Overview:

We continue to anticipate that DISH will opportunistically acquire spectrum in the incentive auction, taking advantage of VZ’s and T’s likely limited participation due to their greater emphases on spectrum reuse and weaker balance sheets (due to the AWS-3 auction). We believe DISH’s spectrum portfolio is progressively devaluing as the industry embraces low-cost, unlicensed and shared spectrum, namely, the 3.5 GHz spectrum band, to solve metro density challenges.

3.5 GHz spectrum is moving more quickly than expected. An ecosystem is quickly building around 150 MHz of shared 3.5 GHz spectrum, which can be deployed in 2017 ahead of priority licenses auctioned in 2017. Contrary to consensus, 150 MHz of 3.5 GHz spectrum should be a significant “5G metro hotspot” game changer. We expect this trend to shift meaningfully the spectrum supply curve, leading to a devaluation of DISH spectrum value.

What is the value creation potential of DISH s wireless spectrum portfolio?

DISH has assembled a potentially solid spectrum position, but the market values this spectrum too highly today. First, it needs to be combined with PCS, G, H, and AWS-4 bands to be optimal. Second, DISH is positioning its spectrum as downlink only; but, with the advent of the smartphone camera and enterprise mobility, uplink and downlink traffic will become more balanced. Third, in light of declining wireless revenues, the wireless industry is undergoing a major strategic rethink with respect to spectrum utilization (i.e., use of unlicensed spectrum for low-cost, small cell deployments, where 80% of traffic is occurring). The key to valuation is how soon the buyer of spectrum needs to move and the appetite for regulatory approval. AT&T and Verizon appear to be prime candidates, with major spectrum challenges in major markets, but they have the highest degree of regulatory risk and are in the midst of a strategic shift regarding their spectrum utilization paths going forward. Furthermore, even if there were appetite for a deal, we do not think a deal will be successful for either of the two major wireless operators until Sprint and/or T-Mobile US become significantly stronger operators. While the AWS-3 auction provided important market direction in valuing DISH s spectrum portfolio, DISH continues to face increased erosion of its pay TV customer base and needs to move quickly, in our view, despite extended buildout milestones. Post-SoftBank and post-Clearwire, Sprint is well positioned on capacity for four or five years and does not need to move quickly; T-Mobile is well positioned on spectrum to manage capacity needs for four to five years, according to Ericsson, so we believe DISH should move to acquire T-Mobile ahead of a Comcast MVNO launch. But we see more strategic alliance opportunities between T-Mobile and Comcast or Google.

What is the longterm outlook for Dish Networks’ organic business?

DISH faces a continued, competitive ARPU and churn disadvantage to cable operators and can only resell broadband. Network trials confirm major challenges with the fixed-broadband business model. We see a more challenging cash flow outlook as a result. Today, as the business slows, margin expansion comes from lower success-based installation costs; but fixed costs rise when DISH loses customers. DISH has to do something soon on the strategic front, particularly as AT&T is positioning to deploy fiber deeper across its access networks in additional markets, potentially covering an incremental 10 million to 15 million homes.

We believe increased competitive challenges in the pay TV market are not adequately balanced by DISH’s options in the wireless arena, which may take longer than expected to achieve. While a bearish signal, an acquisition of a wireless operator is a possible scenario, with T-Mobile being a potential target, in our view. However, we think that a spectrum lease appears to be the more likely outcome, but this may take longer to achieve.