Verizon likely to divest wireless spectrum to get cable deal OK

Verizon Wireless' $3.6 billion bid to buy unused wireless spectrum from cable companies is likely to get regulatory approval. But Verizon may have to give up some of its wireless spectrum to satisfy regulators, say analysts and insiders close to the deal.

Analysts covering the market say it's almost a near certainty that the Federal Communications Commission will approve the deal, which Verizon and a coalition of cable companies owning wireless spectrum proposed late last year. Comcast, Time Warner Cable, and Bright House Networks, which are all part of Spectrum Co. plus Cox Communications, want to sell nearly 20MHz of wireless spectrum in the AWS frequency band to Verizon Wireless. As part of the deal, the companies have also agreed to co-market and sell each other's wireless and broadband services.

"If you read the tea leaves, they will approve the deal," said Craig Moffett, an equities analyst with Sanford C. Bernstein & Co. "And they'll use the conditions as leverage points."

On Thursday, Senate Antitrust Subcommittee Chairman Herb Kohl (D-Wis.) wrote a detailed, eight-page letter to the Department of Justice and FCC, which are reviewing the deal, in which he expressed "serious competition concerns" with both the spectrum sale and the joint marketing agreement between Verizon and its cable partners.

Paul Gallant, an analyst with Guggenheim Partners, noted that the chairman's letter is significant because it may act as a road map for regulators. Gallant said that Kohl's suggestions have been used in other recent telecommunications and media transactions. For example in the Comcast-NBC Universal deal, he recommended extensive conditions, and in AT&T/T-Mobile, he recommended rejection.

In his letter regarding the Verizon/Spectrum Co. deal, Kohl suggested that Verizon divest some of the AWS spectrum the company is hoping to acquire from the cable operators. (Verizon has already proposed selling off existing 700MHz spectrum in the A and B blocks.) But the joint marketing agreement, which has caused the most concern from antitrust watchdogs, may be the sticking point that unravels the entire deal. Because these agreements are pivotal to the transaction, any change that shifts the balance of benefit in another direction could ruin the deal.

The FCC has already extended its 180-day shot-clock for reviewing the deal. And it now says it will finish analysis of the deal by August 7. But the complicated nature of the deal with the marketing agreements in place, could delay a decision. And Gallant expects regulators won't make a final decision until the fall.

All eyes on the FCC

Initially, it was unclear what the FCC would do with this deal. Verizon announced its plans just as AT&T gave up its bid to buy T-Mobile USA for $39 billion after regulators said they'd reject the deal.

The industry has been closely watching the FCC to see how it will handle this transaction, which does not include the purchase of any wireless customers. But instead, only includes the transfer of unused wireless spectrum.

The FCC has made getting new wireless spectrum into the market a main priority of its agency. Wireless operators, both large and small, say they need more spectrum to expand their businesses and satisfy growing demand for wireless data from consumers.

And the agency has made some headway in its efforts, winning congressional approval to design an auction to allow TV broadcasters to sell unused spectrum. It's also working with government agencies to identify and resell spectrum that is being underused by Uncle Sam.

But these efforts won't get new spectrum in the market for years. And wireless operators say they need additional spectrum now. For these reasons, analysts say that the FCC must approve the deal with Verizon.

That said, the agency is still wary of Verizon having too much control in the market. And as a result, it's looking very closely at putting conditions on the transfer of wireless licenses that could help put some of the cable spectrum into the hands of competitors, such as T-Mobile.

"If the FCC rejects the acquisition outright they forgo the opportunity to shape the market," Moffett said.

Last week, Guggenheim Partners' Gallant published a note predicting that the FCC will require Verizon to divest some of its AWS spectrum. Even though Verizon has voluntarily agreed to sell off some of its 700MHz in the lower A and B blocks, Gallant said the agency still will likely require Verizon to also divest some of the AWS spectrum.

Gallant said that Kohl's letter to regulators supports the idea that the FCC is pushing for divestiture of the AWS spectrum. A source close to the FCC confirmed that the agency is looking at this as a possibility.

The spectrum question
The deal that regulators are reviewing has two parts. As it relates to spectrum, the main issue is the fact that Verizon Wireless is the largest wireless operator in the U.S. with one of the best spectrum positions in the market.

While Verizon claims that it needs additional wireless spectrum to grow its 4G LTE network, the company has admitted it won't use the AWS spectrum from the cable operators right away. Verizon bought a nationwide chunk of 700MHz spectrum in the 2008 auction. And it's using those airwaves to build its 4G LTE network.

But Verizon also owns about 20MHz of AWS, or Advanced Wireless Spectrum, in various markets. And the company has said it plans to use this higher-frequency spectrum to add capacity to its network in the future.

The traditional "spectrum-shield" that the FCC uses to help guide these decisions by looking at how much spectrum a carrier has in a given market may not be sufficient, given that it's not just the amount of spectrum that Verizon may have in a market, but the type of spectrum it owns.

The question the FCC must answer is whether Verizon should be allowed to buy the 20MHz of AWS wireless spectrum from the cable operators when it already owns about 20MHz of wireless spectrum in the same AWS band that it's not currently using. In LTE deployments it's ideal to have lower spectrum such as the 700MHz spectrum for coverage and higher-frequency spectrum, such as the AWS spectrum in the 1.7GHz to 2.1GHz range, for additional capacity.

In roughly 100 markets where Spectrum Co. owns licenses, Verizon already owns a significant amount of AWS spectrum. And if it were allowed to buy the Spectrum Co. AWS spectrum, Verizon would own roughly 40MHz of wireless spectrum in the AWS band in many major markets. What's more, at least initially, Verizon wouldn't be using that spectrum for its 4G LTE network. It would be held in reserve to add additional capacity.

This is where Verizon's competitor T-Mobile has argued that Verizon is "warehousing" wireless spectrum. T-Mobile, which also uses AWS spectrum for its HSPA+ network, could easily put the AWS spectrum into use immediately. T-Mobile is also planning to build a 4G LTE network. And it's been re-farming its existing spectrum to get enough capacity to deploy a network.

"The industry is at a critical time in the transition to 4G LTE," said Kathleen Ham, vice president of federal regulatory for T-Mobile. "And spectrum will be the key to success in this transition. We just want to make sure that we aren't in a situation where we end up with spectrum haves and have-nots."

She said that T-Mobile built out its initial swath of AWS spectrum it acquired in the 2006 auction very quickly. And she said that T-Mobile is concerned that Verizon will be holding onto valuable spectrum that could be used by other players to support services consumers want and need, especially since Verizon may not need this spectrum for a few years.

"When it comes to spectrum policy, we're in a time crunch that's driven by data usage on the consumers side," she said. "People want to do more and more cool things with their devices. And that takes capacity and spectrum."

But even if the FCC felt that T-Mobile or some other competing wireless carrier would be a more desirable owner of Spectrum Co.'s AWS spectrum, the agency can't tell the cable companies to which companies they must sell their assets.

"The law is crystal clear on this," said David Cohen, an executive vice president heading up regulatory affairs for Comcast. "The agency is required to review the transaction that is in front of it. They can't say whether or not this is the best purchaser of the the asset. It's their obligation to review this transaction and only this transaction."

That said, the FCC could require Verizon to sell some of the AWS spectrum. And if it did this, it would offer T-Mobile a big opportunity to get a piece of this value spectrum that would fit nicely with its existing spectrum assets.

Marketing deals
But even if Verizon agreed to divest some spectrum assets, there are indications that the Justice Department and FCC are also concerned about the co-marketing agreements between Verizon and the cable companies.

Under this arrangement, Verizon Wireless has agreed to resell cable services and the Spectrum Co. cable companies have agreed to resell Verizon's wireless service to their customers. This deal has come under scrutiny since Verizon Wireless' parent company, Verizon Communications sells broadband, TV, and voice services that compete with cable offerings.

Analyst Paul Gallant in his note on Thursday said that he is uncertain how this would affect the deal.

For example, cable operators may object if there were limits or bans on marketing cable services where cable broadband Verizon Fios services overlap.

Comcast's Cohen has already testified to Congress that the spectrum sale and joint marketing agreement are a single deal.

"So if one side assigned greater value to the Fios-based joint marketing arrangements -- and that aspect of the deal is reduced/eliminated -- it is conceivable (although far from clear) that the companies might need to revise the deal in some fashion to account for that value shift in the economics of the agreement," Gallant said in his research note.

In a conversation this week with CNET Cohen wouldn't say which conditions Comcast would agree to, but he said that the company is willing to sit down to talk. And he reiterated the importance of the marketing deal with Verizon as a cornerstone of the deal.

"There is no secret that our interest is not just in selling spectrum," he said. "This is a strategic asset to enable us to develop a complete wireless strategy. When our Plan A of building our own network didn't work out, we still planned to leverage this valuable asset to help us strategically. That's what the Verizon deal gives us."