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McAdams On: The Auction’s ‘Poison Pill’

TEXAS, HOLDEM—One of the most contested components of the proposed TV spectrum auction rules is “dynamic reserve pricing.”

In a nutshell, DRP is something the Federal Communications Commission invented to cap the sale price of a TV station in next year’s auction. How it works is a different kettle of fish. I asked several experts, including Scott Flick, partner with Pillsbury in Washington, if he could explain it.

“I’ve not met anyone who can, and you are not the first journalist to ask me,” he wrote in an email. “We’ve debated it internally here, and I can’t say we have come to a definitive description. That is part of the reason why everyone says it greatly undercuts the transparency of the auction. If lawyers are struggling to explain it, your average broadcaster is unlikely to get comfortable with it when there are large sums of money at stake.”

How large is anyone’s guess. The FCC said broadcasters could split $38 billion, presumably from wireless carriers who just spent $45 billion on Advanced Wireless Spectrum. Analysts have questioned whether the carriers will want to hit up the credit markets again so soon, but the general consensus is they will. A 45-page analysis from Kagan concludes that “the carriers will be there and bid hard for the spectrum that suits their needs.”

Their needs include getting into broadcasting because WiFi is eating their cellular lunch. Broadband is becoming the delivery mechanism of everything from television content to controlling the fridge temperature from afar. The industry that controls the airwaves controls this delivery mechanism, and Verizon is on it. The carrier is in the process of rolling out LTE broadcasting “to distribute hundreds of cable networks to millions of wireless customers nationwide,” according to The Donohue Report.

Verizon chief Lowell McAdam has indicated they have plenty of spectrumto pull this off, so where the $38 billion comes fromremains speculative. Eric Moreno of Fox referred to the source of the figure—the first of two “Greenhill Reports”—as “a work of fiction.” The figures were indeed derived from a formula suggested by a coalition of station owners intending to sell.

Both the FCC and this coalition need as many broadcasters to participate in the auction as possible or it simply won’t work. FCC officials have even said that the Greenhill Report figures were designed to “encourage robust participation.”

What they were not designed to do is be paid out. That’s according to one D.C. media attorney who referred to dynamic reserve pricing as a “poison pill.”

“They are starting out with ridiculously high prices to lure broadcasters in that they don’t want to have to pay,” the source said.

Another media attorney put it this way:

“DRP is a way for the FCC to draw broadcasters into the auction by starting off with unrealistically high bids, but then actually pay less than the market price for stations in the auction by making what amounts to a bluff.”

Both attorneys noted that dynamic reserve pricing works in conjunction with “impairment,” which refers to TV stations that get repacked on channels where they interfere with post-auction wireless operations. In other words, they are “stranded” in wireless spectrum.

But they won’t know if they’re stranded in wireless spectrum until after they’ve dropped out of the auction. After each successive auction round, the FCC will run a feasibility check to see if there will be room to repack the station in the broadcast band.

Without DRP and impairment, the commission would have to pay stations the last price they accepted in the auction if there were no channels left for them in the broadcast spectrum. That could very well be the inflated opening bid price.

With DRP and impairment, stations that drop out and wind up stranded in wireless territory would be offered a lower price than the last one they accepted. How much lower is anyone’s guess. The idea is to keep a lid on stations holding out for the big dollars, particularly stations along the borders, where repacking will be complicated by international coordination.

What’s more, the feasibility check does not indicate the final channel assignment for TV stations that drop out of the auction or do not participate at all. At the end of the auction, the commission will run an optimization model that may strand TV stations that did not participate in the auction at all, and throw others back into the broadcast band.

Neither broadcast nor wireless contingents are wild about impairment, and some pretty big players are waiting for clarification on DRP. Fox, Tribune, ION and the coalition of the willing are among those asking how it works. Collectively, they own roughly 15 percent of the 2,202 TV stations eligible for the auction—possibly more.

It’s unlikely for any of them to participate in an auction in which they accept one price and get paid significantly less.