Fitch: AT&T Purchase of Leap Highlights Search for Spectrum

The search for wireless spectrum remains evident for telecom companies seeking growth in a highly competitive environment. Fitch Ratings expects the search for spectrum will continue, most recently underscored by AT&T's announcement it would buy Leap Wireless for approximately $1.2 billion, plus the assumption of $2.8 billion in net debt. The value of the spectrum is underscored by the 8 times (x) acquisition multiple, which is rich for a wireless carrier that has struggled to generate EBITDA and revenue growth. Wireless carriers are also acquiring spectrum in smaller transactions, as demonstrated by Sprint's recent battle to acquire the portion of Clearwire it did not own (and full control of Clearwire's spectrum). In June 2013, T-Mobile announced it would bolster its spectrum position by acquiring 10MHz of spectrum in the AWS band in the Missouri Valley REA from U.S. Cellular for $308 million. AT&T is awaiting regulatory approval of its proposed acquisition of Atlantic Tele-Network U.S. wireless operations (operating under the ALLTEL brand) for $780 million. These acquisitions highlight carriers' needs to add spectrum to support the growth in demand for data capacity in advance of future FCC auctions. The FCC has broad plans to hold several auctions in coming years, freeing up 200MHz of spectrum or more, depending on the participation level of TV broadcasters in the FCC's incentive auctions forecast for next year. The first auction is expected to be the PCS "H-block" in late 2013 or early 2014. Of course, acquiring spectrum in the market rather than waiting for the auction process allows carriers to take advantage of the spectrum earlier, and certain blocks of existing spectrum may be more attractive to carriers already operating in those spectrum bands. We expect AT&T's gross leverage to be in the 1.7x to 1.8x range for 2013, compared with 1.7x in 2012 (excluding the actuarial losses on its benefit plans). By year end AT&T will complete several spectrum purchases in addition to stock repurchases and higher capital spending expected in 2013, The Leap acquisition is not expected to close for six to nine months, and has not been included in Fitch's leverage expectations. If included, the effect would be nominal at 0.05x. On average, Fitch expects AT&T's FCF (net cash provided by operating activities less capital expenditures and dividends) to decline to $5 billion-$6 billion annually over the next three years from $9.2 billion in 2012. Total debt increased to approximately $74.1 billion at the end of the first quarter of 2013 from $64.8 billion at the end of 2011, as borrowing augmented FCF to fund $18.7 billion in stock repurchases through the first quarter of 2013. We changed AT&T's Outlook to Negative from Stable in November 2012 due to the expectation that net leverage is likely to move up to a 1.8x upper boundary by 2014 before declining over time. The increase is a notable rise from the 1.5x during the past few years. Aggressive stock repurchases to date, combined with lower free cash flow (FCF) due to higher capital spending in 2013, will lead to additional borrowing. EBITDA growth, while solid, is expected only partially to offset the effect of the rise in debt on leverage. The 'A' rating assigned to AT&T is underpinned by the company's diversified revenue mix, its significant size and economies of scale as the largest telecommunications operator in the U.S., and Fitch's expectation that AT&T will benefit from continued growth in wireless operating cash flows.