A timely review of financial factors to consider when you lease your EBS spectrum
Now that Softbank has acquired Sprint Corporation, and Clearwire has become a wholly-owned subsidiary of Sprint, we can expect Clearwire and other wireless companies interested in using 2.6 GHz wireless spectrum to bring their 2.6 GHz spectrum leasing activity from a near idle to an active and robust pursuit of this spectrum. The 2.6 GHz band is allocated by the FCC to two radio services: the Broadband Radio Service and the Educational Broadband Service or “EBS”. The focus of this article is EBS leasing – specifically, matters relating to the financial side of the transaction. With renewed interest in EBS leasing, now appears to be a good time for EBS licensees to review some of the more prominent compensation-related factors involved in the process.
How is the value of a lease of EBS channels determined?
There is no set formula for valuing EBS channels, nor is there (at present) a sufficient volume of EBS transactions with payment information publicly available to derive a market price for EBS channels or to make a quantifiable determination of the impact of different variables on market price. Even though standard “comps” may be in short supply, factors likely to influence valuation are readily identifiable – such as population density, the demand for channel capacity (including competition for channel capacity), and the specific needs of the wireless companies that desire the use of the channel.
Historically, population density has been the most important metric in EBS channel valuation. And this makes some sense. The more densely populated an area (to a point), the more efficiently it can be served. At the low efficiency extreme are very rural areas where the number of persons who may take the service and support the cell site are so small that the wireless carrier cannot expect to achieve better than a negative return on its investment. At the higher efficiency extreme are dense suburban areas where cell sites are well supported by revenue-bearing traffic.
Competition for channels is another very important value driver. More will tend to be paid for a channel if two or more wireless carriers are competing to win the lease of the channel.
The demand for channels, and hence the lease price for channels, also may be influenced by market factors unrelated to the value of the channels to an operation within the specific geographic market served by the channels. For example, there have been times when wireless companies have focused less upon their immediate needs for channel capacity in specific markets, with their leasing decisions influenced more by a desire to amass a large regional or nationwide footprint of spectrum. This amassing of spectrum rights as inventory has been undertaken by companies seeking to tap the public market for equity and debt infusions.
There are also synergistic value drivers related to the specific needs of the wireless carrier. For example, a wireless operator who has already amassed a “critical mass” of wireless channels for a service area would logically perceive less value in any additional channels. Some wireless operators believe that the whole is greater than the sum of its parts and will thus pay more for a group of channels leased in one transaction than it will pay to place these channels under separate leases.
One might say that two EBS channels on different frequencies, but otherwise having identical characteristics, are of equal value. That may or may not be true, from the eyes of the wireless system operator. One channel might fill a frequency gap, thereby creating operational efficiencies that the other channel that fills no “gap” cannot create for this operator.
How does the industry express the value of EBS lease rights?
Once the above factors are analyzed, weighed and used to determine a value, the industry typically reduces that value to a common denominator metric known as “price per MHz-pop.” It expresses the perceived worth in dollars and cents of a single MHz of EBS spectrum for each unit of the population in the service area of this single MHz of spectrum, thus providing a common denominator that allows an easy “oranges-to-oranges” comparison of the values of any two EBS channels. For example, if you see that the value ascribed to an EBS channel in Market X is $0.15 per MHz-pop, and the value assigned to an EBS channel in market Y is $0.20 per MHz-pop, you know that the value of the EBS channel in market Y is greater than the value of the EBS channel in market X (even though you cannot tell from the information provided why that is the case).
The formula for “price per MHz-pop” can be expressed as:
WHERE: X is the price
Y is the total paid for the channel
M is the number of MHz in the channel
P is the population within the channel’s service area
As an example, if a licensee has a six MHz channel with a service area (called a Geographic Service Area or “GSA”) covering a population of 6,000,000 people, then this channel would have 36,000,000 MHz-pops (that is, 6,000,000 people times 6 MHz). If a proposed lessee is willing to pay the licensee a stream of payments having a present value of $8,000,000 to lease this six MHz channel, then the value of the channel under this proposal on a MHz-pop basis is $0.22.
How is the value of the EBS channel paid in an EBS lease?
An EBS licensee cannot sell its license, except to a non-profit educator and few of them (as far as we know) are trying to buy these channels. To monetize the value of the EBS spectrum, EBS licensees lease it to those who plan to use it to offer broadband wireless services.
After determining the value of the EBS channels, the lessee generally pays that value over a 30-year lease term. This is the maximum lease term the FCC will allow. The lease value of the spectrum can be paid over this period in variable or flat amounts.
The aggregate of these payments is a sum reflecting not only the agreed-upon value of the spectrum but also an additional amount to compensate the EBS licensee/lessor for its willingness to be paid that value over time. As an analogy, the licensee is much like a banker who makes a loan and charges interest to earn a return on that loan. A licensee would be foolish to loan a wireless operator the value of the license without earning a return on that value. Accordingly, over the 30-year lease term licensees are paid an amount of money whose net present value is equal to the value of the spectrum lease at the time the lease is entered into, as determined by the leasing parties. The precise amount of each periodic payment during the lease term – and, thus, the total of all those periodic payments – will depend on the parties’ agreed discount rate. The discount rate provides an expected rate of return which is based upon market factors, the duration of the lease, risk and other considerations. The higher the discount rate, the higher the total amount of payments that will be made. In our experience, EBS leases have been used discount rates varying between 10 and 15%.
What types of payments and structure of payments might appear in a typical EBS lease?
Generally, EBS leases are structured with a lump sum payment made upon FCC approval of the lease, and with monthly payments and access to the wireless operator’s network for the duration of the lease following that approval. The monthly payments may be level or may vary, depending upon the wishes of the parties. Less frequently, the wireless company will issue its stock to the EBS licensee as partial payment. Such stock may be registered for public sale, may have registration rights or may have no rights to be sold on a public market.
EBS leasing is more complicated than most other forms of leasing. The reason is that the FCC regulates EBS leasing, as explained in the EBS Leasing Primer I posted here in 2009. A requirement to lease is for the licensee to actually use a portion of the channel capacity, or other collocated channel capacity, in furtherance of the educational purposes of the licensee. In order to efficiently meet this requirement, the licensee will generally obtain wireless devices and the right to use those devices on the lessee’s wireless network. These devices and use rights will be provided in the lease and the value of the devices and use rights will be part of the compensation paid for the lease.
What due diligence review of the proposed lessee should the EBS licensee?
EBS leasing has been plagued in the past by those who obtain leases of spectrum, and make wildly impossible claims of the income these leases will cast off to lure unsuspecting people to part with their hard-earned money in exchange for shares in the lessee that become worthless very quickly. These securities scams are less frequent today than in the past. More recently, EBS licensees have been victims of lessees who have no prospect of launching a wireless service, but who lease at low-ball rates in the hope of flipping the lease to a real wireless company for a profit. In addition, several companies have leased EBS spectrum as part of good faith efforts to launch and build real wireless operations, but have gone out of business either because they could not compete with established wireless companies or because they lacked the capital to take their operations to a break-even point. In short, not all proposed lessees are created equal.
If you are approached by a proposed lessee, we suggest making sure that it has a real business plan, a management team that is experienced in wireless telecommunications, and sufficient committed funding for its business plan. If the proposed lessee has other leases, we suggest contacting the counterparties of those leases to learn of their experiences with the proposed lessee. While the EBS licensee may not be required by state law to use an RFP to select its lessee, an RFP may be useful in attracting competing lessees and discouraging speculative lessees. Our experience with EBS leasing is deep and decades long, so we often know of the proposed lessees, their reputations and history.