Events: Dish Network DB Spectrum Note Summary February 2015

Dish Network 

Events: Deutsche Bank Spectrum Note Summary

February 11, 2015


SUMMARY INFO

  • NASDAQ: DISH
  • Recent PPS: $76.94
  • Shares Out: 463 million
  • Market Cap: $35,623 million

DISCUSSION

The queue is perpetually chock-full of projects, but right at the top is a deep-dive look at Spectrum broadly and DISH specifically and where it fits into this complex puzzle. My time will free up dramatically after this week, so I anticipate something on this front by mid-March at the latest. Until then, I want to quickly summarize a recent note by the Deutsche Bank HY Corporate Credit team that came out February 4th. I am slightly biased because the note supports my bullish outlook for DISH equity, but with all possible objectivity, the note is a fantastic summary of the spectrum landscape and where the key players stand after the AWS-3 auction.

NOTE SUMMARY

Spectrum Landscape Pre-Auction. Prior to the AWS-3 auction, industry spectrum depth totaled ~584 MHz & ~183B MHz-Pops, with the MHz comprised of 23% low-band (LB), 46% mid-band (MB) and 31% high-band (HB):

  • Verizon: LB = 46 MHz/14.4B MHz-Pops; MB = 56/17.4; HB = 0/0
  • AT&T: LB = 48/14.9; MB = 50/15.6; HB = 28/8.9
  • T-Mobile: LB = 6/1.9; MB = 65/20.3; HB = 0/0
  • Sprint: LB = 16/5; MB = 37/11.5; HB = 152/47.5
  • Dish: LB = 5/1.4; MB = 50/15.6; HB = 0/0

Auction Results. In the AWS-3 auction, the FCC auctioned off 65 MHz/>20B MHz-Pops of spectrum across 6 different blocks:

  • A1 Block: 5 MHz, uplink
  • B1 Block: 10 MHz, uplink
  • G/H/I Blocks: 10 MHz, paired (5×5)
  • J Block: 20 MHz, paired (10×10)

Bidding totaled $44.9B gross with AT&T spending $18.2B, Dish $13.3B, Verizon $10.4B, T-Mobile $1.8B and others $1.2B. Net bidding totaled $41.3B. Valuations for each block on a $/MHz-Pops basis were as follows:

  • A1 Block: $.11
  • B1 Block: $.72
  • G Block: $2.37
  • H Block: $2.70
  • I Block: $2.69
  • J Block: $2.91

17 Mile Comment: My pre-auction DISH fair value was $101 based on a $2/MHz-Pops (tax-free…) and a 6X EBITDA multiple for the core business; in the wake of the auction, I believe this valuation is more than reasonable, as industry participants would likely jump at the chance to buy DISH spectrum for $2/MHz-Pops. However, I would not even consider trimming the position (at its current size) at $101…

In multiple conference calls leading up to the auction, Ergen stated ad nauseum that he believed the “Street” was undervaluing DISH’s spectrum portfolio and that the AWS-3 auction would shed greater light on its fair value. Ergen owns over $10B of DISH equity…my guess – and bet – is that he would laugh a $101 offer out of the room.

Spectrum Landscape Post-Auction. Industry spectrum depth now totals 649 MHz & 203B MHz-Pops, with the MHz comprised of 21% LB, 51% MB and 28% HB.

  • Verizon: LB = 46 MHz/14.4B MHz-Pops; MB = 67/21; HB = 0/0
  • AT&T: LB = 48/14.9; MB = 70/22; HB = 28/8.9
  • T-Mobile: LB = 6/1.9; MB = 70/21.7; HB = 0/0
  • Sprint: LB = 16/5; MB = 37/11.5; HB = 152/47.5
  • Dish: LB = 5/1.4; MB = 75/23.5; HB = 0/0

DB Commentary. Emphasis added.

On higher than expected valuation:

“The net total of $41.3 billion in provisionally winning bids is more than 2x the initial expectations of what the auction might raise. This speaks to: 1) the scarcity of future supply of airwaves, 2) an industry struggling to keep pace with surging user demand, and 3) a desire to future-proof networks for changes in consumer behavior.”

Catalyst for higher valuation:

“The fact that the J-block went for the highest total aggregate valuation should not surprise anyone. Channel depth of spectrum is an important aspect of being able to deliver faster LTE speeds to the user. In our minds, the real catalyst that drove valuations much higher was that unlike in prior major auctions, AT&T and Verizon were not allowed to just walk away with all the most-prized licenses. Without DISH, in our view, this auction would have turned out decidedly different.”

Uplink v. paired:

“Why the disparity of uplink- only vs. paired spectrum? Think about how you use your own phone. All of that surfing, streaming and gaming is downlink in nature. When we think about future usage trends among subs we expect the value of downlink to grow in importance.”

AT&T:

“T won 114 of the coveted 176 J-block licenses for a win-rate of 65% of this block. Its total spend of $18.2 billion is nearly $8 billion more than Verizon or DISH. Some suggested AT&T’s recent deals to acquire DirecTV, Iusacell and NII Holdings may have dampened its appetite to spend heartily. That was clearly not the case here. AT&T was the dominant J-block winner and while the price tag may have been more than T or anyone else thought it would be, AT&T is walking away from AWS-3 with a very impressive bounty of spectrum. AT&T’s pro forma portfolio has become mid-band centric, perhaps owing to a shift in vision that capacity (which is more spectrally efficient in mid and high band) may become more important than coverage (where low-band rules the day) going forward.”

Verizon:

“Verizon was officially this auction’s head-scratcher for us. The largest wireless company in the US by total subscribers bought far less than we had expected in terms of MHz POP’s (which isn’t influenced by pricing). If you allocate VZ’s pro forma spectrum holding in paired form (even amount of uplink and downlink) VZ now has the fourth-largest portfolio of downlink spectrum in the US behind Sprint, AT&T and DISH. We do not cover Verizon and we have no insights into what their plans may have been heading into this auction, but they may have some kind of contingency plan in place on how it will keep pace on needs for additional spectrum given that it boasts the largest post- paid wireless subscriber base in the US. T dominated VZ in the J-block and DISH kept them out of lots of major markets in many other blocks. An interesting tidbit: Verizon actually picked up zero spectrum in the largest market, New York. We would have never guessed that to happen.”

Why Dish involvement was critical:

“Some will be quick to cry foul as DISH does not remind anyone of a small business. The WSJ reported on February 2, 2015 that FCC Commissioner Ajit Pai was planning to officially call for an investigation into potential abuses of the designated entity rule that allowed DISH to save over $3 billion. That makes for some nice press, but in our view the reality is far different. First of all, the designated entity structure is a well-worn loophole that has been used before by most major wireless carriers in prior auctions. If the FCC doesn’t like the designated entity rule then it should probably change or otherwise abolish it. Commissioner Pai argues that the American taxpayer was potentially cheated by DISH winning this discount. However, we strongly believe that the only reason the valuations of the AWS-3 auction reached these impressive levels was that Northstar and SNR, in combination with DISH, were able to bid aggressively enough to keep AT&T and Verizon in line. With Sprint sitting this auction out and T-Mobile looking to be opportunistic only on licenses where it had a more immediate need for spectrum, DISH is the only thing that kept AWS-3 from becoming another Verizon and AT&T runaway. By forcing AT&T and Verizon to pay a very full value for their license wins and to keep several important licenses out of their respective hands altogether DISH not only maximized the returns to the FCC and the taxpayer, but it also helped ensure greater competitive balance in that VZ and T were prevented from using their massive balance sheet advantage to run the table on the most valuable spectrum.”

Dish strategy:

“Prior to the auction, DISH had an average spectrum depth of ~55 MHz across AWS-4, AWS-2, and 700 MHz, which would place them behind all four Big-4 wireless carriers. After AWS-3, DISH actually leapfrogs TMUS into fourth place among all major wireless carriers. That’s both impressive and perhaps odd considering that DISH is not yet in the wireless business. That being said, none of DISH’s spectrum has been built-out, which allows for less expensive investments compared to the Big-4 who generally have to decommission and refarm airwaves for the updated technologies, which are currently LTE. Management at DISH, mainly Chairman Charlie Ergen, is essentially trying to maximize the optionality of its assets and has developed paths for DISH as a standalone company as well as a strategic accumulator of highly valuable assets. With ~14 million DBS subscribers and high capacity mid-band spectrum, DISH is positioning itself to take advantage of the growing use of mobile video as well as the slow migration of the general public from Pay-TV to OTT programs and eventually a-la-carte options such as DISH’s offering released in early January 2015. DISH’s vision for the future effectively envisions the collision of wireless and Pay-TV / OTT as we know it today and the ability for consumers to access video at any point in time – hard to argue with that thesis.”

CONCLUSION

Ergen often compares his strategy to Seinfeld, where not even he knows exactly how the “episode” will end. All he/DISH is doing is giving himself/itself as much optionality as possible by paying reasonable prices for assets likely to increase in value over time. If it makes economic sense to enter the wireless business, then they will do it. DISH bid for Clearwire and Sprint separately, but lost out both times – they would have been perfectly happy to operate those assets at the prices they offered. If it makes economic sense to sell out, then they will do it; if it makes economic sense to become a spectrum wholesaler, they will do it. I will never be a spectrum expert; but I know Ergen is. Ergen has over $10 billion on the line with more than 50% of DISH’s market cap comprised of spectrum value…spectrum that must be 70% built out by 2020; spectrum that, if deployed as a 5th major wireless network, has the potential to become materially impaired. Ergen is an extremely conservative guy – to me, playing chicken with $10B is not conservative. Me thinks he has an Ace up his sleeve…

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