What investors want to know

Corporates Telecom / U.S.A.

What Investors Want to Know: U.S. Telecom Regulation, Consolidation and Convergence in Trump Era Special Report Horizontal Consolidation Not Expected: Despite expectations for a more favorable environment marked by less taxes and lower regulation, Fitch Ratings does not expect largescale horizontal consolidation among telecommunications and cable companies. Rather, convergence within telecommunications and media sector participants revolving around content acquisition, distribution and monetization will provide a catalyst for mergers and acquisition (M&A) activity, we believe.

Lighter Regulatory Touch: The regulatory environment for U.S. telecommunications and cable companies under the new administration is likely to lead to less regulation and lower taxes, which would be positive to operators’ growth profiles. These moves would likely stimulate investment and greater innovation for both operators and business customers given increased clarity and predictability of the regulatory environment.

Expect Time Warner Approval: Fitch believes the merger between AT&T and Time Warner will be approved, given the facts and circumstances of the merger call for the review to fall primarily under the Department of Justice (DoJ). AT&T and Time Warner have structured the transaction so that no wireless licenses will be transferred, potentially avoiding an FCC review.

Pessimistic on Sprint-T-Mobile Merger: We remain relatively pessimistic on the approval of a horizontal merger between Sprint and T-Mobile due to the lack of benefit to public interest, expected likelihood of substantial job losses and the antitrust implications of losing an aggressive price competitor. The unlimited price wars reflect current competitive intensity, which, in Fitch’s opinion, would diminish if a potential merger is approved, with the majority of benefits accruing to shareholders of the new company.

Related Research 2017 Outlook: North American Telecommunications and Cable (December 2016)

5G a Work in Progress: As 5G standards are being defined, Fitch anticipates early commercial service to begin in 2020 or later. We expect 5G to fully interoperate with 4G and be an important enabler for internet of things (IoT) applications. Early 5G requirements could emerge in 4G evolutions, leading to a smooth generational transition. We also believe the economics for 5G fixed-wireless remains uncertain in markets where fixed-line broadband is mature and saturated.

In this report we address the following frequently asked investor questions: How does Fitch view the new administration’s effect on telecom regulatory policy?

Analysts William Densmore +1 312 368-3125 bill.densmore@fitchratings.com John Culver +1 312 368-3216 john.culver@fitchratings.com Alen Lin +1 312 368-5471 alen.lin@fitchratings.com David Peterson +1 312 368-3177 david.peterson@fitchratings.com

What is Fitch’s view on regulatory approval for the AT&T and Time Warner transaction?

What is Fitch’s view on regulatory approval for the wireless consolidation of Sprint and TMobile?

What is Fitch’s view on the price war for unlimited wireless data?

How is consolidation between AT&T and DirecTV different than consolidation between Sprint and T-Mobile?

What is Fitch’s view on cable entry into wireless?

How do convergence and trends change the lens on wireless consolidation?

What is 5G and why do we need it?

www.fitchratings.com

March 21, 2017

Corporates How Does Fitch View the New Administration’s Effect on Telecom Regulatory Policy?

The regulatory environment for U.S. telecommunications and cable companies under the new administration is likely to lead to less regulation and lower taxes, which would be positive to operators’ growth profiles. These moves would likely stimulate investment and greater innovation for both operators and business customers given increased clarity and predictability of the regulatory environment.

Fitch does not expect medium-term large-scale horizontal consolidation within the sector.

However, we anticipate a revised regulatory lens will be used for other M&A transactions.

Convergence trends will continue to serve as a catalyst for telecommunications, cable and media sector integration revolving around content acquisition, 5G, distribution and monetization.

The rating outlook for telecom and cable could remain negative if there are indications management is weakening its commitment with maintaining appropriate credit profiles in the face of more transformational transactions by failing to address rising leverage from acquisitions in a timely and effective manner. The rating outlook could also remain negative if product pricing becomes irrational and detrimental to the health of the sector. Unlimited mobile data plans are a case in point where companies are facing competitive pricing pressures.

Initial comments and actions announced in speeches and in the press from the new FCC Chairman, Ajit Pai, signal a lighter regulatory touch. Chairman Pai plans to advance a retooled agenda from his predecessor, Thomas Wheeler, focusing on policies targeting deregulation and digital empowerment. Fitch also expects any M&A transactions approved by regulators would have less attached conditions.

AT&T’s acquisition of DirecTV, while deemed by the FCC as in the public interest, had 17 pages of attached conditions. Pai expressed significant opposition to the conditions, indicating those extracted from AT&T were meant to satisfy a regulatory wish list and were unrelated to the acquisition. Chairman Pai has also moved to eliminate a portion of the FCC conditions from the Charter-Time Warner Cable-Bright House networks merger. The conditions currently require Charter to build-out its network in 2 million new customer locations, including an overbuild of 1 million consumer locations where existing broadband competition is already present. A revised order would eliminate the overbuild requirement and encourage Charter to focus broadband deployment on under-served areas.

During his time with the FCC, Pai wrote several other dissents that the commission’s decision went beyond its legal authority and could ultimately hamper investment, innovation and job creation. In particular, Pai was critical of the FCC’s net neutrality decision that reclassified broadband Internet access service as a Title II telecommunications service. Pai believes the net neutrality rules that were passed in 2015 and reaffirmed after legal challenges in 2016, will lead to higher broadband prices, slower speeds, less deployment, less innovation and fewer options.

Chairman Pai took quick action in early February 2017 to rescind several controversial orders and reports released late in Wheeler’s tenure that, in his opinion, lacked sufficient reasoning.

As part of these actions, the FCC closed its investigation on zero-rating practices by AT&T and Verizon, indicating these plans have proven to be popular among consumers, while enhancing competition. Further actions to dismantle certain aspects of the net neutrality framework are anticipated around Title II reclassification.

One of Chairman Pai’s other key priorities is closing the digital divide by addressing the gap with consumer’s access to high-speed broadband in urban cores and rural communities.

What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates Strategies will include removing regulatory barriers for broadband deployment and promoting entrepreneurship and innovation to create gigabit opportunity zones in economically challenged urban areas and new funding mechanisms to deploy mobile broadband in rural America.

Chairman Pai has already passed a proposal to direct $170 million in federal funding to buildout broadband in underserved areas in upstate New York. Two additional proposals are currently on the table, one to direct billions of dollars over the next decade to deploy 4G LTE infrastructure in rural areas and a second to allocate almost $2 billion to advance fixed broadband services.

A reshaped FCC could also likely seek more of a consensus approach to find solutions that would have greater acceptance and buy-in for all parties compared with the past commission under Wheeler. President Trump’s advisor selections on antitrust policy would also signal a lighter regulatory touch for the DoJ, although key antitrust appointments at the Justice Department remain outstanding and could take some time to be confirmed, similar to what occurred in the Obama administration. As part of the DoJ’s transition team, President Trump named David Higbee, an antitrust veteran, and Joshua Wright, a pro-business economist, which would suggest a pro-business market-based approach. Some people believe Higbee’s views could take a stronger position against potential competitive price-fixing and horizontal mergers.

The two seated commissioners are Mignon Clyburn, a Democrat, with an expiring term in June 2017, and Mike O’Rielly, a Republican, with an expiring term in June 2019. Commissioner Clyburn is viewed as a consumer champion and defender of public interest. Commissioner O’Rielly has two decades experience on Capitol Hill, including substantial familiarity of the Telecommunications Act of 1996. He has pressed for mandated cost benefit analysis on final rules and favored light regulatory touch reflecting his vote against net neutrality rules. The Trump administration must still fill the two vacant FCC commissioner positons, one Democratic and one Republican, which still adds some uncertainty to the FCC’s final make-up.

What Is Fitch’s View on Regulatory Approval for the AT&T and Time Warner Transaction?

Fitch believes the merger between AT&T and Time Warner will be approved based on the DoJ’s responsibility to approve the transaction and the more deregulatory stance of the new administration, despite President Trump’s campaign trail comments that suggest otherwise. On its earnings call in January, AT&T’s CEO commented that he is encouraged by the less regulatory stance of new administration as well as for the potential for tax reform.

Our understanding from reviewing legal commentary and subsequent comments by Chairman Pai is the DoJ will have jurisdiction over the review, which is subject to a higher level of jurisprudence based on facts, case law and precedent. With this being a vertical merger, rather than a horizontal one that eliminates a competitor, legal commentary generally indicates it should be approved based on the facts. The company would likely have to agree to potential remedies, such as not giving preferential treatment to its own content, for the merger to be approved. Vertical mergers in the communications industry have been approved under the DoJ, as in the case of Comcast-NBCU, so by that logic and not having a precedent case, the merger could go through.

The FCC is unlikely to review the merger, based on comments by Chairman Pai during an interview with the Wall Street Journal at the Mobile World Congress published Feb. 27, 2017.

However, following a hearing by a Senate Commerce Committee, Chairman Pai said he would get an agency staff legal analysis confirming his believe the FCC does not have authority to conduct a public interest review of the transaction. An FCC review is widely thought to present What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates U.S. Postpaid Subscribers (257 Million in 2016) T-Mobile USM 2% 14% Sprint 12% Verizon 42%

Source: Company filings.

U.S. Postpaid Gross Additions (42.7 Million Estimated in 2016) USM 2% Verizon 36% Sprint 16% AT&T 26% Source: Company filings, Fitch estimates.

U.S. Wireless Revenue ($236 Billion in 2016)

T-Mobile 16%

USM 1%

Verizon 38%

Sprint 14%

AT&T 31% Source: Company filings.

What Is Fitch’s View on Regulatory Approval for Wireless Consolidation of Sprint and T-Mobile?

Fitch believes telecom and cable companies will engage in material M&A discussions once incentive auction restrictions are likely lifted in April due to the anti-collusion rules in effect between auction participants. However, while the regulatory environment will be more favorable for certain M&A transactions, we remain pessimistic on the approval of a horizontal merger among the four national wireless operators, specifically Sprint and T-Mobile, due to the lack of benefits to public interest, substantial job losses and the antitrust implications of losing an aggressive price competitor.

AT&T 30%

T-Mobile 20%

a larger hurdle, given the FCC can apply a public interest standard to the transaction. AT&T and Time Warner have structured the transaction so that no wireless licenses will be transferred, potentially avoiding a review by the FCC. The licenses in question are held by an Atlanta TV station that Time Warner has agreed to sell to Meredith Corp., and the only TV station owned by Time Warner. It does not appear that other, older licenses, including those for satellite uplink held by Time Warner, need to be transferred to AT&T.

The robustness of the competitive marketplace is currently demonstrated by Verizon and AT&T’s recent foray into aggressively priced unlimited plans that are now available to their entire subscriber bases, which both had been unwilling to offer in the past. The unlimited price wars reflect current competitive intensity, which, in Fitch’s opinion, would diminish if a potential merger is approved, with the majority of benefits accruing to shareholders of the new company.

Fitch also believes Sprint’s over-leveraged balance sheet, numerous ongoing strategic initiatives to address operating deficiencies and weaker brand remain an impediment to overall consolidation opportunities. The Sprint spectrum securitization notes would not have any effect on a transaction. The secured notes can be prepaid at any time without penalty and have a change of control trigger at 101%.

Chairman Pai has indicated any decision regarding further consolidation in the telecom industry, including wireless, would depend on the information presented in the context of a merger application. His remarks also included that he is uncertain as to the optimal market structure including whether three or four national operators is the appropriate number. This is in contrast to Chairman Wheeler, who strongly believed four national wireless operators’ is optimal for American consumers.

Key questions to be answered as part of the regulatory review would include whether the merger leads to cost savings or product improvements that benefit consumers and its potential effect on pricing, and does a high level of concentration in an industry necessarily mean the industry lacks competition? The regulatory analysis would consider potential harms and benefits to ensure the proposed transaction serves the public interest, convenience and necessity. For a horizontal merger, the review would examine market share, geographic markets and viability of new market entry that would offset lessened competition.

A Sprint and T-Mobile combination would control roughly 290 megahertz (MHz) or 45% of available spectrum. The transaction would likely require material spectrum divestitures in numerous markets, as the combination would be above the spectrum cap, which is one-third of the available spectrum in a specific market area. As part of the review, the FCC could increase the spectrum cap that may limit spectrum divestitures in most markets, depending on specific spectrum holdings, to 15MHz–30MHz.

What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates Estimated Spectrum Holdings Top 100 Markets

U.S. Postpaid Churn 2016 1.18 1.01 1.07 1.62 1.30

(%) USM Verizon AT&T Sprint T-Mobile

700 MHz

2015 1.30 0.96 1.09 1.70 1.39

Cellular/SMR

AWS

ASW-4

PCS

BRS/EBS

WCS

AWS-3

(MHz) 250 200 150

Source: Company filings.

100 50 0 AT&T

Verizon

Sprint

T-Mobile

DISH

Source: Fitch estimates, company data.

The primary benefits of a Sprint-T-Mobile merger would be driven by significant synergy realization and the structural change from three to four national operators. The spectrum divestures would benefit AT&T and Verizon for additional spectrum flexibility to address increasing network capacity requirements. A combined Sprint-T-Mobile would be able to more effectively deploy capital and increase operating scale that would substantially increase cash flows — when combined with material synergies and a likely more rational competitive environment — to better compete over the longer term.

Important objectives that government regulators would want to see, such as additional investment, innovation or job creation, would likely be missing from a potential combination.

Fitch does not believe this merger would serve any public interest beyond the shareholders of the new company, particularly given the need to generate substantial synergies to justify the likely steep transaction premium. The combination would lead to significant job losses, which runs counter to one of Trump administration’s key goals, and overall reduced aggregate investment spending on infrastructure and in future spectrum auctions. Globally, most markets have at least four significant competitors. A reduction to three national operators, in one of the more robust markets globally, would place the U.S. out of step with other global regulators.

U.S. Prepaid Subscribers (77 Million in 2016)

America Movil 34%

USM 1%

Verizon 7% AT&T 17%

Sprint 15% T-Mobile 14% Source: Company filings.

The past reluctance from regulators to allow either an AT&T-T-Mobile or Sprint-T-Mobile combination has resulted in a robust competitive marketplace. T-Mobile and Sprint have responded by changing top management, investing in their networks, and innovating new services to improve their brand proposition, while wireless industry participants have competitively responded with device installment plans, leasing, zero-rated data and unlimited data offerings. Consequently, the significant disruption has resulted in consumers receiving more value. Both T-Mobile and Sprint have strong parents essential to improving their respective competitive positions. Parental support has been realized through lower cost financings, network expertise, procurement/global scale benefits and operational assistance.

T-Mobile’s substantially improved performance and expectations for continued revenue and EBITDA growth leads us to believe that T-Mobile has become more strategic to the group. The improved financial performance of T-Mobile, fueled by structural tailwinds from geographical expansion and increased distribution, along with Deutsche Telekom’s (DT) stronger commitment to parental funding of the U.S. subsidiary, increases the likelihood DT could run this subsidiary as an independent business over the longer term. However, this does not preclude DT from seeing a reduction in its stake if a merger opportunity arises, as T-Mobile management believes the company is uniquely positioned to take part in future strategic transformative opportunities.

Should Sprint’s operational momentum stall and fail to sustain past improvement, ratings concerns would increase, whether SoftBank Group Corp. remained committed to Sprint over

What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates the longer term or not. Fitch views Sprint’s operational and strategic linkages to SoftBank as moderately strong given the extensive operational oversight and effect on SoftBank’s consolidated results. However, legal linkages are weak given the lack of any guarantees provided to existing debtholders. SoftBank has refrained from additional equity injections, preferring to provide support through its extensive financial relationships and sometimes taking subordinated positions in associated financing structures.

A weakening of Sprint’s operating and financial profile, combined with U.S. wireless market maturity, would seem to suggest structural challenges are present, such that the marketplace cannot effectively support four network-based operators. Verizon and AT&T’s substantial financial capacity to weather potential price wars, particularly when considering Sprint’s subscale operations, magnifies this point. In this event, Fitch believes wireless consolidation and/or other consolidation alternatives could be considered.

What Is Fitch’s View on the Price War for Unlimited Wireless Data?

Given the recent aggressive pricing actions, Fitch believes unlimited pricing at this level is not sustainable and would lead to erosion of long-term profitability and increased investment within the wireless industry. This potentially creates more risk for Sprint due to its constrained financial profile and weaker competitive position. The recent move toward unlimited wireless plans could also increase competition within the broadband market, appealing to certain more cost conscious consumers that are interested in reducing their total telecom and cable spend.

Fitch believes the recent changes with unlimited data plans demonstrate the competitive effectiveness that exists within the wireless marketplace. The Unlimited Data Plan Comparisons table below shows the recent changes in unlimited plans by the four national operators. T-Mobile unveiled its latest uncarrier move, T-Mobile ONE, in August 2016, which basically expanded its Binge On unlimited video uncarrier initiative and became the first carrier to move to an unlimited LTE data plan. Sprint quickly matched with its Unlimited Freedom plan.

T-Mobile further simplified its offering and became more aggressive in January 2017 by revising the T-Mobile ONE plan to include all monthly taxes, surcharges and fees.

Unlimited Data Plan Comparisons Unlimited Data Plans T-Mobile

Verizon Sprint

AT&T (HD) AT&T (SD)

Throttling Cap (GB) 28

Hotspot (GB) 10

$80–$200 Two Lines — $140 $60–$190 Two Lines — $100

22

10

23

10

$90–$205 Two Lines — $145 $60–$175 Two Lines — $115

22

10

22

N.A.

Price (1–5 lines) $70–$180 Two Lines — $100 Taxes Included

Other Notes $5 upgrade per for HD. Limited time promotion of $150 per line port in credit or 20% insider discount.

Reduced two lines to $100 after Verizon change.

New to unlimited on Feb. 13. Doesn't cap to SD. $20 upgrade for HD. Certain other data traffic capped. Offering five-line promotion for $90 through March 2018.

Initial unlimited was for DirecTV video subscribers only; $25/month bill credit for DirecTV users.

Had unlimited offer of $220 for five lines initially following Verizon change; 3Mbps maximum data speed.

GB – Gigabytes. HD – High definition. SD – Standard definition. N.A. – Not available. Mbps – Megabits per second.

Source: Company websites.

Verizon stated in January 2017 that the company did not feel the need to offer but would continually monitor market conditions. However, Verizon leaped into by mid-February 2017 and all operators have further adjusted their plans in AT&T in particular materially revising its plans to remain competitive. AT&T’s What Investors Want to Know: U.S. Telecom March 21, 2017

unlimited plans unlimited plans response, with initial unlimited 6

Corporates plan for a family of five with unlimited data was $260, which also required DirecTV video service. Following Verizon’s change, AT&T expanded the unlimited plan to customers without a DirecTV subscription, charging $220 for five lines. Within the next two weeks, AT&T further revised its unlimited plan with two different tiers for video streaming (high definition with hot spot or standard definition [SD]). AT&T’s lowest-priced offer for five lines of unlimited data is $175, including SD video streaming.

The move toward unlimited plans will also likely affect usage behavior and drive more traffic to wireless networks if operators continue these aggressive offers, as consumers become indifferent with seeking access to Wi-Fi hotspots. Consumers previously had incentive to seek out Wi-Fi hot spots given the need to more closely limit their data usage to prevent added charges. While Wi-Fi networks will continue to serve as an important adjunct for traffic offload and provide improved in-building coverage, consumers will have more freedom to use their devices without location constraints given unlimited data caps in excess of 20 GB before speeds are throttled.

The unlimited price war in postpaid also appears to be transitioning into prepaid, which had already become extremely competitive over the last two years following the acquisitions of the Cricket prepaid brand by AT&T and MetroPCS by T-Mobile. Both Cricket and MetroPCS lacked the financial resources to compete effectively over the longer term. AT&T and T-Mobile have successfully integrated the acquisitions, improved the network quality and substantially expanded distribution to create innovative, aggressive attack brands to target typically lowerpriced, niche market segments. Consequently, the traditional prepaid segment has been challenged, as evidenced by Sprint’s and TracFone’s recent performance.

Recent changes include MetroPCS expanding its 8 gigabyte (GB) monthly plans to include unlimited data and Cricket reducing the price of its existing unlimited plan to $60 from $70.

Sprint has new unlimited plans for $60 on Virgin, and either one line for $50 or four lines of unlimited SD data for $100 on Boost Mobile when a family switches carriers, respectively.

How Is Consolidation Between AT&T and DirecTV Different Than Consolidation Between Sprint and T-Mobile?

A combined AT&T and DirecTV is viewed by the FCC as a more effective multichannel video programming distributor competitor that can offer several choices and price-competitive integrated bundles to consumers. As stand-alone companies, neither had the necessary assets to compete against the leading video service providers. Consequently, in the FCC’s opinion, an AT&T-DirecTV combination is expected to increase price competition for video and broadband bundles and stimulate investment, thus benefiting consumers and serving the public interest.

DirecTV lacked broadband capabilities with limited video-on demand and other interactive capabilities, despite material scale with approximately 20 million video subscribers. DirecTV’s broadband and DirecTV satellite video bundles through third-party partnerships was also an inferior competitor to the lower price, useful bundles offered by a single broadband provider.

AT&T had less than 6 million video subscribers, which with limited scale resulted in higher programming costs. This hampered AT&T’s ability to compete through offering lower consumer prices or expanding its high-speed broadband footprint.

Fitch believes the wireless market hasn’t evolved in the way the market for video services has changed. The proliferation of over-the-top (OTT) services, such as Netflix, Amazon Prime, Hulu, MLB.TV, Sling TV and HBO NOW combined with changing consumer viewing habits has driven consumer cord cutting and emerged as a viable competitive alternative to incumbent cable, telecom or satellite providers. These services are focused on price, content and What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates streaming quality. As such, consumers have increased adoption of lower-priced, stream-lined video bundles that leverage the high-speed broadband infrastructure, such as DISH’s Sling TV, Sony’s PlayStation Vue and AT&T’s DirecTV NOW, along with expected new entrants in 2017 from Hulu (Hulu Live TV) and Google (YouTube Unplugged). Over time, cloud DVR functionality could enhance capabilities to improve the competitive position of the service offering.

Outside of the four national wireless providers, several companies offer mobile virtual network operator (MVNO)/reseller services. Fitch currently does not view these MVNO service offerings as strong competitors to the four nationals given the lack of owner’s economics that will become more apparent as more subscribers move toward unlimited data plans. The FCC still attributes MVNO subscribers to their host facilities-based service provider when considering market concentration metrics.

TracFone, the largest MVNO reseller at approximately 26 million subscribers, has multiple prepaid brands, such as Straight Talk, NET 10, Simple Mobile and SafeLink, which target different demographic and market segments, including Hispanic, low-income and some premium subscribers. Other MVNO’s are pursuing Wi-Fi/Cellular hybrid services, including Google Fi, Republic Wireless and Ting, along with expected launches by Comcast and Charter Communications that are activating their Verizon MVNO agreement.

What Is Fitch’s View on Cable Entry into Wireless?

Fitch views the expected Wi-Fi offerings supplemented by host MVNO agreements for Comcast and other companies as a new long-term grinding competitive threat that, if successful, could create market share shifts, pricing and margin pressure and diminish the growth prospects of the four incumbent national wireless operators. Sprint would likely suffer the most negative effects given its more constrained financial profile. However, given the mature wireless market, low churn, entrenched bundled family plans and resurgence of the two smaller national wireless players, any new entrant will likely struggle to gain meaningful scale.

The initial wireless plans offered by Comcast and other cable companies will focus on existing customers aimed at improving subscriber churn and overall customer lifetime value. While recognizing the growth of video consumption by wireless devices both inside and outside the home, Fitch views cable’s initial entry into wireless as more of a defensive strategy to preserve existing market share rather than an attempt to disrupt the wireless market. The asset light business model that leverages existing extensive Wi-Fi capabilities and the MVNO agreement with Verizon materially reduces capital risk. Fitch expects cable companies will offer their respective wireless offerings within their respective service territories, which will position the operators to capture brand recognition and existing distribution capabilities.

Nevertheless, Fitch believes the cable operators will be challenged to provide its subscriber base value and benefit beyond service bundling pricing discounts. Simply adding a wireless service to the cable provider’s existing product bundle and service offering may not prove to be very compelling, and convincing subscribers to sign up for a hybrid-type wireless service could be difficult.

Success of new entrants into the wireless sector is predicated on the new operator’s ability to disrupt the market with innovative, value-creating service offerings similar to T-Mobile. However, new innovative services can typically be replicated relatively quickly by the competition.

Consequently, Fitch believes that a lower-cost wireless build-out by cable companies in their respective service territories would be hard-pressed to effectively compete from a quality

What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates perspective against the four national wireless operators that have invested billions of dollars in wireless infrastructure over a long timeframe.

How Do Convergence and Trends Change the Lens on Wireless Consolidation?

Several broad trends are driving distinct structural market changes and causing industries that were formerly separate to converge and reshape the operating profiles of content, telecom and cable operators. Content has moved away from linear format to the internet with digital consumption through OTT services. Consequently, content development, distribution and monetization are evolving with an eye toward optimizing the mobile experience.

The internet has also moved toward mobile, supported by the proliferation of feature-rich, appcentric smartphones and tablets utilizing higher-speed, lower-latency connections through deployment of LTE networks that cover the majority of the U.S population. Consequently, consumers are increasingly able to control where and when content is watched, particularly as operators encourage mobile consumption through the growing adoption of unlimited data plans, zero-rated/sponsored data or widespread Wi-Fi-based networks.

Speculation abounds as to how wireless, cable, wireline and content could consolidate during the next several years. Exactly what shape and form this takes is unclear as operators attempt to consolidate assets and deploy 5G networks, with new products that will take advantage of even lower-latency, higher-capacity networks to offer innovative new services and wirelessfocused bundles. Consequently, operators must find cost-effective ways for backhauling data through evolving strategies to create a financially viable business model for 5G when considering the required investment that must scale across large networks. Fiber and pole assets used for backhaul have become increasingly critical for densification, as evidenced by M&A activity in 2016. Additionally, cable operators’ extensive hybrid fiber coaxial networks with plans to deploy fiber deeper are increasingly being speculated as a key asset to provide necessary backhaul capabilities for 5G networks.

Thus, with the backhaul challenges associated with 5G, this could potentially serve as the catalyst for merger between telecommunication and cable companies, given the need for networks to evolve to meet the heavy data demands of 5G. However, there would have to be some reliance on buying or building for the wireless companies, as no cable company has assets in all of the major markets. Consequently, there would still need to be investment or partnering with others outside of those cable regions.

Fitch believes there could be some strategic benefits to a Verizon-Charter combination given Charter’s fiber assets could play a role in network densification needed for 5G that could be combined with smart city assets that Verizon has acquired. Verizon’s recent acquisition of XO Communications and its significant amount of fiber in major metro areas would seem to be better suited to providing network densification in urban areas but XO’s fiber could be supplemented by Charter’s assets in suburban areas and smaller markets.

On an ancillary basis, there are some programming cost benefits with Verizon Fios, but this would unlikely be a major driver of a deal. Fitch believes there would still be some uncertainty regarding the most optimal way to merge assets over the longer-term. Regulators would also likely approve a merger, although significant divestitures are probable, as Charter’s cable properties overlap with Verizon’s wireline properties on the East Coast, including the New York and Massachusetts markets.

Likewise, a transaction between T-Mobile and DISH could merit stronger strategic consideration given the resulting robust spectrum position and substantial capacity, along with What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates the ability to integrate and bundle Sling TV. However, such a combination has many barriers, including ownership, high leverage and inconsistent DISH operating performance trends.

DISH’s current operating profile has focused on its maturing video service offering and lacks growth opportunities relative to its competition. Although Sling TV provides a source of growth compared with the traditional pay-TV business, the Sling TV subscriber base is small, with much lower average revenue per user. As such, Fitch views the positioning as defensively oriented given the current subscriber erosion and is unlikely to contribute meaningfully to DISH’s operations in the near term.

Fitch believes a Sprint-T-Mobile merger would still face material uphill challenges during the next couple of years, given the lack of clarity, still early stages of convergence, and the significant development that needs to occur for 5G product and services. As part of the DOJ review process, an assessment is made on the viability of whether new market entry could offset lessened competition. In Fitch’s opinion, an argument for wireless consolidation based on convergence trends, given the uncertainty with how the industry will converge and what products will be successful, is challenging. Additionally, given the potential that other avenues for consolidation could develop, this could likely limit future wireless horizontal consolidation opportunities.

What Is 5G and Why Do We Need It? The evolution of 5G is not only about providing more bandwidth to smart devices, but to enable more connectivity and improve reliability. The vision of all things connected cannot be accomplished without ubiquitous connectivity; 5G will play an important role in enabling the vision. The connectivity and reliability will enable everything from autonomous driving, to connected factory, to smart cities, and everything in between. While some of these solutions will become available prior to full deployment of 5G, Fitch believes more robust solutions would require substantial investments in infrastructure to complement the capabilities of connected devices.

While 5G technical specifications have yet to be finalized, some functional requirements have been identified to enable the next generation of services. The requirements generally fall into three areas of functional enhancements, the first being higher data capacity and peak data rates exceeding 20 gigabits per second (Gbps), which would provide enhanced mobile broadband experience, particularly for rich media consumption. The second is aimed at supporting massive machine communication, providing connectivity for billions of IoT devices with low power consumption. The third area is in support of highly reliable, low-latency communications to enable mission-critical machine communications, such as autonomous driving. These enhancements pave the way for wireless communication to evolve beyond a user-centric service to a machine-centric product and service. The full potential of a connected world cannot be realized without these enablers.

We expect 5G technical specifications to be finalized in 2018–2019, with the first commercial deployments by 2020 and mainstream deployment of 5G services likely in 2022–2025.

However, we believe a number of 5G trials will take place ahead of final specifications to provide real world feedback on 5G specifications development. We also expect 4G/LTE and 5G to coexist for the foreseeable future, as they will complement each other in coverage and capacity. LTE-Advanced Pro, the next evolution of LTE after LTE-Advanced, is expected to adopt some of the technical enhancements proposed for 5G, which should provide for seamless interoperability between 4G and 5G. Fitch also expects a number of operators to declare 5G services for marketing purposes ahead of full 5G standards-compliant commercial deployments.

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Corporates Deployment of 5G is expected in a wide range of licensed and unlicensed spectrums, including below 1 Gigahertz (GHz, low bands), 1GHz–6GHz (mid bands) and above 6GHz, with particular interests above 24GHz (millimeter-wave bands). The FCC has identified the 600MHz spectrum as an essential 5G low band in the U.S.; the assignment of 70MHz of licensed spectrum in the 600MHz band is expected to be completed by March 30, 2017. An additional 14MHz of unlicensed spectrum will also be allocated in the 600MHz band. The sub-1GHz band is critical for wide-area 5G coverage. The FCC is aiming for making the 600MHz band available for 5G commercial deployment by 2020.

The high bands will be utilized for ultra-high capacity deployments in high-density areas; dense small cell architecture is likely to be common in the high bands due to its high signal attenuation characteristics. The industry proposals are calling for a combination of licensed and unlicensed bands ranging from 24GHz to 86GHz. Globally, the 3.3GHz–3.8GHz band is expected to be the harmonized spectrum for 5G services, although specific frequency assignments within this band could vary.

Fitch believes the potential for 5G fixed-wireless to cannibalize broadband in urban areas will be limited, as we expect fiber broadband and cable broadband to provide superior performance to 5G. This is particularly true in urban areas where quality of in-building coverage for wireless could vary significantly. While 5G is expected to offer peak data rates exceeding 20Gbps, we believe the average data rate per user would be substantially below the peak data rate in a multi-user environment where the network capacity is shared among many users.

Fitch believes the sub-1Gbps user data rate would be uncompetitive against fiber broadband and cable broadband, as both are capable of supporting data rates exceeding 1Gbps to single users. Market expectations for reliable high data speed will rise with demand for multi-stream UHDTV, entertainment and smart home applications. Taking into account the cost of providing capacity to a new 5G network, we believe the economics will remain favorable for fixed-line broadband. However, in low-density regions where fixed-line broadband is less competitive due to unfavorable economics, 5G fixed-wireless could be an effective alternative.

In addition to the competitive and economic reasons for fixed-line broadband to remain, we believe it will complement high-speed 5G services, which could be localized in high-density areas. Fitch believes the existing fixed-line broadband network would provide the additional capacity to complement wireless broadband and greatly enhance overall wireless service quality through the interoperability across 4G, 5G and Wi-Fi. While Fitch views 5G as a key enabler for IoT given the machine communications capabilities, we do not view narrowband IoT (NB-IoT) and 5G as being synonymous. NB-IoT technologies were developed to support wide-area, low-power and low-data speed applications that may be supported with 4G. Applications that may utilize NB-IoT include smart metering and smart city, which do not demand high data capacity. The capabilities for NB-IoT can be supported by existing wireless networks or new networks dedicated to NB-IoT applications. Given the incremental costs required to build dedicated NB-IoT networks and limited addressable market, we believe its competitiveness may be confined to areas currently underserved by existing wireless networks limiting the economic feasibility.

What Investors Want to Know: U.S. Telecom March 21, 2017

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Corporates

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What Investors Want to Know: U.S. Telecom March 21, 2017

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