Kerrisdale – Short Straight Path Communications, “Hope Is The Only Real Asset STRP Has Left”

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Kerrisdale Capital – Short Straight Path Communications (STRP), January 19, 2017

“Hope is the only real asset Straight Path has left”

  • Short Straight Path Communications (STRP), a disgraced “5G” hype vehicle whose stock price surged last week for an unusual reason: announcement of a harsh regulatory crackdown
  • After a short seller accused STRP of fraud in 2015, STRP agreed to pay up to $100M over time, surrender many of its licenses, and sell its remaining spectrum portfolio
    • Market greeted this news joyously, relieved that it was not more draconian and convinced that spectrum sale would be fast and lucrative
  • Verizon is set to buy a similar amount of higher-quality spectrum from Carl Icahn for just $200M, 61% lower than where STRP trades, implying massive downside even before taking into account FCC penalties
    • Believe true downside exceeds 70%
    • Notion that a company with less than $10M in cash, burns $7M/year, and must pay $15M in fines in the next nine months will drive a harder bargain than Carl Icahn is absurd
  • Further weakening STRP is immense supply of alternative millimeter-wave spectrum – FCC expanded the 39GHz band that houses vast majority of STRP’s spectrum by 71%

Spectrum Isn’t Worth Much

  • Verizon/XO Holdings deal announced last February – acquired rights to two distinct assets: fiber-optic network and millimeter-wave spectrum; in lieu of an outright purchase, Verizon is leasing the spectrum until 2018 with an option to buy at expiration
    • While Verizon did not disclose the strike price, UBS research states that Verizon has an option to buy for $200M by year-end 2018
    • Tim Farrar has alluded to it publicly: FCC filings show they have 189.6 billion MHz-pops; paying $200M for roughly 200 billiion MHz-pops implies a price per MHz-pop of a tenth of a penny
  • This price closely resembles what MetroPCS paid STRP for a combination of LMDS and 39GHz spectrum in NY, SF, Las Vegas, and Orlando markets in 2012
  • Notwithstanding the dawn of 5G and renewed enthusiasm about mmWave technology, high-frequency spectrum prices have barely moved; nor is there any indication XO’s spectrum sparked a fierce bidding war among Verizon’s competitors
  • How does XO’s spectrum portfolio compare to STRP’s:
    • Similar in size (XO holds 190B MHz-pops; STRP holds 222B MHz-pops)
    • Applying the same aggregate price per MHz-pop, values it at $234M (54% below current market cap before factoring in FCC penalties)
  • STRP’s civil penalties – has three options:
    • Sell all of its spectrum within twelve months, pay 20% of the proceeds to FCC, and pay an additional $15M
    • Sell all of its spectrum more slowly, pay 20% of the proceeds to FCC, and pay an additional $100M
    • Renounce its licenses within 12 months and pay $15M

Spectrum Like STRP’s Is Abundant

  • Management depicts the company’s spectrum as a unique asset, offering any carrier a dominant position in the 39GHz band that will be a crucial part of mmWave 5G
  • After being forced to give up 93 of its 39GHz licenses as part of the FCC consent decree, remaining portfolio contains only 40% of the band’s MHz-pops – leaving some 838 MHz in the hands of others who will ultimately auction off unused licenses
  • In July 2016, FCC applied identical technical and licensing rules to the adjacent band from 37.6 to 38.6 GHz; the 37-37.6 GHz band just next door has also been authorized for mobile use on a shared basis with government
  • FCC rules now mandate that devices operating anywhere from 37 to 40 must support the entire band, thereby ensuring that “incumbent” spectrum like STRP has no special advantage
  • Under the FCC’s Further Notice of Proposed Rulemaking, already proposed to authorize mobile operations in additional bands containing some 18 GHz of spectrum (~27x what STRP holds)
  • Trump transition team’s distaste for the warehousing of large chunks of spectrum by Federal government will only push towards increased commercial supply

Regulatory Risk Still Looms

  • Settlement did resolve the FCC’s previous investigation but risks still remain in the event that STRP drags out its spectrum sale
    • “Discontinuance of service provisions” are rules mandating that any licensee who permanently discontinues wireless service thereby automatically forfeits its license and must notify the FCC
    • Given that STRP currently generates less than $700,000 of annual revenue from a nationwide spectrum portfolio and had to conduct its own investigation just to ascertain what equipment it still had deployed where, pretty clear that it doesn’t provide “substantial service” anymore
    • If 12 months elapse and STRP still hasn’t sold its spectrum, FCC reserves the right to re-initiate an investigation – company could simply lose its licenses
    • STRP simply doesn’t have the luxury to take its time

Indemnification May Not Help

  • Some appear confident that IDT Corporation, former parent, will bear the cost of FCC settlement under the theory that wrongdoing took place prior to spinout
    • Plausible but far less clear-cut
  • Under the Separation Agreement, STRP bears any liabilities flowing from the conduct of its business after the spinoff date, even whose liabilities can also be traced back to pre-spinoff actions
  • What FCC felt it had sufficient evidence to conclude was not that STRP lied at the time of its “substantial service” showings (pre-spinout) but that it “had not actually deployed equipment with any permanency”
    • The question of who bears primary responsibility is murky
Source: Kerrisdale Capital
Image Source: The Washington Post

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