Is U.S. Telecom Capital Spending Going Up in “Spectrum”?

Over the past couple of months several technology companies with meaningful exposure to telecom capital spending in the United States including Adtran, Ciena, Juniper and Procera have provided cautionary outlooks in their respective businesses. Most of the companies, analyst and press commentary on these earnings warnings primarily point to the impact of the AT&T Domain 2.0 vendor qualification process (including the associated architectural shift and additional pricing pressure it has brought to the industry), the pending consolidation of the some of the larger US telecom/PayTV operators (e.g. the AT&T/DirecTV and Comcast/Time Warner Cable deals) and a more front end loaded capital spending environment in the US than normal in 2014. While all of these factors are likely key contributing factors to the recent disappointing earnings of the technology companies exposed to US telecom capital spending, I also believe that pending wireless spectrum auctions in 2014 and 2015 are factors that have not received as much attention in the press and should be considered.

Wall Street analyst reports have suggested that the wireless spectrum being auctioned by the FCC in the AWS-3 auction in November 2014 is likely to cost the winners in the auction from $10-$15 billion with AT&T and Verizon likely being the major winners in this auction. To put this potential spectrum spending in perspective, AT&T and Verizon combined have an annual capital spending budget (both wireline and wireless capex) of about $36-$37 billion in 2014. Thus, if AT&T and Verizon spend a combined $9 billion in the November spectrum auction, it would represent about 24% of their combined capital spending plans for 2014, which is fairly significant percentage.

Another spectrum factor that potentially may impact capital spending in the short to intermediate term is the planned FCC Broadcast Television Incentive Auction, which the FCC estimates will take place in mid-2015. This spectrum auction is unique as the FCC plans on using free market forces to motivate existing broadcasters that own the spectrum to sell it in an auction format on a voluntary basis. Since the spectrum auction will be on a voluntary basis, its difficult to predict the potential timing, outcome and spending for the spectrum. Wall Street analysts, however, have written that wireless operators could pay as much as $34-$48 billion in the 2015 incentive auction for spectrum with AT&T and Verizon potentially spending a combined $21-$24 billion. Thus, if AT&T and Verizon combined spend about $9 billion and $22.5 billion in 2014 and 2015 respectively for wireless spectrum, this would represent about 43% of their combined overall capital spending budgets for the two years 2014 and 2015.  The following table shows how the potential spectrum costs in 2014 and 2015 compare to the overall US wireless industry capital spending budgets.

Estimates 2014 2015
AWS-3 Auction $10-$15 Billion
US Wireless Capex $34.1 Billion
AWS-3 Auction as a % of Capex 29%-44%
Broadcast Incentive Auction $33.6-$48 Billion
US Wireless Capex $34.5 Billion
Incentive Auction as a % of Capex 97%-140%

Source: Company reports and UBS Investment Research

Wireless operators have many cash pressures on their operating cash flow including network related capital spending, dividends, share buybacks, acquisitions and spectrum purchases.   Given the potential significant amount of spectrum purchases expected in 2014 and 2015 in the US, allocation of funds to spectrum spending by wireless operators may be another key factor that has led to weaker than expected network related capital spending, thus, resulting in weaker than expected earnings outlooks for certain technology companies. If one thinks about competing for cash outlays, deferring capital spending on equipment and allowing the network to run “hot” on a short-term basis, if possible, seems rational and plausible when such a large cash outlay is likely going to be needed for upcoming spectrum auctions. Network planning could also be potentially impacted as wireless operators have some uncertainty as to their spectrum assets pending the outcome of the auctions, which also could be impacting some spending in the network.