700 MHz Final Tweaks: Limited Relief for Frontline, Google Looks to Bid

So with the December 3 date for the filing of short forms to participate in the 700 MHz auction looming ever closer, we see some last minute shifting about and settling of a few lingering details. First, in the I called it category (as did my friend and fellow Wetmachiner Greg Rose, various news outlets report that Google seems increasingly likely to bid in the 700 MHz auction. Further support for the idea that Google really intends to bid comes from their filing a request for clarification from the FCC that when the FCC said “no discrimination,” they meant the usual statutory version that allows discounts for volume customers and such what (the usual statutory language prohibits “unreasonable discrimination,” which allows for things like bulk discounts provided everyone that meets the criteria gets the same deal).

Mind, it isn’t a sure thing Google will bid until it files a short form, and folks can file to bid without being willing to put up the money. But given the number of folks who said Greg and I were on crack for expecting Google to actually put up its own money to go against the likes of Verizon, we can perhaps be forgiven for patting ourselves on the back for being so far out ahead of the curve on this.

More importantly, perhaps, is the FCC’s decision last week to provide limited help to Frontline Wireless by allowing a designated entity (DE) that wins the D Block auction to wholesale its spectrum without losing its DE credit. (You can read the FCC Press release here and the full text of the Order here.) Now how does this help? And why limit it to D Block? And what the heck is a “DE” anyway?

Answers and speculations below . . . .

What’s Up With Google? Are They Trying to “Readjust” the Rules Like Verizon Did?“

First, an aside on Google’s request for clarification. No doubt some folks will consider this backtracking, but I remain untroubled. This is exactly the sort of thing that happens when we lawyers are yacking about terms we all know like ”discrimination,“ and its more than 70 year history as a term of art in telecom. Google’s letter boils down to a request that the FCC confirm that we are talking about the same thing we are always talking about when we say ”no (unreasonable) discrimination“ in telecom, because it would be real bad to bid $5 billion only to discover that you had a completely wrong idea about the rules for the spectrum.

O.K., What About This ”DE“ Stuff and Frontline?

Now, back to the only real interesting thing here, the change to the ”designated entity“ (DE) rules. To refresh the memory of my gentle readers on just what is a DE credit and why this helps Frontline. The Communications Act requires the FCC to (among other things) structure FCC auctions in a way to make it possible for small businesses to win licenses. So since the FCC started doing Auction in earnest in 1994, the FCC has given small businesses (and, before the Supreme Court made this problematic, women and minority owned businesses), ”bidding credits.“ These ”designated entities“ (hence the name) can get up to 25% discount on their bid (or, if you will, get credited for up to 25% more than what they bid). So a DE bidding 100 quatloos will be credited with bidding 125 quatloos.

Problem was, this was such a good deal that large wireless companies started partnering with DEs and effectively getting licenses at a 25% discount. The DE would win a license, then turn around and wholesale 100% of its capacity to its ”strategic partner.“ So before the big AWS auction in August ’06, the FCC tightened up the DE rule to prevent this type of fraud and other forms of DE chicanery. So, among other things, the FCC said that a DE that wholesales more than 51% of its capacity loses it’s DE credit, and a DE cannot lease more than 25% of its spectrum to any one entity. That was designed to allow DEs to have some flexibility to lease spectrum for cash, but discourage the use of a DE sock puppet to get a 25% discount for a license that would basically go to one of the big boys.

Then comes the 700 MHz auction and Frontline. Frontline wants to go 100% wholesale as a business model, and wants to do it in a non-discriminatory manner. That’s why we at the Public Interest Spectrum Coalition (PISC) have been generally supportive of Frontline. Now Frontline is a small start up of the kind that needs a DE discount to have a chance at winning major licenses and attracting financing. But the DE rules as written would prevent Frontline from offering a wholesale business model, which is why Silicon Valley entrepreneurs like Jim Barksdale support Frontline. So Frontline has been lobbying like crazy to get the FCC to give it some kind of regulatory relief so it can both get a DE credit and wholesale 100% of its spectrum. Notably, at the time, everyone expected Frontline to make a play for C Block. So about a month ago, I submitted a lengthy ex parte on behalf of PISC which tried to find the right balance between restrictions on the DE to make sure that incumbents didn’t hog up all the spectrum, while simultaneously trying to make it possible for a DE to do wholesale, which we like. Frontline was willing to abide by a lot of what we recommended, didn’t like some of it, and much wrangling and discussion ensued. Meanwhile, the December 3 deadline for filing a Short Form got ever closer.

So the FCC finally issued an Order, and granted DE relief that allows a DE that wins the D block to wholesale up to 100% of its spectrum. No other relief (which means no more than 25% to any single entity), no other conditions, and no other blocks. The FCC justified this on the grounds that because of the joint public-private partnership arrangement between D Block winner and the Public Safety Licensee, it will monitor the activities of any D Block licensee very closely and will determine immediately if the DE is really an independent small business or just a front for someone else.

Why the unexpected result? I do not know for sure, but have several guesses. First, I think trying to find general conditions that simultaneously allowed DEs to make a living and attract financing while preventing an end run around the intent of the rules proved too hard. With the deadline looming down on them, the FCC opted to give relief for D Block only and watch a DE licensee like a hawk. The cap on leasing more than 25% of capacity to any single entity will ensure at least 4 entities can lease capacity. So balancing everything, this looks like the best way to get Frontline in as a DE bidder.

It also has the advantage of pushing some more competition for the D Block. The D Block has a fairly high reserve price (about $1.3 billion), and getting multiple bidders to go for the D Block is a good way to encourage some competition for the license and drive up the bids.

Finally, the FCC still has a pending law suit over the changes it made to the DE Rules in 2006, including this one. A venture capital firm called Council Tree sued the FCC over the rule changes back in 2006, on the grounds that the rule changes were arbitrary and made it very difficult for VCs to invest in DEs and hope to get their money back in a reasonable time. Council Tree lost the first round for jurisdictional reasons, but it has another lawsuit pending where the court seems willing to listen and has ordered the FCC to respond.

So the FCC is going to be very reluctant to make broad changes to the rules while trying to explain to a court that no, the rules are not arbitrary, they are very well thought out and the court should reject Council Tree’s arguments and affirm the FCC. Making a minor exception for the unique circumstances of D Block is a lot safer than a broad and complex change to the overall rule.

Anything Else?

The one downside here is whether, with Frontline bidding exclusively on D Block, whether C Block will attract enough bidders to meet the reserve price. Of course, Google being smart, it may just come out of the starting gate and bid the reserve price to avoid the threat of a reauction. Or it may do a jump bid after a few rounds to see if such a drastic move is necessary. Remember, if the C Block goes for less than the reserve price, then there is an immediate reauction of the C Block as two 11 MHz blocks and no conditions. So Google is far more likely to want to win at the reserve price then ”win cheap,“ only to have the block taken away and find itself against eager incumbent bidders who want smaller licenses with no conditions.

And, of course, I’m still waiting for the FCC to resolve the Petition for Recon PISC filed asking that the FCC prohibit any one entity from winning the C Block and D Block. The recent approval of the AT&T acquisition of the rural cellular carrier Dobson, where the FCC indicated it would raise its ”unofficial” spectrum cap from 70 MHz to 95 MHz, was predicated on the 700 MHz auction introducing more spectrum and more competitors into the market. If an AT&T or a VErizon wins both C Block and D Block, that prediction will look pretty damn silly.

Stay tuned . . . .

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