York, Chicago and Boston. The licenses that Dish's DEs are relinquishing represent around $3.4 billion worth of their winning bids; they will keep about $9.8 billion worth of the licenses they won at the auction.

The Deutsche Bank analysts noted that Dish will have to pay a 15 percent penalty on the gross value of these bids, or $515 million. "Dish will use its previously paid deposits to both pay the winning gross bids on the licenses that it wants to retain, as well as part of the penalty. The FCC will re-auction these licenses and, should they sell for less than Dish's winning gross bid, Dish will need to make the FCC whole. Interesting to note, Dish will have the ability to bid on these assets, as well."

Joan Marsh, AT&T's vice president of federal regulatory, said in a company blog post how "wholly frustrating and maddening it is that Dish is now permitted to throw up its hands and say 'never mind' to $3 billion of licenses while retaining the right to reacquire them later" after Dish and its partners "created an environment in which it was exceedingly challenging to make rational bid decisions" during the AWS-3 auction.

"Said another way, the FCC will now effectively store $3 billion of spectrum licenses for some undetermined amount of time for a 15% fee then give Dish the right to buy them back at auction for the same value," Marsh said. "And because Dish must cover any deficiency as part of its penalty, it has every incentive to do so. I'm no finance expert but, when you factor in the time value of $3 billion, this doesn't feel like a just or appropriate result."

A Dish spokesman did not immediately respond to a request for comment.  

For more:
- see this AT&T blog post

Related articles:
Dish exec says company may participate in the FCC's 600 MHz incentive auction
Dish's DEs give up $3.4B in AWS-3 spectrum, but Ergen's Verizon strategy remains intact
Dish's DE partners get extension from FCC to make $3.3B in payments on AWS-3 spectrum
Verizon's McAdam: We're open to talking to Dish about spectrum-- but won't buy whole company
FCC denies Dish partners $3.3B in bidding credits in AWS-3 auction

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