United States: FCC To Increase Flow Of Wireless Spectrum - New Block is Likely to Cost Less Than Old Ones and Attract New Money to the Mobile Communications Industry

Since the late 1990s, America's wireless economy has faced a serious scarcity of new radio spectrum due to several regulatory impasses that have cut the flow of spectrum to a trickle. That has placed rising burdens on existing mobile communications networks and led many carriers to postpone next-generation, multimedia services. Recently, however, the nation's top "spectrum banker," the Federal Communications Commission (FCC), has promised some relief.

First, in November 2002, the FCC voted to allocate 90 megaherz (MHz) of new spectrum for so-called third-generation (3G) mobile wireless services. The FCC's action reflects a historic band-clearing agreement with the Department of Defense and, with the prior reallocation of several UHF TV channels, could eventually lead to the sale of more than three times the amount of mobile radio spectrum now licensed for cellular telephone service.

Second, in December 2002, the FCC indicated that it would seriously consider making more spectrum available for unlicensed services, such as wireless Internet access, or WiFi, by initiating two new public inquiries based on a landmark new report by the agency's Spectrum Policy Task Force. Unlicensed services, which also include cordless phones, medical devices and security tags, must usually operate at very low power and cannot interfere with licensed services such as television and radio broadcasting.

The availability of large blocks of new spectrum for mobile services_ especially for new 3G applications_may have far-reaching consequences. Just as the Internet boom of the mid-1990s was underpinned by ever cheaper fiber-optic transmission networks, more and cheaper spectrum could help to jump-start a mass market for unwired Internet services from handheld games and instant messaging, to streaming music and portable video entertainment. On the other hand, the sale of new spectrum and the growth of unlicensed services is likely to devalue the frequency portfolios of existing players and provide a further impetus for industry consolidation.

To better understand the implications of the FCC's new "monetary expansion" and why it has been so long in coming, some history is helpful.

The bulk of the spectrum now used for public mobile radio services_ approximately 195 MHz_was licensed in two main groupings. In the early 1980s, the FCC licensed 50 MHz of spectrum in the 800-MHz band (just above the UHF TV channels) for two competing cellular telephone operators: one for existing local exchange carriers (today Verizon, BellSouth, etc.) and one for new entrants (e.g., McCaw Cellular, now AT&T Wireless). The latter licenses were mainly assigned by lottery, allowing many speculators to resell their rights quickly for millions of dollars but adding nothing to the U.S. Treasury.

About a decade later, the FCC allocated another 120 MHz of spectrum in the 1800-to 1900-MHz band for a new (second generation) mobile service known as Personal Communications Service (PCS). This time, at the direction of Congress, the FCC auctioned licenses to the highest bidder, beginning in 1995. With mobile handset prices falling rapidly and the economy booming, the price for each successive block of PCS spectrum was bid higher and higher. Several winning bidders_including most notably NextWave Communications, which bid $4.8 billion for licenses_later filed for bankruptcy and defaulted on their spectrum payments to the government. That led the FCC to cancel their licenses and re- auction the frequencies.

The largest spectrum reauction, in January 2001, generated more than $16.5 billion, but NextWave sued to prevent the FCC from implementing the results. The matter is now before the U.S. Supreme Court in FCC v. NextWave Personal Communications Inc., nos. 01-653 and 01-657 (U.S.), with a decision expected by mid-year. Pending the court's decision, though, about 25% of the original PCS spectrum remains "in the bank."

While the United States was preoccupied with PCS spectrum auctions, the global wireless industry began to move ahead with ambitious plans for a third generation of multimedia mobile services and, in the late 1990s, governments in Europe and Asia allocated a substantial amount of spectrum for these new 3G services. By the end of 2001, more than $100 billion had been paid for 3G licenses in Western Europe alone, leaving many winning carriers with more spectrum than their U.S. counterparts (155 MHz was allocated to 3G in most countries) but also with potentially crippling new debt.

A similar scenario might have played itself out in the United States but for the inability of the FCC and private industry to agree on how much spectrum should be allocated to 3G, and which frequency bands should be cleared to accommodate the new services. The Clinton administration initially pledged to resolve the impasse before it left office so that 3G spectrum could be auctioned by October 2002. But it was not until July 2002 that a working consensus was finally reached by the mobile radio industry and the executive branch on a 3G allocation of 90 MHz in the 1700-MHz and 2100-MHz bands. The FCC formally endorsed this decision in November 2002.

Since the early 1990s, the FCC has also sought to clear an additional 85 MHz of spectrum for 3G services in the UHF band (TV channels 52-69). Legislation generally requires this spectrum to be vacated by broadcasters by December 2006 as part of a comprehensive plan for the introduction of new digital television (DTV) services by all broadcasters on channels 2-51. To that end, Congress originally directed the FCC to reclaim and auction much of the vacated UHF spectrum by December 2001 and to encourage voluntary relocation arrangements underwritten by new users. Thus far, however, the majority of affected broadcasters have been reluctant to initiate DTV service on their new channels, and, given the interim relocation costs for new users of the spectrum, most of the FCC's UHF spectrum auctions have been delayed. In addition, the 700-MHz bands now used by UHF broadcasters in the United States are not part of the global 3G spectrum allocation, which means cellular handsets and base stations are not currently available for these frequencies.

The upshot is that while the base of cellular and PCS subscribers grew more than 350% between 1996 and 2002 to almost 140 million, the FCC licensed only a few slivers of new spectrum for these mobile services_a credit crunch by any other name.

It is too early to predict the full impact of the FCC's recent "monetary easing." However, some consequences may include the following:

First, new spectrum auctioned in 2003 and beyond will cost less per MHz than old spectrum, and possibly much less. Since peaking in early 2001 (with the reauction of licenses recovered from bankrupt NextWave Communications), U.S. spectrum prices have fallen considerably as the economy has weakened and investors have become more skeptical of capital-intensive communications businesses.

Second, cheaper spectrum is likely to attract new money to the mobile industry_entrepreneurs, equipment vendors, private equity firms. It will also make spectrum-hungry applications more economical. At the same time, cheaper spectrum may well devalue the assets of existing mobile operators.

Third, more competition and cheaper spectrum are likely to increase the pressure for industry consolidation. That will be aided by the January 2003 expiration of the FCC's historic 55-MHz "cap" on the amount of spectrum any service provider can license. There are already six national mobile operators and at least twice that number of regional carriers. With even more competition on the horizon, mergers seem inevitable. Caveat emptor: With the expiration of the FCC's spectrum caps, future mergers may be subjected to more competitive scrutiny by both the FCC and the Antitrust Division of the Department of Justice.

Fourth, more spectrum means multiple new FCC auctions. And that could stimulate merger and acquisitions business too, as various bidding groups and alliances form to acquire spectrum they desire. Some cross-industry consortia may also emerge to acquire licenses to showcase next-generation services or products (e.g., multipurpose video phones).

Finally, if spectrum prices fall, some wireless services that have been launched on unlicensed free spectrum_for example, the WiFi or 802.11 Internet access networks_may migrate to licensed frequencies. At a minimum, such services are likely to face stiffer competition as existing cellular and PCS players try to bundle "free" services with their core offerings. Indeed, some operators (T-Mobile) have already started doing that with WiFi points at Borders book stores, Starbucks cafes and other popular meeting places.

While a new era of cheaper spectrum is almost certainly on the way, the FCC's ability to ease the current crunch will not be without controversy. Just as a looser monetary policy tends to favor debtors over creditors, any increase in the supply of available spectrum will create winners and losers. Many of the affected parties can be expected to urge the FCC to amend its future auction plans and spectrum policy initiatives accordingly.

The Supreme Court's anticipated spring 2003 decision in FCC v. NextWave (ruling on whether the FCC can lawfully cancel the licenses of a bankrupt carrier that defaults on license payments) will also affect the timing and scope of future spectrum auctions. In addition, Congress will doubtless make its own views known as a rising national deficit makes revenues generated from FCC auctions more important than ever.

As noted earlier, the opportunities for wireless providers also will be influenced by the agency's ongoing efforts to reform its existing spectrum- management rules_a top priority for FCC Chairman Michael Powell. At the same meeting where the agency voted to release more spectrum for 3G services, Powell endorsed a landmark report by the agency's Spectrum Policy Task Force. It recommends that the FCC grant existing licensees much more flexibility to use their spectrum as they see fit, like a property holder, and to make it easier for mobile radio licensees to lease or trade their spectrum to third parties_a proposal that could lay the basis for a new type of commodity market.

The task force report also urges the FCC to allocate more spectrum for unlicensed users, such as WiFi networks, and to permit licensees to sell access to their networks during off-peak periods by, for example, using smart receivers that search for unused frequencies.

To advance the agenda, in December 2002, the FCC initiated two proceedings_one to solicit further public input on the expansion of low-power unlicensed services (e.g., on TV channels that are not used today, to protect the same or adjacent TV channels in other cities from interference), and a second to consider the demand for unlicensed spectrum in rural areas where potential interference issues may be more limited. Comments on the proceedings as well as on the appropriate rules for FCC's new 3G mobile services (auction procedures, franchise areas, license terms) are all due in the next few months.

In sum, with large amounts of new mobile radio spectrum just over the horizon and the FCC set on reforming the rules applicable to existing licensees, the year 2003 could be the most important one for the mobile wireless industry and its overseers_the FCC, Congress and the courts_since the early days of cellular telephony. And that means whatever one's interest in the future of wireless services, whether as vendor or investor, incumbent carrier or entrepreneur, 2003 will be a year for decisions.

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