Beware the role of 3.5GHz in shaping the future of the sector

Nothing seems to generate more discussion amongst investors at the moment than the future role of 5G, and within that, it is the 3.5GHz spectrum band that is currently at the nexus of the debate. Most of the leading global operators are hoping that 5G will lead to new products – and by virtue of this, new revenue streams - for example, only this week DT was lauding the benefits of using IoT to improve kitchen hygiene!: HERE.  While we believe the route to monetising these new 5G services is unclear, we feel the leading operators should actually be watching over their back as 3.5GHz using massive-MIMO is allowing new challengers to emerge to challenge the existing wireless ecosystem.

This week saw a further development, as new mobile entrant Fastweb in Italy teamed up with Wind to share the costs of building out a 5G network. So much for 4-3 consolidation in Italy - it could even become a 5-player national market with such a development. Fastweb is suggesting that a 3.5GHz network build with shared access to Wind sites would allow them to reach 90% of the population by 2026 – far higher than our earlier expectations of the potential scope of this type of network.

We believe this new 3.5GHz business model looks attractive on paper, but whilst the technology remains untested in the field, investors are taking a dimmer view of prospects. United Internet, for example, in Germany is probably the largest operator to consider rolling out a pure 3.5GHz network following its recent win in the spectrum auction (see here for more details: HERE). However, since speculation began last year that they might enter the auction, its market value has declined by almost €2bn, despite spending just €1bn on the 3.5GHz licences. We held a call with the United Internet CFO this week (see HERE for more details) highlighting the optionality this spectrum brings. While the route to getting a German tower deal like Fastweb has just struck in Italy is less clear for United given the smaller independent tower sector in Germany, we still believe it is likely they should be able to strike a deal, most likely with Telefonica Deutschland, who has most to lose if United signs with someone else. We also like the idea of investing alongside entrepreneurs like Dommermuth. Although it can certainly mean a rocky ride, their level of incentivisation for delivering longer-term value is far higher than elsewhere in the sector.

The corollary in all of this is rising network demand should be positive for the tower operators. Just look at the near-vertical performance of Cellnex’s share price this year. However, we are more sceptical here – in fact, the contrary might end up being true. The incumbent wireless operators who are feeling industry pressures (and looking at their beaten-up share prices) are looking to reduce costs. Going back to Italy, it has been Iliad’s entry into the market which has caused such financial pressure for Wind. Wind’s historic business plan almost certainly didn’t assume that they would end up sharing network with Fastweb, which means Wind-3 has now facilitated both the entry of Iliad, and accelerated the entry of Fastweb into the market. But financial pressures force these difficult operational decisions, and saving RAN capex and backhaul capex through sharing the cost of the buildout is likely to mean less future growth for the tower companies. Vodafone and Orange have taken the same approach in Spain (see our note HERE for more details) and we believe this could lead to them pulling c.2k tenancies off Cellnex’s Spanish network over the next few years.

Unleashing the mid to high band spectrum will likely also cause disruption in other markets too. Sprint’s 2.6GHz spectrum has languished for many years, but the potential T-Mobile merger could open up this band for commercial deployment materially increasing their spectrum share in use by 5x (see HERE for more details). And this is all before the C-band spectrum comes to market too, and this is unlikely to simply be the reserve of the existing household wireless names. Japan will also witness the entry later this year of Rakuten that boosted its share of 3.5GHz spectrum in the recent spectrum awards (see HERE for more details).

The drumbeat of disruptive new entrants into the wireless space is rising. So, when might theory become reality? We will be looking for evidence of whether this really will work technically and Hutch’s UK launch in August of a 3.5GHz FWB offering will be one of the first tests (more details on that HERE). Incumbents worldwide…watch carefully.