What’s behind the recent wave of wireless mega-mergers and alliances?
First, AT&T Corp. launched its bold acquisition of cellular leader McCaw Cellular Communications Inc., and MCI Communications Corp. responded by attempting to purchase a stake in enhanced specialized mobile radio operator Nextel Communications Inc. More recently, Bell Atlantic Corp. and Nynex Corp. combined their wireless operations and AirTouch Communications and U S West Inc. announced plans to do the same.
Are even bigger combinations on the horizon? What implications do such deals have for the wireless industry and the upcoming personal communications services auctions?
According to a recent research report by Action Information Services (AIS), PCS functions as a powerful catalyst, speeding the pace of consolidation sweeping the wireless industry. Its main impact will be a huge increase in wireless industry capacity.
Moreover, digital technologies and relatively small cells will let PCS providers support more customers per megahertz. And competition from PCS will spur cellular operators to accelerate their upgrade to high-capacity, digital systems.
For the first time, two-way wireless voice systems will have enough capacity to serve the mass market. What’s more, PCS providers must price aggressively to attract the customers they need to fill their huge capacity and recover their substantial capital investments. In other words, PCS providers will have both the ability and the need to serve the mass market.
Increased competition will force cellular companies to reduce prices and seek efficiencies in purchasing, operations and distribution. The potential for such savings is an important motivation for the wireless industry consolidation that we are seeing. Effective consumer marketing will be essential for success. This is the key benefit that MCI offered Nextel. It’s also the biggest advantage that AT&T brings to McCaw.
AT&T’s acquisition of McCaw was a watershed event in the evolution of the wireless industry. The development set off alarm bells in the executive offices of the regional Bell holding companies (RHCs) and large independents that dominate the cellular industry because they lack AT&T’s brand-name recognition and sophisticated consumer marketing capabilities.
For the LECs, AT&T’s entry made tangible the previously abstract threat of increased competition. PCS gives AT&T the opportunity to transform McCaw’s cellular holdings into a nationwide system. The more competitive environment significantly increases business risks for wireless industry participants. Another key reason for combining forces is to reduce such risk.
Companies are also looking to reduce uncertainty because of the wireless industry’s high financial leverage. Huge new investments will be required to purchase spectrum, build digital systems and conduct mass marketing campaigns. Even cellular operators that shun expensive PCS licenses will need substantial sums to upgrade their systems to digital. Combining wireless businesses allows companies to pool their financial resources. And spinning off such businesses permits them to raise capital and assume financial risks without directly impacting the parent company’s balance sheet.
Expect to see more consolidation. Ultimately, three or four strong wireless competitors are expected to emerge in most major markets. Only a handful of the nation’s largest metropolitan areas can support more than three wireless telephony systems. However, several smaller players should find success in geographic or service niches.
Since enormous sums have to be committed in auction bids, some of the expected consolidation is occurring in the United States prior to the PCS license awards. There will be further combinations next year as companies align their wireless operations according to the auction results. Look for yet another wave of consolidation in a few years as new capacity comes on line and the effects of greater competition begin to appear in quarterly financial reports.
Casual alliances for common branding and roaming won’t survive in this new environment.
Competition will show up first in metropolitan areas. PCS systems are expected to be constructed initially in large cities that offer the highest concentrations of potential customers. After service has been established in major metropolitan centers, PCS networks will be expanded to less densely populated regions that surround major cities, to medium-sized cities and along connecting travel corridors. In rural areas, PCS licensees would have to compete with entrenched cellular companies for a share of the relatively rural customer base. Don’t expect to see PCS widely available in rural areas during the next few years. In fact, the most remote regions are unlikely to ever have PCS.
PCS customers will be concentrated in urban areas. Since market potential differs considerably for individual cities, AIS prepared separate forecasts for each of the top 30 urban markets. Each metropolitan area forecast was adjusted according to such characteristics as income and population density, which significantly influence PCS demand. In the first few years, these markets are expected to account for nearly all PCS subscribers. By 2005, these major metropolitan markets should still contain more than 75 percent of total PCS subscribers, even though coverage will have extended into many other areas. Collectively, these top 30 metropolitan areas comprise about half of the U.S. population.
The opportunities and challenges PCS present for cellular operators depend largely on where their cellular systems are located. New PCS spectrum gives cellular companies the opportunity to expand their operations geographically and add 10 megahertz of capacity in their current territories. AIS’ research shows the extent of overlap between current cellular coverage areas and the potential PCS market in the top 30 metropolitan markets, based on detailed forecasts for individual markets. Among the 30 cities, PCS market potential varies considerably. For instance, the potential for PCS in top-ranked New York exceeds that of cities 21 through 30 combined. The cellular PCS overlap was calculated according to potential customers rather than simply the number of markets served.
Both the vulnerability of cellular operators to PCS competition and the gap each needs to bridge in order to serve the core PCS market are indicated. For instance, Sprint’s cellular systems cover less than 2 percent of the PCS market potential in the top 30 metropolitan areas. This means Sprint has little to fear from PCS competition. However, Sprint would need to buy PCS licenses and construct systems in almost all 30 markets in order to contend for the core PCS customer base.
On the other hand, AT&T/McCaw, with cellular coverage of nearly 50 percent of the core PCS market, is highly vulnerable to PCS competition. But AT&T/McCaw would have to acquire relatively few PCS systems to provide service throughout the core market. The Air Touch/US West and Bell Atlantic/Nynex combinations both have cellular coverage of slightly more than a third of the PCS market in the top 30 metropolitan areas. Although Southwestern Bell Corp. ranks second in total cellular subscribers, its systems serve only about 22 percent of the principle PCS market. GTE Corp./Contel Corp. has coverage for about 19 percent, BellSouth Enterprises has 17 percent and Ameritech 12 percent.
This urban PCS market will be the main battleground as companies vie for wireless market share. And market share will be a key factor in determining the three or four dominant providers. Companies that win in these top 30 metropolitan areas will enjoy scale economies that will be difficult to match. Future business combinations will be driven largely by the need to assemble coverage in these urban areas.
What form will these combinations take? Casual alliances for common branding and roaming won’t survive in this new environment. While Southwestern Bell might like to replicate its former Cellular One arrangement with McCaw, AT&T will likely insist on ultimate authority over its brand name and wireless customers. Since the systems are a good fit, a merger giving AT&T effective control is possible. Meanwhile, former Mobilink partners will be aggressively expanding into each other’s cellular territories.
Equity partnerships are another option. Owning a minority stake signifies greater commitment. It also provides a straightforward means of distributing profits and capital gains. The key problem with such arrangements is management control. If none of the partners have a majority share, decision making is complex and cumbersome.
Mergers or acquisitions such as those of AT&T/McCaw, Bell Atlantic/Nynex and Air Touch/U S West avoid this problem by ceding effective control to one party. Bell Atlantic/Nynex and Air Touch/U S West are both reportedly seeking additional cellular properties. For the dominant partner, one problem with adding another large cellular operation is the potential loss of decision-making authority. The combined equity of the other two might exceed 50 percent. This would let them jointly overrule the largest stockholder.
Such couplings are also complicated by overlapping cellular properties and dissimilar technical approaches. For instance, AirTouch is said to have talked with Ameritech about combining wireless operations, but this combination would require AirTouch to divest substantial cellular holdings in key Midwest markets. Since GTE’s cellular operations were never aligned according to RHC boundaries, the overlap issue is particularly significant for that company. But most RHCs also have significant cellular operations beyond their local exchange service areas. Moreover, it’s difficult to combine operations based on different digital cellular technologies. Companies that are strongly tied to TDMA (Time Division Multiple Access technology) are less likely to join forces with those in the CDMA (Code Division Multiple Access technology) camp. The partnership between AirTouch and U S West was facilitated by the fact that both are committed to CDMA.
Potential competition in other business areas also limits wireless combinations. With its well known brand and national consumer marketing capability, MCI is a highly desirable partner. However, many RHCs plan to enter the long-distance market as soon as regulatory barriers are lifted, and MCI has announced its intention to build competitive local access facilities across the country. These factors make it awkward for RHCs to work with MCI.
Such problems did not exist with Nextel. MCI may revisit the idea of linking together taxpayer-subsidized “designated entity” C block PCS licenses. Such entities might be so dependent on MCI that majority stock ownership wouldn’t be needed for de facto control. And MCI could get a lion’s share of revenues by charging fees for services such as branding, billing and network operations.
Because Sprint has local exchange, cellular and long-distance operations, it is in a somewhat different position than MCI. Sprint is already working with Bell Atlantic on a joint PCS trial. Its mainly rural cellular territories don’t create a big overlap problem for Bell Atlantic/Nynex. Like MCI, Sprint offers a national brand and marketing capability. Unlike MCI, Sprint has not aggressively played the alternative local access card. And Sprint’s lesser share of the long-distance market means it is probably more open to joint activities in that area. For Bell Atlantic/Nynex, a wireless venture with Sprint might well lead to a broader business combination once LECs are permitted to provide long-distance services.
What does this imply for the upcoming broadband PCS auctions? For one, it is unlikely that any single company or coalition will put together a winning bid for a national license in the 30 megahertz A or B blocks. Except for MCI and Pacific Telesis, all of the anticipated major bidders have significant cellular properties. Since FCC rules preclude cellular companies from holding 30 megahertz PCS licenses in their current territories, they will seek such licenses for geographic expansion. Companies or coalitions that need only certain licenses are likely to be willing to pay more for them. Moreover, a substantial portion of the potential 30 megahertz A block market is reserved for pioneer preference holders. It might be possible to form a coalition that includes these companies, but such a combination would have to accommodate the different technologies being used.
In theory, a nationwide license could be constructed by piecing together 10 MHz blocks, but cellular companies will be willing to pay a premium for such blocks in their existing territories to boost capacity. And one of the three 10 megahertz blocks is reserved for designated entities.
This article was based on material from a report entitled “Personal Communications Services Opportunities and Challenges: U.S. Market Forecast 1995-2005” by Action Information Services. For more information, contact Sim Hall, the company’s research director, at (703) 847-9805.)
