What the AT&T/DirecTV merger, 600 MHz auction rules and new spectrum screen mean for M&A in wireless

Mike Dano

Now that AT&T's (NYSE: T) bid to acquire DirecTV (NASDAQ: DTV) is official, and the FCC's rules for the spectrum screen and the 600 MHz auction are finalized, the merger-and-acquisition landscape in the wireless industry is now much, much clearer. Specifically, the proposed merger between Sprint (NYSE: S) and T-Mobile US (NYSE:TMUS) appears significantly more daunting, and a Verizon (NYSE: VZ) purchase of Dish Network's (NASDAQ: DISH) spectrum appears somewhat more likely.

To be clear though, the FCC's rules for the spectrum screen and the 600 MHz auction, along with the AT&T bid for DirecTV, are just a few more pieces to a much larger puzzle. A range of other factors--from corporate strategy to executive ego--could ultimately tip the next major round of M&A in wireless.

The AT&T/DirecTV merger and what it means

Now that AT&T's $49 billion bid for DirecTV is official, a transaction between AT&T and Charlie Ergen's Dish Network appears much less likely. Dish has been working to build up a massive trove of spectrum, and many analysts had expected AT&T to move forward with a purchase of Dish's spectrum in order to challenge Verizon Wireless with a more robust network. "DISH's ~45MHz of mid-band downlink spectrum would confer a capacity advantage to AT&T that Verizon could not hope to close," analysts from New Street Research noted last week.

Now, however, it's clear that AT&T believes DirecTV is a more strategically beneficial use of its money. AT&T may also believe it will be able to shore up its spectrum holdings in the FCC's AWS-3 auction later this year and its 600 MHz incentive auction next year.

Whatever the reason, the result is that Dish's most likely suitor appears to have left the dance.

The spectrum screen and what it means

As New Street Research analysts recently pointed out, the FCC's spectrum screen previously covered a total of roughly 453 MHz of spectrum on average across the top 100 U.S. markets, and would kick in if a carrier acquired more than one-third of that total (150 MHz) in a given market. If a carrier purchases enough spectrum in a market to push its total holdings over the screen, the FCC would review the transaction more carefully and could move to block it.

Sprint had lobbied the FCC hard to get the commission to weigh low-band spectrum more heavily in its screen than high-band spectrum. Sprint argued that low-band spectrum, like 700 MHz, penetrates buildings more easily and transmits a signal farther, and is therefore more valuable than high-band spectrum, like 2.5 GHz.

However, the FCC ignored Sprint's arguments and instead instituted a screen that weighs all spectrum the same, though the FCC will pay closer attention to deals involving spectrum below 1 GHz. Further, the FCC is now including the vast majority of Sprint's 2.5 GHz spectrum in its screen. The result is that Sprint already violates the screen as it stands today--according to New Street analysts, Sprint owns an average of roughly 201 MHz of spectrum in the nation's top 100 markets, and the FCC's new screen sits at 195 MHz.

In comparison, in the top 100 U.S. markets, Verizon owns an average of 105 MHz, AT&T owns 129 MHz and T-Mobile owns 78 MHz of spectrum.

What this means is that Sprint has no chance of acquiring T-Mobile or Dish without tripping over the FCC's new spectrum screen. And that could pave the way for Verizon to make a play for Dish--T-Mobile likely doesn't have the financial resources to go after Dish, which currently commands a market cap of $27.5 billion. As the New Street analysts point out, the addition of Dish's roughly 54 MHz of spectrum to Verizon's holdings would remain safely under the spectrum screen.

However, as the Wall Street Journal points out, Verizon is working to pay down the debt created by its $130 billion acquisition of Vodafone's stake in Verizon Wireless. And with the AWS-3 and 600 MHz auctions looming, Verizon could decide to let Dish marinate for the foreseeable future.

One last element that could be affecting Dish's efforts in the wireless industry is the carrier's spectrum holdings, which sit outside the traditional bands used for wireless networks. Any carrier that acquires Dish's spectrum would not only have to pay the purchase price but also the cost of integrating those bands into its network and devices.

The 600 MHz auction rules and what they mean

As for the FCC's new rules for the 600 MHz incentive auction of TV broadcaster spectrum, those too appear designed to prevent Sprint from merging with T-Mobile. In its auction rules, the FCC agreed to save up to 30 MHz of spectrum in a given market for Sprint, T-Mobile and smaller carriers by forbidding big carriers like AT&T and Verizon from bidding on it. The FCC hopes that this "reserved" spectrum will entice smaller carriers into the auction and ultimately make the wireless industry more competitive.

However, as analysts at Credit Suisse pointed out, "there is language in the spectrum aggregation rules that could allow the FCC to retract the reserve rules if a major transaction among the top 4 carriers is announced." Thus, the FCC could withdraw its plan to reserve up to 30 MHz of spectrum during the auction for smaller carriers if Sprint and T-Mobile pursue a merger before the auction.

"The revocation of the set-aside (the 30 MHz of spectrum reserved for smaller carriers) in the event of a deal attempt seems punitive," New Street analysts wrote of the FCC's rules.

Punitive, indeed. The FCC seems almost desperate to retain four nationwide wireless carriers.

Interestingly, those same reserve rules could push Verizon closer to Dish. If Verizon is prevented from acquiring significant chunks of 600 MHz spectrum due to the FCC's rules, that could motivate the carrier to ink a deal with Dish's Ergen for extra spectrum.

One last element affecting the auction--as well as the screen--is that the new rules for the spectrum screen won't apply to companies bidding in either the upcoming AWS-3 auction later this year or next year's 600 MHz auction. That means that Sprint, AT&T and any other company can safely bid in both auctions without worrying about violating the FCC's new spectrum screen.

So what will happen next?

Despite clear opposition from the FCC, SoftBank CEO Masayoshi Son may well decide to pursue a merger with T-Mobile anyway. Bloomberg recently reported Sprint and SoftBank are lining up the necessary financials in order to make a bid for T-Mobile as early as this summer. After all, Son hasn't been shy about promoting his maverick style and desire to upend the U.S. wireless business.

Sprint may also consider selling some or all of its 2.5 GHz holdings in an effort to make a transaction with T-Mobile more palatable. But such a move would force Sprint to backtrack on its plans to offer super-fast wireless service via its Spark technology, which relies on its 2.5 GHz spectrum. And finding a buyer for Sprint's 2.5 GHz holdings could also prove difficult.

As for Dish, if the company doesn't ink an agreement with AT&T or Verizon it may well decide to participate in the upcoming AWS-3 and 600 MHz auctions to increase its spectrum portfolio. And Chairman Charlie Ergen has said that Dish could make a move on T-Mobile if Sprint isn't able to merge with the uncarrier.

The FCC's auction and spectrum screen rules, and AT&T's move on DirecTV, do add more puzzle pieces to the picture, but the full picture still remains cloudy. --Mike |+MikeDano | @mikeddano