Jonathan Cohen, one of my partners at Wilkinson Barker Knauer LLP, has been closely following the incentive auction by which the FCC is looking to clear a significant part of the television band and take that spectrum, slice it up into different size blocks, and resell it to wireless companies.  He has been guiding numerous companies through its complexities. We’ve written much about the auction on these pages, and now Jonathan offers these observations about the auction. – DDO

With the FCC’s Incentive Auction poised to move into its next phase with the August 16th start of active bidding in the forward auction, where companies looking to provide mobile broadband services will bid on licenses carved out of the spectrum vacated by TV broadcasters, we thought it might be helpful to address a few of the myths that seem to be floating around about the auction.

Myth:      In the initial stage of the reverse auction, broadcasters were greedy, demanding that the government pay $86.4 billion for their spectrum.

Reality:   This line of thinking demonstrates a fundamental misunderstanding of the way the Incentive Auction was designed to work. In each round of the reverse auction, the FCC makes price offers to TV stations, who decide whether or not to accept them. Not the other way around. The FCC decided to set opening price offers at very high levels. The highest opening “go off-air” price offer was $900 million (for a station in New York City), but nine-figure opening offers were plentiful, including to a station in Ottumwa, Iowa (DMA #200). These high prices apparently encouraged a lot of stations to make the initial commitment to accept its opening price offer, which led the FCC to try to clear 126 MHz of spectrum in the initial stage – the most the rules would allow. Under the FCC’s auction design, as prices decline, a TV station can reject the FCC’s offer at any point, but the FCC can continue to reduce its clearing price offers to a station still in the auction only as long as it was still feasible to repack that station given all the other stations that would remain in operation after the auction. At the 126 MHz clearing target, only channels 14-29 are available in the repacked UHF band, and this apparently caused the auction prices for many stations to “freeze” at high levels (once it was determined that a station could no longer be repacked), resulting in the $86.4 billion total clearing cost announced at the end of June. For all we know, however, a great many TV stations that are now possible “winners” in the reverse auction might have been willing to keep accepting price offers below their frozen prices. It was the auction design – freezing station’s buy-out prices when that station could no longer be repacked – that set the prices, not the broadcasters.

Myth:      Given the $86.4 billion clearing cost, this auction is sure to drag on into 2017.

Reality:   It may be a bit of a stretch to call this a “myth,” because this could happen if the auction extends to three or more stages. But it’s far from certain. To be sure, revenues in the initial stage of the forward auction would have to far exceed most analysts’ expectations in order for the auction to close in this stage, but the level of demand for the new mobile broadband licenses is as yet uncertain. We just don’t know for sure whether the forward auction bidders will pony up the funds to clear 126 MHz, or if not, how close they will come. Even if we assume that revenues in the initial stage of the forward auction fall short and that a second auction stage is needed, the second stage of the auction will take less time than the first stage, for two reasons: (1) the reverse and forward auctions will “pick up where they left off” in the prior stage; and (2) there will be no six-week hiatus between the reverse and forward auctions, as has been the case in the initial stage. Furthermore, clearing costs will decline in the second stage of the reverse auction, but no one can be sure how much lower they will be, or whether they will decline enough to meet the demand expressed in the second stage of the forward auction. Bottom line: it is still possible that the Incentive Auction could close before the end of 2016.

Myth:      If the auction goes to a second stage, all of the TV stations that are still in the auction will be forced to accept lower prices.

Reality:   Some stations will certainly see their price offers decline in a second stage, but that’s not necessarily true for all stations.  Before explaining why, it’s important to understand that each price offer made to a station is determined by a formula that multiplies a base price set by the FCC (called the “clock price”) by that station’s “volume” (which takes into account the station’s covered population and the constraints it would place on the repacking).  At the beginning of a second stage, the FCC will “reset” the clock price to the highest level at which any station froze in the prior stage, and the clock price will tick down round-by-round from there.  A station with a frozen bid at a clock price level well below the newly-reset clock price will not even be asked to accept a reduced price offer until the clock price ticks down to its frozen level, and before that happens, the second stage could end.

Myth:      The FCC’s rules have chilled all deal-making activities during the Incentive Auction.

Reality:   The FCC’s “rules prohibiting certain communications” already have been in effect for what seems like an eternity (nearly seven months for broadcasters and for nearly six months for forward auction applicants), and have no doubt had some impact on transactions. However, the FCC last year amended these rules (commonly referred to as the “anti-collusion rules”) to make it easier for certain business discussions to be conducted during the auction “quiet period.” Although broadcasters must be careful to avoid revealing any auction-related information, they can continue to hold routine business negotiations regarding affiliation, retransmission consent, program syndication, etc. On the wireless side, while some rules were tightened to restrict the deal discussions that the four nationwide wireless providers can have, other rules were relaxed to allow deals involving spectrum acquisition, spectrum leasing, and roaming to occur, as long as they are unrelated to the 600 MHz spectrum being auctioned.

Except for the total clearing cost, very little information is known about the bidding by TV stations in the reverse auction. In contrast, beginning on August 16th, the FCC will publicly release some information regarding the demand expressed in the forward auction, including the total revenue generated round-by-round. This should give us all some greater visibility into the prospect that the Incentive Auction – whenever it may end – will succeed.