The Battle for Bandwidth

by Investing Daily
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Dish Network Corp’s (NSDQ: DISH) $3.30 per share bid for battered Clearwire Corp (NSDQ: CLWR) is the latest escalation in the battle for scarce remaining US wireless spectrum.

On its face, Dish’s bid is definitely superior to the $2.97 per share offered by Clearwire’s 50 percent owner Sprint Nextel Corp (NYSE: S). It also makes it far less likely Sprint will be able to convince a majority of the other 50 percent of Clearwire owners to accept its current bid.

At present, 26 percent of those eligible to vote on the Sprint offer have declared their intention to vote for it. That’s against 32 percent who have said no and 42 percent yet to declare one way or the other.

Sprint can clearly block Dish’s bid, even if the other Clearwire shareholders favor it. And management’s initial statement is it has no intent of “agreeing to, waiving or permitting” any of the conditions in the Dish proposal.

Neither, however, is Sprint likely to be successful convincing a majority of other shareholders to accept less than Dish’s bid to tender their ownership. That means, despite company statements that it “doesn’t feel pressure” to raise its bid, it will almost certainly have to pay up or else resign itself to the fact that it won’t own more than half of Clearwire.

This bidding war for what’s essentially a bankrupt former unit is just the latest stumble for Sprint in the US wireless market, as it struggles to defend high-end business against AT&T (NYSE: T) and Verizon Communications (NYSE: VZ)–as well as low-end business against Deutsche Telekom’s (GR: DE, OTC: DTEGY) T-Mobile USA and others. It also makes an eventual takeover of Leap Wireless International (NSDQ: LEAP) more likely, possibly by T-Mobile USA.

As I’ve written many times before, it takes money and scale to win in today’s fiercely competitive and rapidly growing US communications business. Companies that are able to spend heavily on networks are widening their lead in technology and network quality over those that can’t. And scale is essential to having adequate capital.

Giants AT&T and Verizon, for example, spent nearly $26 billion combined in the first nine months of 2012 alone. By contrast, No. 3 US wireless company Sprint was only able to deploy $3 billion, and not without increasing its already prodigious debt load.

Sprint’s sale of 70 percent of its stock to Japan’s Softbank Corp (Japan: 9984, OTC: SFTBY) should bolster its cash position. And that should keep it alive a while longer as the bidding war for wireless spectrum continues to wind up.

There is a very real question, however, about whether paying up for wireless spectrum is really the most cost-effective way to boost communications companies’ long-term capacity to run broadband networks. Fiber-optic cable, for example, has far greater capacity and speed to send and receive data.

Out-of-Favor Fiber

Back in the 1990s, Wall Street raised more than $100 billion to finance companies that laid fiber-optic cable for businesses known as competitive local exchange carriers, or “CLECs.” But by 2002, virtually all of them had either been acquired or gone bankrupt, including WorldCom, which had bought literally hundreds of CLECs before being acquired out of bankruptcy as MCI by Verizon.

The early CLECs went bust because their builders assumed business would automatically flow to them, and were overwhelmed by debt when it didn’t. Their networks, however, speeded the advanced wireline development of AT&T and particularly Verizon, which augmented them with their own fiber-optic cable deployment.

Verizon’s FiOS fiber-to-the-home network continues to grow. On a corporate level, however, it’s been overshadowed by construction of the 4G wireless network, built on long-term evolution (LTE) technology. And with the company still adding wireless customers and migrating 50 percent of its data traffic to LTE, that’s likely to remain the focus of its capital-spending plans.

AT&T will likely be slightly more wireline-centric with its network outlays, at least over the next few years. The company has promised to build out its U-verse broadband system in order to win Federal Communications Commission (FCC) approval for shutting down its traditional phone network entirely.

Rural wireline companies such as Windstream Corp (NYSE: WIN) are constructing fiber networks for the purpose of better connecting wireless towers. And others such as Frontier Communications (NYSE: FTR) have actually based their long-run strategies on converting a dwindling base of traditional phone customers to wireline-based broadband, with fiber-optic cable as the chief raw material.

In dollar terms, however, all of this investment is a fraction of what’s being poured into expanding wireless networks. And there’s absolutely nothing happening in the cellular-focused US communications industry to indicate that will change any time soon.

One reason for the dominance of wireless is simply greater panache. The information technology industry led by Apple (NSDQ: AAPL) has turned the telephone into a popular consumer item, capable of performing as a perfectly functional camera, computer and television as well as direct communications device.

The basic wireline phone simply can’t compete on that front. Americans have also gotten used to being able to communicate with anyone at any time by voice, text and email. The portable wireless phone is the obvious vehicle for doing this, and desktop phones and computers can’t do the job.

The problem with a US communications “strategy” focused solely on wireless is spectrum. In the words of a friend who deals with communications issues on Capitol Hill, wireless “is the equivalent of a two-lane highway.” It’s only capable of providing so much capacity, no matter how you stretch it out with software. We’re already seeing the resulting traffic snarls, and the gridlock is only going to get worse in future years as demand for greater and faster global connectivity escalates.

By contrast, building a network with fiber-optic cable today is the equivalent of constructing a 32-lane super highway. The capacity may not be needed now, but it will be in the next decade. And with corporate borrowing rates at record-low levels, cash in abundance and construction crews apparently available, there may never be a better time to build one than now.

Uneven Playing Field

Building fiber, of course, is not nearly as attractive to capital as it was in the 1990s. For one thing, the FCC has decided to tightly regulate wireline broadband networks, while basically keeping hands off wireless networks.

That’s been a pretty huge incentive for companies that have the capital to focus on wireless innovation, rather than a fiber buildout. And again, there doesn’t appear to be a move in Washington to establish a level playing field.

Wireless companies, for example, have successfully challenged in court the FCC’s ability to regulate their broadband networks. Meanwhile, the Obama FCC’s 3-2 Democratic majority isn’t likely to give up one of its few levers left to shape the industry by rolling back wireline regulation.

As a result, bidding billions for scarce wireless spectrum will almost certainly remain the rule for the communications industry in the foreseeable future. That in turn will favor the large and well capitalized, and handicap those that lack scale.

The bits and pieces we’ve seen on fourth-quarter earnings prior to upcoming releases are definitely bearing this out once again in real-world numbers. Verizon, for example, activated 9.8 million smartphones during the three months ended Dec. 31 with “a higher mix of Apple” products, as well as 2.1 million retail postpaid contract additions. AT&T reportedly did even better at 10 million-plus activations.

It’s possible many of those new customers are entirely new to wireless phones. Most likely, however, they came from smaller rivals, increasingly less able to compete and less profitable because of it.

That trend has accelerated the past few years. And with rivals unable to remotely keep up with spending, odds are it’s got a long way to run. Uncover my top telecom picks in my free report, The Top 5 Dividend-Paying Companies for 2013.

This article was originally published on Investing Daily under the title: The Bruising Battle for Bandwidth.

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