Will AT&T Inc Catch Verizon in Spectrum Race?

AT&T Inc. (NYSE:T) has put together roughly $2.6 billion in deals for airwaves to catch up to Verizon Communications Inc (NYSE:VZ), which is winning the race of stockpiling the industry’s next big asset.  Verizon has been very aggressive in building out its industry leading 4G LTE network, and AT&T has proposed at least 24 deals in the past four months to try to keep up with Verizon’s spectrum acquisitions (radio waves used to transmit mobile-phone calls and data connections).

AT&T Inc. (NYSE:T)

On August 23, Verizon won U.S. approval to buy airwave rights from Comcast Corp. (NASDAQ:CMCSA) and three other cable companies for $3.9 billion.  AT&T has made a push to acquire more spectrum not only to keep up with Verizon, but also to relieve pressure generated by network traffic from smartphones and tablets.  A larger spectrum range offers companies greater capacity to handle demand, and that’s why we’re seeing AT&T Inc. (NYSE:T) try to rake in as much spectrum as possible.

AT&T’s proposals still face review by the Federal Communications Commission (FCC), but assuming the deals go through, they would boost spectrum holdings by 62% in the biggest 100 U.S. markets.  The notable deals in the proposal include a $600 million purchase of NextWave Wireless, an arrangement with Sirius XM Radio Inc. (NASDAQ:SIRI) to utilize satellite signals, and a radio-wave deal with Comcast Corporation (NASDAQ:CMCSA) and Horizon Wi-Com LLC.

Analysts have estimated that AT&T will bid about $2 billion for airwaves that Verizon Communications Inc (NYSE:VZ) is also interested in.  The bid for Verizon’s airwaves will be AT&T’s second attempt to fill in the gaps in the company’s spectrum holdings, the first being the company’s attempted $39 billion takeover of T-Mobile that was opposed by regulators.  AT&T fell back in the spectrum race in 2006 when they were pursuing the acquisition of T-Mobile.  While AT&T was focused on the acquisitions, Verizon was purchasing cable airwaves from cable companies that abandoned their plans to build a high-speed wireless network to compete with Verizon and AT&T.

Many believe that AT&T and Verizon are becoming a national duopoly.  Concerns were voiced to the FCC by competitors, stating that AT&T’s proposal will weaken competition and increase the slope on the uphill battle.  AT&T’s purchases, along with Verizon Communications success acquiring cable spectrum, will prevent small and rural carriers from having access to airwaves.  The government appears open to letting AT&T buy more airwaves, and many are concerned that consolidation in the telecommunication industry will leave consumers with nowhere else to turn.

AT&T Inc. (NYSE:T) and Verizon already dominate the U.S. wireless industry, claiming roughly 60% of all customers.  AT&T’s wireless unit is the firm’s largest and most attractive segment and accounts for about half of sales.  The second largest wireless provider, only behind Verizon, has done a good job capitalizing on the wireless unit’s position, driving improvements in customer service, cutting costs, and securing exclusive rights to several phones.  Apple’s (NASDAQ:AAPL) iPhone remains important to AT&T.  Now that AT&T lost its bar on the phone, customer behavior is tough to forecast.  Data revenue is growing adequately, but the industry still faces a difficult translation as customers increasingly use data services, requiring new network infrastructure.  Data plan pricing likely needs to increase substantially from current levels to preserve wireless profitability.

With the spectrum race heating up between the wireless carriers, the FCC’s approval of AT&T’s proposal to acquire more spectrum is more important than ever.  The FCC uses the rules, known as a “spectrum screen,” when deciding whether to approve mergers and spectrum purchases.  Deals that violate the spectrum screen are viewed much more closely by regulators.  After regulators struck down AT&T acquiring T-Mobile, AT&T has lobbied for a review on how to measure spectrum.  Currently, the FCC devises a new screen for each deal on a case-by-case basis.  Although it relies on general guidelines, the rules are unique to every individual transaction.  AT&T’s persistence for a new method of reviewing spectrum did not go unnoticed.

This month, The Federal Communications Commission could overhaul the way it measures competition in the wireless industry.  Smaller carriers and consumer advocacy groups welcomed the news.  They argue that the current screen doesn’t accurately account for the fact that not all frequencies are equal. Higher frequencies, for example, aren’t as effective as lower frequencies at penetrating walls.  A company should trigger the screen, they argue, if it collects all of the most valuable spectrum.  “The current spectrum screen fails to identify the utility of different spectrum bands for wireless broadband communications,” said John Taylor, a spokesman for Sprint, which is nowhere near the size of AT&T and Verizon. “We are pleased that the Commission plans to consider improvements to its spectrum aggregation regulations and we look forward to participating in these discussions.”

It is difficult to speculate on how regulations will play out, and whether AT&T’s spectrum proposal will be approved.  We believe that it’s a flip of a coin what the outcome will be.  On one side, AT&T should be allowed to acquire to spectrum to catch up to Verizon Communications Inc (NYSE:VZ), on the other side, the two companies may be well on their way to a duopoly if that the proposal goes through.  AT&T has been known for flaunting their size and having a cocky mentality (they even gave regulators cupcakes when the T-Mobile acquisition was still in question), we believe that instead of complaining about regulation and looking at their massive spectrum muscles in the mirror all day, the company should be thinking strategically when seeking approval for a major proposal.

The question of will AT&T catch Verizon in the spectrum race may be the right question for investors, but the question regulators are asking themselves is what will happen if AT&T does catch Verizon Communications Inc (NYSE:VZ).  The question regulators answer will ultimately answer investor’s question.  We believe that competition is often correlated with the number of competitors in a market, and what keeps markets competitive is the possibility of new entry.  Spectrum has been treated as if it were protected land, barring anyone from entering the wireless market unless acquiring somebody who is already in the market.  To protect consumers from the threat of price gauging, policymakers should adopt policies that put spectrum in the hands of the providers that need it the most, not just the providers that can pay the most.  This month we believe that regulators will disappoint AT&T Inc. (NYSE:T) yet again, denying their proposal to grow their spectrum market to an even greater size.