Kerrisdale Capital’s short report on Straight Path Communications Inc (STRP) – Setting the Story Straight.
— ValueWalk (@valuewalk) January 18, 2017
We are short shares of Straight Path Communications, a disgraced “5G” hype vehicle whose stock price surged last week for an unusual reason: the announcement of a harsh regulatory crackdown. After a pseudonymous short seller in 2015 accused Straight Path of “fraud,” the FCC opened its own investigation into whether the company had violated its legal duty to actually provide service rather than merely hoard spectrum for the sake of speculation. To end this investigation, Straight Path agreed to pay up to $100 million over time, surrender many of its licenses, and sell its entire remaining spectrum portfolio, with 20% of the sale proceeds going to the FCC.
The market greeted this news joyously, apparently relieved that Straight Path had avoided an even more draconian penalty and convinced that a spectrum sale would be fast and lucrative. This optimism is badly misplaced. Straight Path’s spectrum is worth far less than the company’s current half-billion -dollar market cap. Indeed, as we discuss below, Verizon is set to buy a similar amount of higher-quality spectrum from a sophisticated, deep-pocketed seller – Carl Icahn – for just $200 million, 61% lower than where Straight Path trades, implying massive downside for its stock price even before taking into account the harsh FCC penalties. Adjusting for these penalties and the lower quality of Straight Path’s spectrum, we believe the true downside exceeds 70%. The notion that a company that holds less than $10 million in cash, burns $7 million a year, and must pay out $15 million in fines in the next nine months will drive a drastically harder bargain than Carl Icahn – in a government-mandated fire sale – is beyond absurd. Yet to own Straight Path at this price, that’s what one must believe.
Further weakening Straight Path’s bargaining position is the immense supply of alternative millimeter-wave spectrum. In a rulemaking concluded last July, the FCC effectively expanded the 39GHz band that houses the vast majority of Straight Path’s spectrum by 71%; with so much directly adjacent greenfield spectrum, Straight Path’s holdings are nothing special. Moreover, a follow-on rulemaking, initiated at the same time and now in its final phase, proposes to open up an additional 18 gigahertz of mmWave spectrum for mobile use, likely quintupling the existing inventory and further diluting Straight Path’s value.
As much as management might want to raise capital and hold out for an unrealistic sweetheart deal, a little-noticed term of the FCC settlement makes that a dangerous strategy, allowing the FCC to re-open its investigation after twelve months and potentially revoke Straight Path’s licenses. Likewise, shareholders confident that Straight Path’s former parent company will foot the bill for its fines fail to appreciate the legal subtleties that put this outcome in serious doubt. But who can blame them? At this point, hope is the only real asset Straight Path has left.
1. Straight Path’s Spectrum Isn’t Worth Much
What will potential buyers pay for Straight Path’s portfolio? The most obvious benchmark is the Verizon/XO Holdings deal announced last February. In that set of transactions, Verizon acquired rights to two distinct assets: the fiber-optic network business of XO Communications, bought for $1.8 billion (with expected synergies and tax benefits valued at $1.5 billion); and the millimeter-wave spectrum held by an XO Holdings subsidiary called Nextlink. In lieu of an outright purchase, Verizon is leasing the spectrum through 2018, with an option to buy it at expiration, which observers widely expect Verizon to exercise.
Unfortunately, Verizon’s initial press release didn’t disclose what it would actually have to pay to acquire the XO spectrum in 2018. However, industry sources, including the investment bank UBS, indicate that the strike price is $200 million. Below we reproduce the relevant section from a February 22 UBS research note on Verizon:
Investor’s Business Daily summarized the same UBS piece and provided the same $200 million figure; the spectrum expert Tim Farrar has also alluded to it publicly. 1 Though XO is a private company (solely owned by Carl Icahn), FCC filings allow us calculate how much mmWave spectrum it holds, which amounts to 189.6 billion MHz-pops, the vast majority of which is in the 28GHz LMDS band. Paying $200 million for roughly 200 billion MHz-pops implies a price per MHz-pop – a common spectrum valuation metric – of a tenth of a penny.
Strikingly, this price closely resembles what MetroPCS paid Straight Path for a combination of LMDS and 39GHz spectrum in the New York, San Francisco, Las Vegas, and Orlando markets in 2012 – namely, $0.0010 per MHz-pop 2 – implying that, notwithstanding the dawn of 5G and renewed enthusiasm about mmWave technology, high-frequency spectrum prices have barely moved. Nor is there any indication that XO’s spectrum sparked a fierce bidding war among Verizon’s competitors; to the contrary, Icahn’s public statement about the deal expresses not triumph but resignation:
Although this sale to Verizon does not represent a significant annualized return on our investment, we believe that in today’s environment it does represent the best achievable outcome for the company’s customers, employees and owner.
How does XO’s spectrum portfolio compare to Straight Path’s? In sheer size (as well as geographic scope), it’s similar; XO holds 190 billion MHz-pops, while Straight Path holds 222 billion. Simply applying the same aggregate price per MHz- pop to Straight Path’s portfolio would value it at $234 million – 54% below the company’s current market cap even before factoring in the FCC penalties. Clearly the gulf between where Straight Path is trading and where the Verizon/XO transaction implies it should be is enormous.
Refining the analysis further, we exclude from XO’s total MHz- pops the portion of the LMDS band that has not been authorized for mobile use – everything outside the A1 block that runs from 27.5 to 28.35 GHz. Valuing non-A1 LMDS spectrum at zero necessarily implies a higher price for the remaining, almost entirely A1 spectrum, which amounts to $0.0016 per MHz-pop. While this price might serve as a reasonable benchmark for Straight Path’s own 28GHz A1 spectrum, it’s too high for its far larger holdings of 39GHz spectrum, which suffer from inferior propagation as a result of their higher frequencies and thus are more costly and difficult to deploy. To adjust for the difference in frequencies, we use a piece of technical analysis prepared by AT&T Labs’ Advanced Wireless Technology Group and submitted to the FCC in July 2016, comparing the simulated performance of 28 and 39GHz spectrum. 3 AT&T concludes that “a licensee will need somewhere between 44% – 66% more spectrum in the 39GHz band to provide the same cell edge data rate with the same cell radius as compared to 28GHz.” If it takes 1.44x to 1.66x more 39GHz spectrum than 28GHz spectrum to accomplish the same network goals, then 39GHz spectrum