September 30, 2020

Investors Prospect for 5G Treasure in Cellphone Spectrum

Big stock gains seen as wireless providers scramble for valuable new turf, up where the satellites roam.

Reported by Larry Light

Art by A Richard Allen

An invisible gold rush is underway that should improve the lot of the US’s head-knocking trio of top wireless providers—AT&T, Verizon Communications, and T-Mobile. Plus their investors, eventually.

The race is to lock in the new cellular spectrum the companies need to compete in upcoming fifth-generation, or 5G, data transmission, from federal auctions. That’s the first step in the quest for 5G leadership, which will be fierce.

Broadcast frequencies (aka bandwidth or spectrum) are invisible to the eye, but a lot of very tangible money is on the line, up among orbiting satellites that beam signals back to the ground. Spectrum is the pathway that cellphones, TVs, radios, and myriad other electronic communications devices use to reach the public. Cellphones and the other digital uses are vital infrastructure for the US and the world, so enhancing them provides a good opportunity to investors.

On the 5G front, T-Mobile is the market darling compared to its two rivals, with its stock up 46% this year. One reason: The company has a head start in claiming bandwidth territory. AT&T’s stock is down 27% and Version is essentially flat, off just 1%. The auctions by the Federal Communications Commission (FCC), which oversees the spectrum, could make the other two much more competitive in the stock market with T-Mobile, which earlier this year added to its capacity by buying Sprint.

“For carriers, 5G is a critical and necessary buildout,” said Nic DiLoretta, deputy head of private equity and real assets research at consulting firm Aksia. “For investors, there’s the potential for private equity-like returns.”

Corporate demand for valuable real estate out in the ether, already high, is set to expand exponentially. Licenses for this capacity, such as the ones next being auctioned off in December, last for 15 years. DiLoretta said it’s expected the licenses can be renewed, or leased out to others. The frequencies, he noted, “should be worth more as time goes by.”

Bandwidth Bonanza

And how. These assets have appreciation built into them because of the rising need for broadband that goes far beyond your phone. Witness the dawning of the so-called Internet of Things, or IoT, which connects physical devices via sensors to digital networks.

The current manifestation of this is the “smart home,” where security alarms, doorbells, thermostats, and the like are connected to an electronic hub. Want to make your house warmer before you’re back home? While you’re still at work, you can tell the basement furnace to crank up. The IoT’s uses will spread through every aspect of life, from factories to retail, from offices to medical care. A wearable device might signal you and your doctor about an underlying health problem, for instance. Autonomous cars and robot surgeons are all part of the possible 5G future.

Meanwhile, much of the action is centered on mobile devices. What will a 5G phone deliver that an older model won’t? Much faster speeds, up to 100 times quicker than the now-dominant 4G version. Plus, 5G offers dramatically reduced latency, which is how long different devices take to talk to one another. Once the rollouts are complete, there will be less need for Wi-Fi. Then, your phone can download a two-hour movie in three seconds.

Right now, phones are popular, of course, and they stand to be even more so once they are 5G-enabled. Revenue from the cellphone industry in the US almost doubled over seven years to reach $59 billion in 2019, according to research firm Statista. Although a dip is expected this year from the recession, the sector is expected to see a 3% annual growth in the future.

In the short term, though, the lack of widespread 5G capability may slow the pace of phone sales growth somewhat. The new iPhone 12, which should soon arrive (a launch date remains unclear), is billed as 5G enabled. The problem is that 5G chips are very expensive now, which boosts the price of the new devices. Acclaimed industry analyst Ming-Chi Kuo of KGI Securities has predicted that shipments of the 12 model this year and next will be half the level that prognosticators expect.

The shift to 5G will be costly, as the carriers must lay out a lot of money for the new frequencies. The FCC is likely to garner anywhere from $10 billion to $30 billion from the wireless firms. That’s not all gravy for Washington, however.

The agency must pay satellite operators Intelsat SA, SES, and Telesat, now occupying a chunk of the spectrum to be auctioned, just under $10 billion to relocate elsewhere. At least the carriers need not pay the Pentagon to relinquish some of its bandwidth, which the FCC also aims to peddle to the wireless bunch. A 5G future also calls on the industry to install thousands of new antennas.

Different bandwidths are affected: low-band (the most basic level, used for TV and some cell traffic, usually in rural regions), mid-band (blessed with the ability to cover a wide area), and high-band or “millimeter wave” (which is faster and can carry more capacity, but has trouble penetrating walls, so many booster antennas are required). This last group has wavelengths that are so close together they are measured in millimeters, hence the moniker. Verizon has a large position in high-band, and much of the current auctioning focuses on mid-band.

All over the earth, a push is on to adopt 5G. “It will be the world’s central nervous system,” said Paul Dellaquila, president of Defiance ETFs, one of whose exchange-traded funds (ETFs) tracks 5G, listing 78 different stocks including AT&T, Verizon, and T-Mobile. In a time of ascendant tech names, the fund is up 13.8% this year through August.

Certainly, a lot of companies around the globe will benefit from the advent of 5G. China’s Huawei this year became the world’s largest smartphone seller, zipping past South Korea’s Samsung. But Huawei has a weakness: The firm faces trouble in the huge US market from the Trump administration, which accuses the company of spying and restricts it from buying American chips or equipment. Other 5G winners, Dellaquila said, will be cell tower businesses, such as Crown Castle.

Spectrum Scrum

T-Mobile is less of a player in the auctions, as the post-merger company already owns a lot of bandwidth. The other two are playing catch-up. While 5G is being deployed now, the vast framework needed for ubiquitous use is still in the future. Here’s how the major US competitors stack up as companies and as investments:

AT&T. By revenue, $175 billion (12 months trailing), the old American Telephone & Telegraph is the nation’s largest telecom company. Founded by Alexander Graham Bell in 1885, what’s now AT&T also is an entertainment conglomerate, after its 2018 buyout of Time Warner, so now it’s also into TV and movie production.

The acquisition, and an earlier takeover of DIRECTV, has ballooned long-term debt, which at $153 billion now towers over that of Verizon ($106 billion) and T-Mobile ($72 billion).

The monster debt and the splintered focus have dogged AT&T’s stock, in contrast with Verizon’s flattish performance and T-Mobile’s romp. But, on the good side, the previous Ma Bell’s price/earnings ratio (P/E) is an affordable 17, a lot less than the S&P 500’s and only slightly above the index’s long-term average. In addition, AT&T has whittled down the debt, from a high of $168 billion in 2018, the year it purchased Time Warner. Thanks to its devotion to paying and hiking dividends, the payout yield now is a lush 7.4%.

Revenue and earnings are shaky, however, with analysts estimating they will slip 7% and 10%, respectively, for the year. To be sure, AT&T’s wireless operations still are expanding, with an 8% annual increase in subscribers last quarter.

Unfortunately, cord cutters are hurting the pay-TV business: AT&T lost around 20% of those customers last quarter, versus the prior-year period. Its DIRECTV and broadcast channels are lagging behind standalone streaming services, prominently Netflix. And Warner Media has suffered from the pandemic, which has crippled production of new TV shows and movies.

Nonetheless, AT&T has a big advantage in the 5G race: the largest wireless subscriber base. “They can roll out 5G to many more cities” than the others, Defiance’s Dellaquila said. As of mid-year, by Statista’s count, AT&T had 34.8% of the US market, with T-Mobile at 24.9% and Verizon at 24.3%.

Verizon. The company has mounted a major push to move beyond its high-band spectrum base into mid-band. In the most recent auction, it paid $1.9 billion for part of that segment. Another auction is coming in December for a different batch of mid-band, known as C-band. The carrier intends to expand into 30 US cities this year, including Houston, Indianapolis, Los Angeles, and Sacramento, California. It just struck a partnership with a small outfit called AWS Wavelength to gain a large piece of the Boston market.

The company is touting its 5G technology as superior to others. Verizon points to its sizable presence in the high-band spectrum—last year, it beat out AT&T to buy Straight Path, which added to its millimeter trove—even as it seeks to bulk up in mid-band.

Verizon recently had an ad that said it was “building the most powerful 5G experience in America.” But the National Advertising Review Board told the carrier to stop making that claim, arguing that what constitutes “most powerful” is unclear. Critics say Verizon’s large occupancy of high-band spectrum means that some of its signals won’t cover much acreage: This frequency level is best concentrated in one area, like a sports stadium or a convention center, places that aren’t too populous in this time of pandemic.

The stock is cheaper than that of the other two big boys, with a P/E of 12.8, below the market long-term average. And it has a nice dividend yield, at 4.2%, albeit not as enticing as AT&T’s. Verizon also has a large debt load, from its 2014 deal to buy out the large stake that British telecom Vodafone owned of it. This sent long-term debt soaring at $116 billion; it since has pared that by $10 billion. Another acquisition, of AOL and Yahoo, proved to be troublesome, and entailed a $4.6 billion write-down.

T-Mobile. With the addition of Sprint, the scrappy telecom’s 5G coverage extends to more than 7,500 U.S. cities and provides 5G access to a third of the country. That means over 1.3 million square miles, which T-Mobile claims is more than double AT&T’s geographic footprint. The broad-ranging coverage relies on holding a wide swath of the low-band spectrum. Downside: This strategy sacrifices speed, at least temporarily, until better techniques come along.

Further, T-Mobile has cut back its capital spending during the long quest for Sprint, said Joe McCormack, associate for telecom and media at Third Bridge. The carrier took on a lot of debt for the Sprint deal, thus it may face some constraints finding the money it will need for the 5G buildout, he pointed out.

Undercutting the competition on price has long been a T-Mobile tenet. The company, which calls itself “the un-carrier,” plans to stick to the practice. Completing the Sprint deal took a long time and, after a bloc of state attorneys general sued, T-Mobile had to divest some assets, such as spectrum licenses, cell towers, and a pre-paid plan to Dish Network, which is now the nation’s fourth largest cell company.

The market certainly appreciates T-Mobile’s spunk, which maybe stems from its origins outside the fusty confines of Ma Bell (AT&T and Verizon are both her offspring). Despite a lofty P/E (41) and no dividend, T-Mobile managed to create a lot of good will on Wall Street—and among the public.

Nobody seemed to care that it was foreign-owned, by Deutsche Telekom. Created in 1990, T-Mobile moved aggressively into the US. The newcomer’s hallmark, aside from lower prices, was extensive customer service, even going so far as to send subscribers gifts like meal certificates at Taco Bell. Post-merger, Deutsche Telekom owns 43% of T-Mobile and Japanese holding company SoftBank, 24%, with the rest held by the public.

One thing we do know is that 5G will spark a lot of industry growth. As Aksia’s DiLoretta put the matter, “bandwidth will no longer be sufficient to meet higher demand.” And regardless of the stock market picture at the moment, robust demand is a fertile ground for a good investment.