Contents

Communications & Digital Technology Industries Committee ABA Section of Antitrust Law

Spring 2012

2

Committee Leadership

3

From the Editors

4

Looking Forward From AT&T/T-Mobile: SpectrumRelated Transactions and Policies Paul de Sa

14

Verizon’s Deals With Cable Companies Raise Significant Competitive Issues Richard Brunell

29

AT&T/T-Mobile: The Importance of State Enforcement Ben Labow and Helen M. Mickiewicz

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Committee Leadership Paul H. Friedman, Co-Chair Dechert LLP Washington, D.C. [email protected]

Winter 2011

Gail F. Levine, Co-Chair Verizon Communications [email protected] Matthew C. Hammond, Vice-Chair United States Department of Justice, Antitrust Division [email protected] Sujal J. Shah, Vice-Chair Bingham McCutchen LLP [email protected] Martin L. Stern, Vice-Chair K&L Gates LLP [email protected] Emilio E. Varanini, IV, Vice-Chair Office of the Attorney General, California [email protected] Dana R. Wagner, Vice-Chair Square Inc. [email protected] Melanie Sabo, Council Representative Federal Trade Commission [email protected] Jason D. Cruise Young Lawyer Representative Latham & Watkins LLP [email protected]

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From the Editors In this issue of ICARUS, we take a look at the aftermath of the the failed AT&T/T-Mobile merger and what lies ahead for a wireless industry facing increasing incerasing demand on its spectrum.

Winter 2011

ICARUS EDITORIAL BOARD EDITORS-IN-CHIEF SUJAL J. SHAH BINGHAM MCCUTCHEN LLP [email protected]

Paul de Sa looks at the landscape of the wireless industry after AT&T/T-Mobile, surveying the myriad spectrumrelated transactions we may see in the coming years and the regulatory challenges they may face. Richard Brunell turns to Verizon’s bid to acquire spectrum from cable companies, and argues that Verizon’s deal with the cable companies raises significant competitive concerns.

EMILIO E. VARANINI, IV OFFICE OF THE ATTORNEY GENERAL, CALIFORNIA [email protected]

Ben Labow and Helen Mickiewicz review California’s involvement in challenging the AT&T/T-Mobile merger and signal what may be a move to increased state merger enforcement in the wireless industry.

ECONOMICS EDITOR ROBERT J. LEVINSON CHARLES RIVER ASSOCIATES [email protected]

As always, the views expressed in these articles are those of the authors alone, and do not represent the views of the Committee or its leadership. If you have comments on any of this issue’s articles or, better yet, an article idea for a future issue of ICARUS, please let us know. We appreciate your engagement with the Committee and look forward to seeing you at future programs. – Sujal J. Shah – Emilio E. Varanini

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Looking Forward From AT&T/T-Mobile: SpectrumRelated Transactions and Policies Paul de Sa 1

[email protected]

Introduction AT&T’s desire for additional spectrum was a central justification claimed for its attempted acquisition of T-Mobile, 2 and in recent months other major spectrum-focused deals have also been in the headlines: AT&T’s successful acquisition of spectrum from Qualcomm; Dish Network’s recently approved purchase of satellite-spectrum-owning companies DBSD North America and TerreStar Networks; and Verizon’s proposed acquisition of spectrum from Cox and SpectrumCo, a consortium of cable companies. This article discusses aspects of spectrum policy that readers of this journal may find of interest as context for the review of these mergers by the Federal Communications Commission (FCC), as well as for considering future spectrum-related transactions. Spectrum-Policy Issues Mark Twain’s aphorism about real estate – “Buy land, they’re not making it any more” – also describes the main challenge of spectrum policy: the amount of spectrum available is limited as a matter of physics, with much of it is already allocated to particular uses and users as a matter of history; but innovation has increased the demand for spectrum as wireless applications have

1

Paul de Sa was Chief of the Office of Strategic Planning at the Federal Communications Commission (FCC) from July 2009 to February 2012. The views expressed in this article are personal and do not necessarily reflect those of the FCC, other Commission staff, or any Commissioner.

2

For example, the press release announcing the proposed transaction stated that it “[a]ddresses wireless spectrum challenges facing AT&T, T-Mobile USA, their customers, and U.S. policymakers. This transaction quickly provides the spectrum and network efficiencies necessary for AT&T to address impending spectrum exhaust in key markets driven by the exponential growth in mobile broadband traffic on its network.” See AT&T to Acquire T-Mobile USA from Deutsche Telekom, AT&T (Mar. 20, 2011), available at www.businesswire.com/news/home/20110320005040/en/ATT-Acquire-T-Mobile-USADeutsche-Telekom. Ironically, the actual result of the failed deal will be for AT&T to lose about $1 billion worth of spectrum, which it is transferring to T-Mobile as part of the breakup fee agreed with Deutsche Telekom. See T-Mobile, AT&T Seek Approval of Spectrum Transfer, WALL. ST. J. (Jan. 24, 2012), available at online.wsj.com/article/ SB10001424052970203806504577179300684107824.html.

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grown from radio to broadcast television to mobile voice to mobile narrowband data and, most recently, to mobile-and-fixed wireless broadband. At present, the FCC finds itself in the unfortunate position of having very little incremental spectrum ready to distribute for commercial mobile use, despite demand from all existing wireless carriers (and potential entrants), as well as the widespread recognition that devoting more spectrum to mobile broadband could benefit both consumers and the nation’s economy. As a result, to meet its statutory goal of managing commercial spectrum to “encourage competition and provide services to the largest feasible number of users,” 3 the FCC’s actions have recently been focused on efforts to reassign spectrum currently suboptimally allocated for other purposes (such as broadcast TV, satellite services, and government functions) to terrestrial wireless use. 4 In parallel, wireless carriers have made efforts to use the spectrum they currently have more efficiently, for example by investing in advanced network technologies, offloading traffic using unlicensed Wi-Fi hotspots, and instituting new pricing schemes, such as charging customers based on usage in an attempt to better match supply with demand. Some companies have also attempted to acquire spectrum from existing licensees via transactions, the regulatory implications of which are the focus of this article. A.

Current Spectrum Allocation

Based on FCC information and other data, Deutsche Bank recently estimated that a total of 166 billion MHz.POPs of spectrum has been licensed nationwide for mobile wireless services. 5 Of this, 30% is held by the two largest wireless retailers – Verizon Wireless (15%) and AT&T Mobility (15%); almost 20% by the other two national carriers – Sprint (9%) and TMobile(9%); and 5% by small regional retail carriers, such as Leap, MetroPCS, and US Cellular. The remaining 45% is currently held by licensees who do not provide significant retail services: 24% is held by Clearwire, which primarily wholesales capacity to Sprint; 3% is currently held by cable companies (SpectrumCo and Cox) pending its proposed transfer to Verizon; and the remainder is fragmented, mostly among small licensees.

3

47 U.S.C. § 332 (a)(3) (2012).

4

See, e.g., Chairman Genachowski’s Remarks at the GSMA Mobile World Congress (Feb. 27, 2012), available at www.fcc.gov/document/chairman-genachowskis-remarks-gsma-mobileworld-congress.

5

Brett Feldman et al., Coping with the Spectrum Crunch: Part 1, Deutsche Bank (Sept. 30, 2011) (on file with author). Spectrum bandwidth is measured in megahertz (MHz) and, as licenses may cover some or all of the United States, estimates of spectrum holdings are generally made by multiplying the capacity (MHz) allocated by the number of people covered (POPs). For example, a license for 20 MHz of spectrum covering the entire country corresponds to 20 MHz x 300m POPs = 6 billion MHz.POPs.

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Note that spectrum varies with respect to physical characteristics – such as the ability of transmissions at different frequencies to propagate through air and through walls and windows into buildings, which affects the cost of constructing a network of a given service quality as well as business-model aspects, such as the availability of equipment and devices (e.g., handsets). For example, although Clearwire has a large holding in terms of MHz.POPs, its spectrum is at a relatively high frequency, making it much less valuable on a stand-alone basis than the lower frequency spectrum licensed to the larger wireless carriers. 6 Thus, not all spectrum is of equal importance with respect to the competitive advantages bestowed on its licensee. Furthermore, as not all licensed spectrum is currently being used to serve wireless customers, not all spectrum transfers necessarily entail the simultaneous transfer of subscribers. This is an important distinction between the proposed AT&T/T-Mobile transaction and other potential deals. 7 B.

The Pipeline of New Spectrum

In March 2010, recognizing the value of making more spectrum available for mobile broadband use, the FCC established a 5-year goal of adding 90 billion MHz.POPs of capacity (300 MHz of nationwide spectrum) to the existing 166 billion MHz.POPs already licensed. 8 This additional spectrum would mostly come from reassigning spectrum currently used or allocated for other purposes. In the two subsequent years however, only modest progress has been made, perhaps because other branches of government do not yet appear to share the enthusiasm of the FCC and wireless carriers for repurposing spectrum for commercial use. Despite a presidential memo

6

In addition, Clearwire has to date not been able to benefit from a large ecosystem of devices capable of operating on its frequencies. This may change in the next few years as Clearwire migrates from WiMax to LTE, and large international carriers such as China Mobile, Softbank (Japan), and Hutchison (Scandinavia) operate similar networks, driving scale for the supply of chipsets and devices operating on those frequencies.

7

For example the Verizon/SpectrumCo transaction currently under review does not involve any subscriber transfers, as SpectrumCo, having purchased the spectrum in a 2006 auction, did not subsequently put it to use. Although beyond the scope of this article, it is worth noting that the FCC may increasingly attach use-it-or-lose-it conditions to spectrum licenses to discourage the hoarding of spectrum for reasons of either speculation or competitive foreclosure.

8

See, e.g., FED. COMMC’NS COMM’N., CONNECTING AMERICA: THE NATIONAL BROADBAND PLAN (March 2010), available at www.broadband.gov/plan.

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echoing the FCC’s spectrum-related goals, 9 federal agencies have not yet volunteered any spectrum that could be practically repurposed from the government to the private sector, and recently vetoed the long-planned use of 12 billion MHz.POPs (40MHz) of nationwide satellite spectrum (“MSS L-band”) for terrestrial broadband due to previously undisclosed interference issues with GPS receivers. 10 Moreover, last month Congress reallocated 3 billion MHz.POPs (10 MHz) of prime commercial spectrum (“D block”) to governmental public safety use as part of a package that gave the FCC authority to begin the process of offering over-the-air broadcasters market-based incentives to sell their spectrum for reallocation to mobile broadband if they so choose (“incentive auction authority”). 11 Although holding such an incentive auction could ultimately release 15-30 billion MHz.POPs (50-100MHz nationwide) of spectrum, the process of designing and executing the auction mechanism, as well as clearing the spectrum sold back by broadcasters, is unlikely to be completed in time to help achieve the 2015 goal. This leaves as the most significant spectrum likely to be added to the inventory over the next 3 years the 12 billion MHz.POPs (40MHz nationwide) of satellite spectrum (“S-band”) that Dish Network just received FCC approval to purchase from DBSD North America and TerreStar Networks. 12 This spectrum is currently approved for terrestrial use under somewhat restrictive conditions, which are likely to get relaxed in the course of a rulemaking that the Commission started in March of this year, making the spectrum more economically attractive for wireless broadband use. 13 Thus, it seems likely that the amount of available spectrum will be relatively unchanged in the short-to-medium term. Therefore, notwithstanding the failure of the AT&T/T-Mobile merger, further spectrum-related transactions will likely be attempted, driven by companies

9

See White House Office of Press Secretary, Presidential Memorandum: Unleashing the Wireless Broadband Revolution, WHITEHOUSE.GOV (June 28, 2010), available at www.whitehouse.gov/ the-press-office/presidential-memorandum-unleashing-wireless-broadband-revolution.

10 See, e.g., Letter from Lawrence E. Strickling, Assistant Sec’y for Commc’ns and Info., U.S.

Dep’t of Commerce, to Julius Genachowski, Chairman, FCC (Feb. 14, 2012), available at apps.fcc.gov/ecfs/document/view?id=7021860324. 11 See Title VI, PUBLIC SAFETY COMMUNICATIONS AND ELECTROMAGNETIC SPECTRUM

AUCTIONS OF THE MIDDLE CLASS TAX RELIEF AND JOB CREATION ACT OF 2012, signed by President Obama, Feb. 22, 2012, available at www.gpo.gov/fdsys/pkg/BILLS112hr3630enr/pdf/BILLS-112hr3630enr.pdf. 12 See FCC Int’l Bureau “DBSD and Terrestar transfer of control” (Mar. 2, 2012), available at

transition.fcc.gov/Daily_Releases/Daily_Business/2012/db0302/DA-12-332A1.pdf. 13

See FCC Announces Tentative Agenda for March Open Meeting, available at transition.fcc.gov/Daily_Releases/Daily_Business/2012/db0229/DOC-312739A1.pdf

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trying to gain control of as much of this scarce, critical resource as possible. In the following sections I discuss the types of transactions that might occur and how they might be regarded from a regulatory perspective. Implications For Spectrum-Related Transactions To the extent that transactions play a role in carriers’ strategies to meet growing customer demand for wireless services, three different types of deal are likely to be attempted: (1) M&A of existing carriers (e.g., AT&T/T-Mobile) involving the transfer of spectrum licenses, customers, and other assets such as network infrastructure; (2) the transfer of only spectrum licenses (e.g., Verizon/Cox & SpectrumCo); or (3) the leasing, sharing, or transfer of other assets (e.g., leasing spectrum, wholesaling capacity, or sharing network resources such as towers or backhaul 14 ) rather than the transfer of spectrum itself. The potential public-interest considerations that may be involved in each of these deals are described below. 15 A.

M&A of Existing Carriers

The framework applied in examining the proposed combination of AT&T and T-Mobile is a useful template for considering other potential combinations of existing carriers. In essence, it involves three components: (a) the competitive implications of eliminating a company that currently participates in the wireless market and serves a base of customers; (b) efficiencies from combining the two companies’ spectrum and infrastructure, for example by being able to more efficiently use larger blocks of spectrum or eliminating duplicate cell towers and retail stores; and (c) other transaction-specific “public-interest benefits,” an imprecise category that may, for example, include effects on investment, innovation, and consumer welfare beyond the competitive and efficiency benefits accounted for in (a) and (b). 16

14 Backhaul connections link cell towers to the rest of the network, and the cost of building or

buying backhaul often represents a significant portion of the cost of wireless providers’ network operations. The issue of backhaul pricing was raised in the context of the AT&T/T-Mobile merger. Applications of AT&T Inc. and Deutsche Telekom AG, 26 FCC Rcd 16184, 16243-44 (Appendix: Staff Analysis and Findings) (Nov. 29, 2011). 15 Under the Communications Act, the FCC reviews applications for the transfer of control

and assignment of licenses and authorizations to ensure that the “public interest, convenience, and necessity” would be served by approving the transaction. See 47 U.S.C. §§214(a), 310(d) (2012). The FCC also has explicit authority under Sections 7 and 11 of the Clayton Act to review the proposed mergers of common carriers. 16 For example, AT&T promised to repatriate call-center jobs to the United States and increase

its network build out to a broader geographical extent on approval of its merger with TMobile.

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In proposing to merge two of the top four carriers, the AT&T/T-Mobile deal was unprecedented in terms of both the potential reduction in competition and the potential efficiencies that could be realized, given the national scale and overlap of the two companies’ networks and operations. After significant fact gathering, document review, and analysis, the FCC agreed with the U.S. Department of Justice that the harm from the former would outweigh the benefits from the latter and further concluded that no other material transaction-specific public-interest benefits had been demonstrated. Given the current industry structure and trends, however, the balance of factors may come out differently for other potential mergers. This is because by almost any metric – financial (e.g., revenue, cash flow, enterprise value, or cost of capital), operational (e.g., subscriber count, network coverage, capital expenditures, or political influence), or spectrum-related (e.g., total spectrum holdings, as described above) – the U.S. wireless industry consists of four distinct tiers, with vast gaps between them: (1) Verizon and AT&T (who also control extensive wireline networks); (2) Sprint and T-Mobile; (3) Leap, Metro PCS, and U.S. Cellular; and (4) small local carriers, such as ATN, Cincinnati Bell, and Ntelos (see Table 1, infra [setting out some representative facts about these tiers]). The only mergers of similar scope to AT&T/T-Mobile in terms of competitive impact are combinations within Tier 1 or between Tiers 1 and 2, none of which are likely to be attempted. Other combinations, either within or between tiers, would be of far smaller scale, have correspondingly less competitive impact, and are perhaps more likely to receive regulatory approval (although they would also realize smaller efficiencies and aggregate less spectrum). 17

17 Frequently rumored potential combinations include Sprint/T-Mobile, MetroPCS/Leap, and

Sprint/Metro PCS and/or Leap (Clearwire is also the frequent subject of acquisition speculation given its fragile finances and extensive spectrum holdings). Any proposed transaction would, of course, be considered on a case-by-case basis, including, for example, the extent to which the footprints overlap and the competitive impacts in local markets. Note also that perhaps the best argument for the AT&T/T-Mobile merger is that it would have made little difference to an industry structure that has already become essentially duopolistic. Making this argument would, however, invite additional regulatory scrutiny (which may in any case be inevitable if Verizon and AT&T continue to increase their lead and take advantage of their resulting market power).

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Table 1: Illustrative metrics showing of the U.S. wireless industry’s current four tiers

Subscribers (million as of end Q4 2011)

Total service revenue ($ billion, 2011)

Profit (EBITDA, $ billion, 2011)

Capital expenditures ($ billion, 2011)

Tier 1 Verizon (National) Wireless

109

59

26

9

AT&T Mobility

104

57

22

10

Tier 2 Sprint (National) T-Mobile

55

27

4

3

34

19

5

3

Tier 3 MetroPCS (Regional) Leap

9

4

1

1

6

3

1

0.5

US Cellular

6

4

1

1

4 Many smaller companies

~2

~1