5G: Who Are the Winners and Losers?
A plethora of recent headlines on 5G have promised the moon and then some. It starts modestly with blazing fast mobile speeds that will render home broadband useless and quickly escalates to autonomous cars, smart sensors, augmented reality, and connected cities – the stuff of science fiction. Unfortunately, we believe science fiction will remain fiction for some time.
As of July 31, 2019, Diamond Hill owned shares of AT&T, Inc., Verizon Communications, Inc., American Tower Corp., Crown Castle International Corp., Comcast Corp., and Charter Communications, Inc. (Cl A).
We are far more circumspect about the near-term disruption potential of 5G, which is simply the next generation of wireless standards and represents a logical progression from today’s 4G network. There are many practical considerations that will impede progress, including regulatory challenges and spectrum availability, cost, population density challenges, and strategic disadvantages to being a first mover, to name a few. At the margin, we believe a home broadband alternative will create some level of disruption, but only in limited urban neighborhoods. Wireless (cellphone) users will only see incremental speed improvements that will be nothing to write home about for some time. Somewhat ironically, as more customers adopt 5G, 5G networks will face more congestion, which will slow down speeds. Any single-device lab tests demonstrating “blazing fast” speeds will not be applicable in a real-world environment facing congestion. In fact, we believe 5G’s near-term impact will be more meaningful for cost savings for network operators (more bandwidth, same total cost), rather than in significant new revenue opportunities.
Wireless networks are a function of three levers: spectrum (airwaves), network density (cell sites per unit area that transmit spectrum), and spectral efficiency (information transmitted per unit of spectrum per unit of time). As an analogy, spectrum can be thought of as a lane on a highway, while cell sites are roads – the more roads, the more traffic can be accommodated; spectral efficiency meanwhile is comparable to lane or road quality. Spectrum can further be disaggregated into three layers, with ubiquitous coverage in the “low-band” layer, a mid-range “mid-band” layer to add more capacity to alleviate congestion, and a “high-band” short-range layer in the densest urban markets that can support sufficient traffic to offer a potential home broadband replacement. It is mid-band spectrum that will get the most attention in 5G for now, but making 5G spectrum available will take far longer than is anticipated.
In short, adding 5G capacity will require more of each wireless network lever – more spectrum, greater network density, and more spectral efficiency. This is where problems begin.
WIRELESS NETWORKS: SPECTRUM AND NETWORK DENSITY1
No single industry is currently best positioned to “win” the 5G race. Telecom companies have spectrum but lack network density. Cable companies have network density but lack spectrum. We believe substantial industry consolidation or close cross-industry partnerships will be critical in creating a scaled 5G blueprint, but it is unclear whether that is regulatorily feasible today. True disruption will likely come from a newcomer rather than incumbents who will be loath to cannibalize any existing businesses.
Today, we believe the single best-positioned industry remains the tower industry due to their high barriers to entry, despite rhetoric regarding the rise of urban small cells that augment macro site capacity and potentially jeopardize the tower business model. We like SBA Communications, American Tower, and Crown Castle. Among telecom incumbents, we have a weak preference for Verizon due to its scale, network efficiency, and importantly, the strength of its balance sheet. If the T-Mobile merger with Sprint is completed, new T-Mobile will have a very attractive asset portfolio, although its pro forma debt burden may handicap its ability to make substantial network investments. We also believe that cable companies like Comcast, Charter, Altice USA, and Cox Enterprises enjoy substantial runway on their home broadband products (a 90%+ gross margin business). Furthermore, cable rights-of-access should not be discounted – prohibitive zoning restrictions and the large number of municipalities with whom telecom operators must now negotiate severely delay telecom carriers’ time-to-market.
Spectrum is widely viewed as the most “glamorous” lever of wireless networks, as public spectrum proxies have long existed and have allowed investors (and speculators) to express their views on network advancements. Two such companies today that are primarily valued by their spectrum holdings are Intelsat and Dish Networks – both companies’ enterprise values have been strongly correlated with market perception of a combination of spectrum policy and demand.
Any enthusiasm over investments in spectrum is premature. With a significant amount of money at stake, many parties are at disagreement over how much spectrum must be made available and who gets paid, problems that will create an overhang for Intelsat and importantly delay monetization of spectrum. Clearing incumbent satellite operations and equipment adoption to use the latest spectrum and network standards will take even more time. Dish Networks as an investment also has its own problems over who will receive proceeds from any potential sale of Dish’s spectrum. Most of Dish Network’s debt has been issued at the Dish DBS Corporation level, with those bondholders having no claim on the company’s most valuable asset, spectrum – Dish’s satellite business is secularly challenged and has little value. Furthermore, Dish’s spectrum is better suited to traditional 4G applications than 5G, as they lack the breadth needed to push through 5G capacity (and spectral efficiency) improvements.
In summary, we believe that the next 10 years will see incremental advancements in wireless networks, but progress will be far slower and less disruptive than many expect.
SUMMARY 5G POSITIONING: TELECOM AND CABLE1
1 Source: Diamond Hill Analysis.
As of July 31, 2019, Diamond Hill owned shares of American Tower Corp., AT&T, Inc., Charter Communications, Inc. (Cl A), Comcast Corp. (Cl A), Crown Castle International
Corp., and Verizon Communications, Inc.
The views expressed are those of the author as of August 2019, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice.
Originally published on August 21, 2019.