Verizon is running out of spectrum but could get escape hatch by leasing Dish's airwaves, analysts say

Verizon Wireless (NYSE: VZ) is going to run out of spectrum over the next few years but could get a lifeline if it strikes a spectrum leasing agreement with Dish Network (NASDAQ: DISH), according to a report from analysts at New Street Research.

In a research note, New Street analysts Jonathan Chaplin, Spencer Kurn and Vivek Stalam repeated a contention they made in July that Verizon will run out of spectrum capacity in the next two to three years even if it refarms all of the spectrum it is currently using for 2G and CDMA services. The analysts acknowledge that their "supply/demand analysis is inherently simplistic. Neither network engineers nor spectrum bands are created equal; Verizon has consistently delivered a better experience with fewer cell sites and less spectrum than peers. The analysis is intended to demonstrate that VZ will run out of capacity before others will. If usage continues to grow, they will need significantly more spectrum or they will lose share."

The analysts noted that yesterday Verizon Communications CFO Fran Shammo disclosed that LTE traffic increased 75 percent over the last 12 months, while the number of its LTE subscribers increased by 35 percent, which they said suggests a 30 percent growth in usage per subscriber. They added that 55 to 65 percent of Verizon's total current useable spectrum in the largest U.S. markets is currently deployed for LTE. Verizon's LTE network currently carries 89 percent of its mobile data traffic.

"We believe this is fully utilized (the network is under noticeable strain at busy hour)," they said. "If over the next two years subs continue to move to LTE and usage grows at 30% per year, total LTE traffic would more than double. Even if VZ refarmed all available spectrum for LTE they would still need an additional spectrum in the top 25 markets. Of course, usage growth may slow and densification should help; however, VZ will need more spectrum sooner or later (absent a breakthrough in technology)."

The analysts said that on average, Verizon currently has 103 MHz of readily usable spectrum (excluding the AWS-3 spectrum it won at auction this year, which Shammo said would not be deployed until 2017 or 2018). On a nationwide basis, they said, only around 44 percent of this is being used for LTE, with most of the rest being used for 1xRTT or EV-DO. "However, in the dense urban markets like NYC, the company has deployed 20 MHz of 700 MHz, and up to 40 MHz of AWS-1; re-farming of PCS has begun, and the company has deployed 20 MHz of PCS on a handful of cell sites in NYC already," they said. "Altogether, 55-65% of total spectrum has been deployed for LTE in the largest markets."

Dish's designated entities, in which Dish holds an 85 percent economic stake, have agreed to selectively default on some spectrum licenses they won in the AWS-3 auction and give up around a third of the paired AWS-3 spectrum licenses they won -- mostly spectrum licenses covering New York, Chicago and Boston. That could help Verizon if Verizon were to win the licenses in a re-auction of the airwaves, the analysts said.

However, the analysts noted that Verizon has 39 percent of industry revenue today and just 17 percent of industry spectrum, and that while Verizon will continue to densify its network, other carriers will as well. "If capacity utilization approaches 100%, as we believe it will over time, VZ either needs to more than double its spectrum share or cede half of its revenue share," they said.

Verizon CEO Lowell McAdam and Shammo have indicated Verizon would be interested in Dish's spectrum. 

"We like the higher band like AWS. We've said that all along that [Dish Chairman and CEO] Charlie [Ergen] is sitting on very good spectrum," Shammo said yesterday on Verizon's earnings conference call, according to a Seeking Alpha transcript. "It's very good for capacity, which is why we spent $10.4 billion in the auction." Shammo added that "higher frequency spectrum is capacity and that's really what we need at this point in time."

The New Street analysts estimate that Dish's core mid-band spectrum, consisting of 40 MHz of nationwide AWS-4 spectrum, 10 MHz of the 1900 MHz PCS H Block and 8 MHz of paired AWS-3 spectrum, is valued at around $55 billion. To realize that value, Dish would need to lease it out at $4.25 billion per year at a 3 percent escalator. "Since Dish has no need for the capital, we assume that they are willing to structure the deal to receive payments as VZ deploys the spectrum, which minimizes near-term dilution to VZ," they said.

Verizon might be able to pay even less, at $2.75 billion per year, the analysts said, adding that "the spectrum would bolster VZ's network lead over peers and would drive increased subscribers, revenues, and profits."

Related articles:
Verizon's Shammo: We'll be in the 600 MHz auction, but more interested in high-band spectrum like AWS
Analysts: Verizon could strike deal to lease Dish's spectrum by end of 2015
Verizon's McAdam: We're open to talking to Dish about spectrum -- but won't buy whole company
Analysts: Verizon could run out of network capacity in 2-3 years
Verizon's Shammo: We don't have a 'great need' for 600 MHz airwaves, remain focused on small cells