by David Dixon, FBR Technology, Media & Telecom group (edited by Alan J Weissberger, IEEE ComSoc Content Manger)

Editor’s Note:

U.S. wireless telcos + DISH Network are covered in this detailed FBR report along with Nokia and several smaller network/ telecom equipment vendors.

Takeaways for AT&T, Verizon & Nokia:

AT&T is poised to win the FirstNet contract to build a nationwide public safety network, with a Court decision expected as early as next week. We think this will drive an AT&T capex mix shift to wireless as parallel deployment of 700 MHz, AWS-3, AWS-1, and WCS spectrum gets underway in 1H17. AT&T sees a relative industry spectrum advantage.

Verizon is likely to accelerate its spectrum plans as well, and the industry may benefit from more sub-6 GHz access spectrum coming down the pipeline. Meanwhile, in the short run, Verizon is making a tactical shift from small cells to macro densification.

Nokia has created a wireless network wrinkle for Verizon, AT&T, and T-Mobile to a lesser extent, by discontinuing support for Alcatel equipment forcing a costly swap.

If AT&T deploys on schedule, a spectrum advantage is possible if 3.5 GHz industry momentum slows. However, our checks suggest that this is not occurring, a negative for DISH, in our view.

From a derivative perspective, we think AT&T’s wireless push and Verizon’s macro densification push are positive for tower, radio equipment, and antenna equipment providers.

Companies in these sectors include: American Tower, Crown Castle, SBA Communications, Nokia, Commscope, and ARRIS.

Conclusions for AT&T:

■ We view AT&T as likely to be the imminent beneficiary of $6.5B in federal funds to build a nationwide public safety network on behalf of FirstNet. This front-end-loaded network is scheduled to be completed over the next five years. A lawsuit between FirstNet and AT&T’s competing bidder, Rivada Networks, has delayed deployment but is quickly drawing to a close.

Our industry checks indicate:

(1) Oral arguments of two hours each were provided to a very engaged Judge, who clearly understood the legal basis and arguments;

(2) a decision could come as early as the end of this week or, more conservatively, by the end of March.

–>We think AT&T is the likely winner of the FirstNet contract, even in the unlikely event that Rivada wins the lawsuit and is readmitted to the bidding process because, we believe, AT&T is using its balance sheet (if necessary) to ensure bidding victory.

Importantly, certain major states have opted out of the FirstNet network build, (including Florida, New York, California, Texas). AT&T may need to work harder to provide option incentives. These markets will be targeted by Rivada Networks, in our view, should its bid be unsuccessful.

■ AT&T capex mix shift to wireless as ramp in 1st half of 2017 gets underway. AT&T capex has recently been weighted to the wireline segment. For months, AT&T has been waiting for the FirstNet contract to be awarded, frustrated by the Rivada lawsuit. At the conclusion of the lawsuit, assuming AT&T is declared the winner, we believe the company will commence adding substantial wireless network capacity. AT&T has delayed adding capacity using the combination of its non-utilized AWS-3, AWS-1, and WCS spectrum due to the costly nature of the upgrade. It planned, instead, to wait for the FirstNet contract to be awarded and piggyback the 700 MHz buildout program.

■ Assuming a win, AT&T gains access to 2×10 MHz of 700 MHz spectrum to be deployed on 20,000 cell sites, complementing deployment of 40 MHz of non-utilized spectrum in the AWS-3, AWS-1, WCS bands (recently proposed as a lease to utilities as a shared priority-access network). If it deploys on schedule, there is a potential spectrum advantage; we think this could occur in the event that 3.5 GHz industry momentum slows, either through FCC approval delay, denial for license changes to be requested by Verizon, or delayed FCC certification of Spectrum Access System.

Verizon Also About to Move Fast on Spectrum:

At the conclusion of the broadcast incentive auction, we expect Verizon to seek FCC approval for license changes to the 3.5GHz band; 150 MHz of this band was approved by the FCC for indoor and outdoor use, with 80 MHz reserved for general access and 70 MHz reserved for priority access licenses. These priority access licenses are currently based on 70,000 census blocks across the U.S. and for three-year license terms. We think Verizon will seek approval to have this changed to only 400 market areas and license terms extended to 10 years. This should mitigate interference challenges in adjacent areas because interference protection contours were impossible to manage in such small areas. Once approved we see Verizon and T-Mobile moving fast to endorse and deploy low-cost 3.5 GHz spectrum and see device support in 2018 and 2019. This is significant because investors rightly point out that 3.5 GHz spectrum is not a differentiated spectrum band since all market participants and new entrants can access this spectrum. However, once the spectrum is fully utilized and congested, priority-access licenses can create differentiation.

Much More Sub-6 GHz Access Spectrum Coming Down Pipeline:

We point out potential for: (1) an additional 500 MHz of spectrum in the 3.7 GHz to 4.2 GHz band, which may be utilized for both 4G and 5G; (2) as a TDD spectrum, operators that deploy could benefit from a change to High Performance User Equipment (HPUE), first approved for Sprint’s 2.6 GHz band, but could be applied to any TDD spectrum band globally. This would substantially lower network deployment costs by increasing the cell-site area when using higher-power devices.

We maintain that Verizon and T-Mobile are not likely to pursue DISH spectrum, and Verizon is less spectrum challenged strategically than the market assumes.

Verizon Tactical Shift to Macro Densification in Short Term:

Verizon recently issued an RFP to build fiber in 20 to 30 cities, where it plans to deploy additional wireless network capacity using its fiber based Cloud-Radio Access Network architecture.

Our industry checks indicate Verizon recently made a tactical switch from small cell to macro densification to alleviate capacity constraints in certain areas. We think this is due in part to Mobilitie (a Sprint partner) having created zoning approval havoc in many markets. Our checks indicate that the small cell zoning approval time frame has lengthened from six months to two years.

T-Mobile Focused on 600 MHz Deployment ahead of 3.5 GHz:

From a T Mobile perspective, vendor checks indicate that T Mobile is doing OK on the network front but is being pushed very hard to get 600MHz spectrum deployed in every market where they do not have 700MHz coverage.

T Mobile’s network remains the fastest network in many metro markets (and is the surprising roaming partner of choice for international carriers we spoke with in many more markets than we had assumed). However, its Achilles heel is that they still do not have good coverage away from urban markets in areas where there is less competition.

Nokia Creates a Wireless Network Wrinkle for Verizon, AT&T, and T- Mobile to a Lesser Extent:

Following the merger of Nokia and Alcatel, Nokia mandated the sunset of Alcatel network equipment, deployed on approximately half the AT&T and Verizon networks. T-Mobile is also affected to a lesser extent because certain Nokia equipment is also being discontinued. This equipment will have to be replaced on each network because software features will no longer be supported. At a minimum, this will be a costly, unexpected capital outlay. All operators are frustrated because they do not have a choice. Nokia is the only vendor option and will likely dictate pricing.

Although we expect the migration to be well managed (this is not a network rip-and-replace) this could create network performance challenges.

Implications for AT&T, Verizon, and DISH:

If AT&T wins the FirstNet bid and deploys on schedule, there is a potential spectrum advantage. We think this could occur in the event that 3.5 GHz industry momentum slows, either through FCC approval delay, denial for license changes to be requested by Verizon, or a delay in FCC certification of the Spectrum Access System.

However, our Mobile World Congress (MWC) checks suggest this is not likely. On the contrary, we see 3.5 GHz momentum accelerating across the industry, including from the cable sector. This has negative implications for DISH, in our view.

From a derivative perspective, we think AT&T’s wireless push and Verizon’s macro densification push are positive for tower, radio equipment, and antenna equipment providers. Companies in these sectors include: American Tower, Crown Castle, SBA Communications, Nokia, Commscope, and ARRIS.

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Company-Specific Disclosures:

FBR acts as a market maker or liquidity provider for the company’s securities: AT&T Inc., DISH Network Corporation and TMobile US, Inc.

For up-to-date company disclosures including price charts, please click on the following link or paste URL in a web browser: www.fbr.com/disclosures.

General Disclosures Information about the Research Analyst Responsible for this report:

The primary analyst(s) covering the issuer(s), David Dixon, certifies (certify) that the views expressed herein accurately reflect the analyst’s personal views as to the subject securities and issuers and further certifies that no part of such analyst’s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the analyst in the report. The analyst(s) responsible for this research report has received and is eligible to receive compensation, including bonus compensation, based on FBR’s overall operating revenues, including revenues generated by its investment banking activities.