Tuesday, March 25, 2008

On C Block

There was a time when the sale of communications spectrum by the Federal Communications Commission (FCC) could be considered manna from heaven for communications equipment suppliers. Yet market dynamics are ever in flux. Does the link still exist between new spectrum ownership and equipment sales?

The FCC just concluded another round of spectrum auctions last week. This time it was a slice of the 700 Megahertz spectrum previously allocated to television broadcast. The spectrum will not need it as television goes completely digital in February 2009. It was a big haul for Uncle Sam. Winning bids totaled $19.1 billion from 101 bidders for 1090 licenses.

The highest bid for D Block was $472 million, but it did not meet the reserve price and so did not become a “winning” bid. The reserve price was $1.3 billion set before the auction started. The FCC apparently plans to hold D Block back and reconsider its options. The FCC planned to created a 10 MHz license in the D Block for the Public Safety/Private Partnership, which was set up to work on interoperability issues that prevent police, fire and other first responders from communicating with each other.

The D Block will sit there tantalizing communications industry analysts for a little longer. In the meantime, we can all start drooling over how the winning bidders will deploy Blocks A, B, C and E.

Many had speculated that the auction would redefine the wireless communications landscape. Google persuaded the FCC to designate a portion of the spectrum swath in C Block as “open access,” allowing the use of any device or application a consumer or service provider might want. Google argued this would encourage innovation among device manufacturers. Verizon is challenging the open access rule and since Verizon was a big spectrum winner and Google was not, it will be interesting to see whether the FCC reverses itself.

The market opportunity for equipment manufacturers is not limited to the open access matter. Signals behave differently in the 700 MHz spectrum, passing more easily through obstacles like walls. This means that network operators do not need as many base stations as with networks operating in other spectrums. This is great for the margins of service providers like Verizon (VZ: NYSE) and Qualcomm (QCOM: Nasdaq), but not so good for the suppliers of base station equipment such as Motorola (MOT: NYSE) and Alcatel (ALU: NYSE).

Perhaps more important for communications equipment supplies is progress in broadband penetration. In the U.S. broadband penetration is approximately 45% in early 2008. Sounds impressive, expect that this puts the U.S. about 15th in the world. The failure to keep up with broadband is expensive. According to the OECD, U.S. service providers are charging around $10 per Mbps, while the cost is near $1 per Mbps among the broadband leaders.

Catching up to the rest of the world in broadband access could be a huge savings for U.S. consumers. However, we strongly suspect the wireless telecoms are more interested in maintaining their profit margins. The telecom industry is a strong lobby in Washington, but the need for saving for the consumer and the need to catch up with the rest of the world may finally make an impression on politicians. Perhaps the new president will turn to this issue after next year. The broadband build-out could truly be an opportunity for equipment suppliers.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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