Dish Network (NASDAQ: DISH) and Verizon Communications (NYSE: VZ) could strike a deal by year-end for Verizon to get access to Dish's spectrum through a leasing arrangement, according to analysts at New Street Research.
In a research note, New Street analysts Jonathan Chaplin, Spencer Kurn and Vivek Stalam said that "Verizon seemed to shift their tone on Dish's spectrum last week, which we think potentially sets up a transaction between now and year end."
Verizon CEO Lowell McAdam said last week at a Goldman Sachs investor conference that Verizon would be interested in having a discussion about commercial terms for Dish's spectrum.
"The spectrum that he has we have had discussions about how we can provide him megabytes and he could pay for it to with spectrum," McAdam said, referring to Ergen, according to a Seeking Alpha transcript of his remarks. "Those sorts of options are still open to us. But to get the spectrum by buying the entire company isn't something that we are interested in."
That framing was deliberate, according to New Street. The analysts noted that Verizon "could potentially structure a transaction with Verizon getting spectrum and Dish getting access to capacity. The last point suggests a very specific structure that we have written about before. We are inclined to think that the shift in tone is significant. Verizon management is generally careful about their messaging."
Given Verizon's debt load, it would be difficult for the carrier to pay cash to acquire Dish's spectrum, according to the New Street analysts, who think that all of Dish's spectrum is valued at $63 billion and just its AWS-3 and AWS-4 airwaves are valued at $53 billion.
Dish controls 40 MHz of mid-band AWS-4 spectrum, 10 MHz of 1900 PCS H Block spectrum and 6 MHz of 700 MHz spectrum. Additionally, Dish's designated entities made $13.3 billion in gross provisional winning bids in AWS-3 auction and won 702 licenses, winning 25 MHz of total spectrum including 13 MHz of paired spectrum. The two DEs recently received a two-week extension from the FCC, until Oct. 1, to pay the $3.33 billion they owe for their AWS-3 spectrum licenses after the agency said they were not entitled to a 25 percent bidding discount.
"This has been the stumbling block to a transaction, in our view," the analysts said. "One way around this would be a very long term lease with a right of first refusal if the spectrum is ever sold." They think Dish would need to lease it for around $4 billion annually to "lock in what we think the spectrum is worth."
In addition, Verizon "might be able to structure the lease such that the payments escalate as Verizon utilizes the spectrum. If Dish is keeping the satellite business they will need capacity in order to offer a broadband product" to its 14 million satellite-TV customers. Verizon might be able to pay some of the lease in capacity rather than cash, the analysts said. Alternatively, Dish "could sell the spectrum to Verizon outright and negotiate a capacity deal in the process."
Verizon CFO Fran Shammo said on the carrier's second-quarter earnings conference call in July that Verizon would want to lease spectrum only in perpetuity. He said that "as far as a leasing of spectrum goes, as I've said before, in order to protect the viability of our network and our planning and our capital allocation, this would have to be almost a lease in perpetuity so that you could never be held hostage by anybody. Because once you deploy a spectrum in your network, if somebody turned around 10 years from now and said I think I'm not going to lease that you anymore, that would be detrimental to your business and you just can't let that happen."
What could be forcing a Verizon/Dish deal is the upcoming incentive auction of 600 MHz broadcast TV spectrum, which is expected to start on March 29, 2016. The FCC will impose a "quiet period" that forbids negotiations over spectrum that will likely start at the very end of 2015 and extend at least six months.
"600 MHz spectrum is not ideal for Verizon or AT&T; they have enough low band spectrum and need more mid- or high-band spectrum," the analysts said. "The 600 MHz auction is the last auction on the horizon; if the incumbents can't find spectrum from an alternative source they will be forced to invest another $10-15 billion on sub-optimal spectrum. If they are going to buy Dish spectrum at some point they ought to thoroughly explore the opportunity with Dish before the auction."
TMF Associates analyst Tim Farrar said in a blog post that the extension the FCC gave Dish's DEs signals that Dish is "close to a deal to restructure its spectrum holdings and presumably announce the spinoff of a spectrum leasing company before October 1."
"It seems clear that Verizon would be interested in gaining access to both Dish's AWS-3 winnings and the adjacent AWS-4 downlink through a leasing deal," he said. "However, by advertising its bottom line in public, and in particular that Verizon is not willing to pay Dish's asking price in cash to lease this spectrum, it seems that Verizon has presented [Dish Chairman and CEO Charlie] Ergen with a take it or leave it proposition, calculating that Dish has no other options."
Farrar said Dish could potentially use a leasing deal and get access to wireless capacity to set up an MVNO business, "and the price established by Verizon could then serve as a benchmark for cash deals with other parties (i.e. a 700 MHz E block deal with AT&T and an H-Block/AWS-3 uplink deal with Sprint). Theoretically Verizon could offer quite a high price, especially if it calculated that Dish might not succeed in the MVNO business and would therefore leave most of the megabytes unused."
However, Farrar said, in that scenario Dish would not be able to raise substantial debt for the company that contains its spectrum, unless and until further cash deals were struck. "That's likely a wise move for Verizon, since it would prevent Dish from bidding aggressively in the incentive auction, and potentially result in lower prices in that auction and a correspondingly lower benchmark for future spectrum transactions," he said.
"So now we'll see if Ergen accepts Verizon's offer or if he can come up with an alternative leasing partner in the next week and a half," Farrar said. "Alternatively, and perhaps even more likely, is that no deal will be struck now. Then Ergen might have to wait for a long time for the next opening, as operators focus their attention on the incentive auction next spring and beyond that on the possibility that a change of administration in November 2016 could result in a different regulatory climate for deals that are impossible today (such as a Sprint/T-Mobile merger)."
- see this TMF Associates blog post
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