D Block allegations don’t add up

For the past few months, one of the big debates in the wireless community concerns the failure of the 700 MHz D Block spectrum to attract a legitimate bid that would allow the partnership between the commercial operator and the Public Safety Spectrum Trust (PSST) to become reality.

It’s also been a topic of interest in our nation’s capital, where officials want answers—House Oversight and Government Reform Committee Chairman Henry Waxman (D-Calif.) posed a number of pointed question before the auction began, and FCC Chairman Kevin Martin has asked his agency’s inspector general to look into the matter. Of course, because of the FCC’s anti-collusion rules, no one involved in the auction have been able to talk about it until those rules were lifted last night.

As a result, the debate largely has been limited to Internet blogs. And the hot topic in those blogs has been a discussion between officials of Cyren Call—the Morgan O’Brien-led advisor to the PSST—and Frontline Wireless—a startup company headed by former FCC Chairman Reed Hundt and other high-profile leaders—that supposedly undermined Frontline’s plans to bid on the D Block.

Frontline’s interest in the D Block was no secret, as it had driven many of the rules included in the FCC’s plans for a public-private partnership that would develop a nationwide broadband network for public safety, including the commission’s decision to allow Frontline to participate in the D Block as a designated entity. Despite receiving this status—one that allowed it to bid 25% less than the high bids of existing operators and still win the rights to the spectrum—Frontline surprisingly did not make the necessary downpayment to enter the auction and announced that it was closed for business.

Frontline didn’t say why it made these decisions, but multiple reports indicated the company was unable to secure the financing necessary to make the downpayment for an auction bid, which had to be at least $1.3 billion to meet the FCC’s reserve price for the D Block. Of course, with its 25% discount as a designated entity, Frontline would have been looking at a minimum of $1 billion out of pocket to win the D Block.

While $1 billion is a lot of money, the real financial risk is the nationwide network that would need to be built on the 10 MHz of D Block spectrum and the adjacent 10 MHz of public-safety spectrum licensed to the PSST. While the cost to deploy a normal commercial nationwide wireless network probably would be $13-15 billion, most estimates for this network—given FCC and public-safety buildout requirements—were said to be about $20 billion.

In other words, Frontline needed at least $21 billion just to get its business off the ground, and that’s before figuring in money for employees and other operating costs. Given the ever-tightening capital markets at the time and speculation that an inflationary period is just around the corner, it’s understandable that investors might be hesitant to support such an endeavor—especially committing so much money to a startup that wants to compete in a cutthroat industry against deep-pocketed giants like AT&T Mobility and Verizon Wireless.

However, several bloggers have indicated the big problem was that Cyren Call told Frontline it would have to pay the PSST $500 million over 10 years as a spectrum lease ($50 million per year) for the right to use public safety’s airwaves. To read these blogs, this spectrum-lease cost was much higher than Frontline officials anticipated and undermined the company’s financing efforts.

Today, the PSST and Cyren Call confirmed that a $50 million-per-year figure was discussed with Frontline, although the other terms cited in the blogs were not. Certainly the need for the PSST to seek a spectrum-lease payment is understandable.

After all, the PSST has expenses—not the least of which includes paying Cyren Call as its advisor—and no way to generate revenue until customers start subscribing to the network, an event that is several years away. Moreover, the FCC’s order contemplates a spectrum lease and the PSST’s bidder information document informed potential bidders that such a lease would be part of the package.

In other words, the idea of a spectrum lease should not have been a surprise to Frontline, although maybe the amount was. However, even if the spectrum-lease cost was more than anticipated, I’m having a difficult time understanding the notion that it was a deal breaker in this instance, contrary to what the blogs are stating.

When you’re facing a $21 billion investment over 10 years (again, not including Frontline’s operating costs), would a $500 million spectrum lease obligation to the PSST—which represents just 2.38% of $21 billion—be a big concern for your investors, especially after the FCC’s designated-entity ruling effectively handed you at least a $350 million break? It’s difficult for me to believe that this was the proverbial “straw that broke the camel’s back” for Frontline’s potential investors.

In fact, on Dec. 4—after short forms were filed and Cyren Call stopped talking to anyone about any subject related to the auction—Frontline told the FCC to disregard its petition to lower the reserve price on the D Block, stating that the commission’s decision to allow a designated entity credit removed the need to lower the reserve price. That’s not the kind of stance a company that is having trouble securing financing typically would make on the eve of an auction—and Frontline presumably already had the alleged spectrum-lease discussion with Cyren Call by that point.

Meanwhile, the fact that the PSST needs a spectrum lease to generate revenue in the early stages of this partnership is an issue that needs to be addressed. As we’ve stated in this space before, an underfunded PSST may not be in a position to adequately represent public safety’s needs in negotiations with a D Block winner.

This issue cannot be addressed by the FCC, which has no funding power. However, Congress has funding authority and, more importantly, $7 billion more in its coffers from the 700 MHz auction than it expected. With a little help from Capitol Hill, the entire spectrum-lease issue could be taken off the table.

In addition, removing the substantial financial penalty (10% of the winning bid price, according to the FCC order) that the D Block winner would have to pay had it failed to reach an agreement with the PSST needs to happen. In fact, Cyren Call advocated removal of this stipulation more than six months ago, noting that the complexity inherent in a unprecedented network-sharing arrangement could prevent a deal being made, even if both sides are negotiating in good faith. Meanwhile, with the U.S. Treasury already meeting its 700 MHz budgetary goals, there is no need to have a reserve price on D Block spectrum when it is reauctioned.

Many in public safety believe these changes will be enough to attract bidders. I’m not sure. The big problem for anyone considering a D Block bid is the network cost, and even the PSST’s bidder information document carried the caveat that most items were “subject to negotiation.” It may be that the network-buildout expectations need to be crystallized more—for instance, a timeline for hardening tower sites, both critical and non-critical—so that bidders can more precisely value this important swath of spectrum.

By all accounts, officials in Washington, D.C., will be re-evaluating and investigating what happened in the D Block auction. Hopefully, the bulk of these efforts will be focused on helping address the significant network-cost issues and not on fingerpointing regarding a spectrum-lease arrangement, which seems to be a red herring by comparison.

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