BIGGER GETS BETTER

The FCC decides its spectrum cap is no longer needed. The largest carriers stand to gain the most as mergers and acquisitions become the path to growth. Antitrust scrutiny is the only barrier to consolidation.

The FCC's 3-to-1 vote last week to phase out its wireless spectrum cap will set off what many believe is an overdue consolidation among the nation's biggest wireless carriers.

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As part of its biennial review, the commission immediately raised the cap on the amount of commercial mobile radio services spectrum that a carrier may own in any single urban market to 55 MHz from 45 MHz. This brings it in line with the rural market cap that had been raised previously to the 55 MHz level. The commission included a sunset provision that would eliminate the cap altogether on Jan. 1, 2003.

Although FCC Commissioner Kathleen Abernathy conceded the cap was designed to promote competition by keeping the incumbents from gobbling up the available spectrum, she said six strong national carriers and a number of smaller regional carriers are evidence it had outlived its purpose.

“A cap by its very nature is arbitrary and inflexible, and not all mergers are created equal. A better approach is to consider mergers on a case-by-case basis,” she said. Abernathy stressed that any merger involving major players in the wireless space would still be subject to the scrutiny of the FCC and the Department of Justice.

In fact, any notion of rampant consolidation is premature, said Gene Signorini, wireless analyst for The Yankee Group. “The government will keep a pretty close eye on any merging of the big players.”

The large wireless carriers have been pushing for removal of the spectrum cap, believing the future of third-generation wireless depends on it. Such services likely will eat up spectrum, a dilemma that is exacerbated when they are deployed in customer-dense urban markets.

“In some markets, carriers don't have enough spectrum to provide top-quality service,” said Brian O'Connor, vice president of legislative and regulatory affairs for VoiceStream Wireless.

However, Sue Swenson, president and chief operating officer of Leap Wireless, said many carriers inefficiently use their spectrum, and the FCC is “almost irresponsible” in abolishing the cap in light of its lack of a comprehensive spectrum management policy.

“Why would you give more spectrum to someone that's less efficient?” she asked. “That's like giving an airline that's only flying DC-3s more gates than one that's flying 747s.” Swenson said the FCC should have developed a policy to grant new spectrum “only on a selective basis.”

The problem with that theory is the government doesn't have any new spectrum to grant. “It will take the FCC two to three years to find and allocate spectrum,” said Douglas Makin, analyst for Kaufman Bros. “Without additional spectrum on the horizon, this is their only alternative.” The only way companies can acquire the spectrum needed to provide wireless broadband services is by partnering with, merging with or acquiring companies, said Brian Fontes, vice president of federal relations for Cingular Wireless.

FCC Commissioner Michael Copps acknowledged as much in his dissenting opinion. “Let's not kid ourselves — this is, for some, more about corporate mergers than anything else.”

While conventional wisdom says consolidation is on the way, less clear is the form it will take (see table). Carriers that will benefit most aren't talking M&A yet, saying only that it's too early to identify their strategies. Which is nonsense, said Sean Butson, senior analyst for Legg Mason. “Everybody talks to everybody all the time. It's going to take six to 12 months to sort out the regulatory and antitrust issues of any merger involving a big player, so we'll see some announcements in the first or second quarters of next year.”

CONSOLIDATION SCENARIOS AMONG THE BIG SIX Raising the cap from 45 MHz to 55 MHz makes it easier for mergers to occur, in some cases profoundly. Under the old rules, for example, a combined AT&T/Nextel would be over the cap limit in 23 of the top 50 markets, but over in only one under the new rules.
	VERIZON WIRELESS		CINGULAR		AT&T WIRELESS
	45  MHz	55  MHz	45 MHz	55 MHz	45 MHz	55 MHz
Verizon	x	x	44	30	47	42
Cingular	44	30	x	x	43	31
AT&T Wireless	47	42	43	31	x	x
Sprint PCS	45	28	33	10	46	35
Nextel	12	5	1	0	23	1
VoiceStream	42	31	30	12	43	32
	SPRINT PCS		NEXTEL		VOICESTREAM
	45 MHz	55 MHz	45 MHz	55 MHz	45 MHz	55 MHz
Verizon	45	28	12	5	42	31
Cingular	33	10	1	0	30	12
AT&T Wireless	46	35	23	1	43	32
Sprint PCS	x	x	0	0	37	18
Nextel	0	0	x	x	6	0
VoiceStream	37	18	6	0	x	x
Source: Legg Mason

The first potential merger could be a Verizon Wireless/Sprint PCS match, according to Frank Marsala, senior research analyst for Robertson Stephens. “This one was made to happen. They use the same technology, Verizon is spectrum-constrained in key regions and Sprint has lots of spectrum in many regions,” he said. Cingular/VoiceStream also makes sense. “Cingular will be a buyer at some point. They're big, they have a pretty strong balance sheet, they want to stay in the business — and they need spectrum,” Marsala said. VoiceStream is ripe to be plucked because it has the smallest number of subscribers among the Big Six as well as plenty of spectrum, he added.

A third pairing could put together AT&T and Nextel. The two have had previous merger talks, and it wouldn't take much to revive those talks, Marsala said. Nextel is a particularly attractive target because of its customer base — $70 average revenue per user and 2% churn — and its wealth of contiguous spectrum.

Beyond the megamergers, large carriers will set their sites on smaller carriers to “fill out their footprints in rural areas to avoid roaming charges,” said Kelly Cameron, a former FCC attorney who is now a partner with the Washington law firm Powell, Goldstein, Frazer & Murphy.

Regardless of how the merger game plays out, the FCC could have avoided being forced into lifting the cap had it not insisted on allocating spectrum to smaller, non-competitive players, said Patrick Comack, analyst for Guzman & Co.

“That was a joke. It resulted in the formation of baloney wireless companies backed by investors engaged in spectrum squatting,” he said. “And why give 10 MHz to companies that won't be around because they can't finance their operations?”

Another option would have been to exhibit a little patience and allow the development of new technologies that use spectrum more efficiently, said Bill Hipp, investor director of venture capital for 2M Invest. “The FCC is treating this as an ad hoc solution given current technology,” he said. “It's a knee-jerk reaction. They need to see the bigger picture.”
With additional reporting by Vincent Ryan in New York and Kelly Carroll in Chicago.