Philip Falcone netted billions with contrarian bets on the metals and U.S. housing markets. Now he’s making what may be his riskiest wager yet.
Falcone’s Harbinger Capital Partners hedge fund is starting a telecommunications company that will square off against AT&T Inc., Verizon Wireless and Sprint Nextel Corp. in selling wireless Internet service. He needs billions of dollars to build the planned network of 36,000 radio towers and two satellites. If he doesn’t move fast enough, the government can take away the wireless licenses he needs to operate.
All of which suggests Falcone’s best option may be to sell the venture for its wireless licenses before the full network is built, say analysts such as Christopher Larsen of Piper Jaffray & Co. While the most likely acquirers, AT&T and Verizon, are barred from a purchase now under current federal regulations, they’re both trying to change the rules.
Falcone paid an estimated $500 million for SkyTerra Communications Inc., the core of his telecom assets, based on securities filings tallied by Bloomberg. A surge in demand for wireless services means the licenses may be worth as much as $7 billion, according to a Credit Suisse Group AG analysis of wireless spectrum values.
In filings with the U.S. Federal Communications Commission, Harbinger said it plans to build a nationwide wireless network that uses so-called fourth-generation, or 4G, technology to offer high-speed Internet connections to at least 260 million people over the next five years. The company plans to supplement wireless service from land-based, or terrestrial, radio towers with satellites 22,000 miles above Earth.
Satellites provide the potential advantage of offering service in remote areas that AT&T and Sprint can’t reach. Even so, the technology’s costs have overwhelmed similar efforts in the past. Iridium’s predecessor, Globalstar Inc. and Teledesic, backed by wireless pioneer Craig McCaw and Microsoft co-founder Bill Gates, all sought bankruptcy protection a decade ago after investing billions in satellite systems that never paid off. “There’s been more than one satellite company that couldn’t make this work,” said Todd Rethemeier, a New York- based Hudson Square Research Inc. analyst. “The cash needed to just build out the network can be very substantial, and that’s before you have a single customer.”
Falcone, 48, may have an astute strategy he hasn’t shared publicly, much like in 2007 when he bet on a decline in the U.S. housing market, analysts said. Joshua Lefkowitz, a Harbinger spokesman, declined to comment.
One possibility is that Falcone decides to sell instead of build. The 54 megahertz of spectrum Harbinger has under license through its satellite and telecom investments may be valued at about $7 billion, assuming a potential customer base of 260 million, according to Credit Suisse.
Such a sale would require FCC approval, however, and the commission will only sign off if a deal is in the public interest, said Paul de Sa, chief of the FCC Office of Strategic Planning and Policy Analysis.
Harbinger risks falling farther behind the competition. While the company plans 4G trials in Phoenix and Denver by September 2011, Sprint is already offering 4G service with partner Clearwire Corp.
Basking Ridge, New Jersey-based Verizon Wireless, the largest U.S. provider, will begin rolling out its 4G network later this year, and Dallas-based AT&T, the second-largest U.S. wireless company, plans to introduce service next year.
“With Verizon, AT&T and Sprint building 4G networks, who knows whether there’ll be a market,” said Steve Clement of Pacific Crest Securities Inc.
It’s a departure for Falcone to be starting up a business, rather than investing in one. Falcone founded New York-based Harbinger in 2001, specializing in what it called “distressed” businesses and industries. The firm took stakes in New York Times Co. and recently invested in Citigroup Inc.
In 2007, Harbinger generated returns of more than 65 percent on bets that bonds backed by mortgages to subprime borrowers would lose value. The fund also gained from its holding in U.S. Steel Corp., which benefitted from soaring commodities prices.
Before running Harbinger, Falcone oversaw the distressed- debt desk at Barclays Capital, a unit of London-based Barclays Plc, and supervised high-yield investments at Gleacher Natwest.
Falcone entered the telecom business by unusual means. Harbinger started buying stock in the satellite company SkyTerra in 2005 at $18 to $40 a share, according to Securities & Exchange Commission filings.
After SkyTerra ran into difficulties, Harbinger loaned the company $500 million in 2008 and then offered to take the whole company private as its shares fell to less than $5. The estimated $500 million he paid for SkyTerra comes from totaling the final offer and more than 100 open market purchases Harbinger disclosed in SEC filings.
Falcone needed FCC approval for the acquisition because SkyTerra held wireless spectrum through licenses issued by the government. Though the commission signed off on Harbinger’s deal, it imposed conditions.
Harbinger had to agree to a business model that will help bring more competitors into the U.S. broadband market, an explicit goal of the FCC and Chairman Julius Genachowski. The company will offer broadband service wholesale to other companies so personal computer manufacturers, Internet companies, or consumer electronics firms can resell the service to customers, according to the filings.
“If Harbinger successfully deploys its terrestrial network, Harbinger could have a beneficial impact on competition,” the FCC wrote in a filing related to the SkyTerra deal. “It may be a catalyst for market-changing developments.”
The commission included requirements to ensure Harbinger invests enough to create a viable Internet services provider. Harbinger has agreed to build out its network to cover 100 million Americans by the end of 2012, 145 million by 2013 and 260 million by 2016, according to the filings.
If Harbinger fails to meet those commitments, its licenses to use SkyTerra’s radio spectrum may be declared “null and void,” according to a March filing. Harbinger would risk losing its spectrum license, effectively putting the venture out of business, said the FCC’s de Sa.
Harbinger will need as much as $4 billion to build its network, including at least $1 billion for the satellite component, according to Tim Farrar, president of Telecom, Media & Finance Associates in Menlo Park, California.
Larsen of Piper Jaffray said Falcone may need to cast a wide net to raise the billions he needs, given the track record of satellite ventures and the tumultuous capital markets.
“It’s an extremely difficult proposition financially,” said Larsen, who is based in New York.
Harbinger Capital has about $10 billion under management and it’s unlikely Falcone’s hedge fund investors would want a substantial chunk of their money tied up in a long-term, capital intensive business.
Harbinger in 2008 said it was considering an acquisition of Inmarsat Plc, in which it already holds a 29 percent stake, and the company’s stock has jumped several times since on speculation Harbinger would proceed with a bid.
London-based Inmarsat is the world’s largest satellite communications company and is generating cash that could be used to finance Falcone’s U.S. venture. Such a deal would cost more than $5 billion at Inmarsat’s current share price and would require regulatory approval in the U.K. An Inmarsat spokesman, Christopher McLaughlin, declined to comment.
The wireless Internet market Harbinger is targeting is promising and fast-growing. Consumers are increasingly using smartphones such as the Apple Inc.’s iPhone and Motorola Inc.’s Droid to surf the Web, socialize and play video. Sales of such devices jumped 49 percent worldwide in the first quarter to 54.3 million units, compared with 17 percent for conventional mobile phones, according to Gartner Inc.
Fourth-generation networks allow for download speeds of up to 10 times faster than third-generation, making applications such as live television and video-calling services more viable.
Harbinger should focus on its terrestrial network as more users opt for data-thirsty devices, said Peter Rysavy, president of Hood River, Oregon-based consulting firm Rysavy Research.
“Based on current trends, you’re going to start seeing serious issues in busy markets in three to five years,” he said. “There will be a market for every bit of spectrum these companies can get their hands on.”
AT&T, Verizon Interest
Verizon and AT&T have already shown an interest in Harbinger’s licenses. After the FCC barred the country’s two largest wireless carriers from amassing more than 25 percent of Harbinger’s spectrum without commission approval, both companies protested, arguing the restriction was unfair.
AT&T filed a petition with the FCC to rescind the restrictions, arguing they are “entirely arbitrary.”
Verizon and AT&T are among the most active contributors to Washington lawmakers. In the 2009 to 2010 election cycle, AT&T’s political action committee gave $2.14 million to political candidates, more than any other organization in the country, according to data from the Center for Public Integrity.
AT&T CEO Randall Stephenson in March said the government needs to make more spectrum available to wireless carriers so they can deliver new services to customers. Michael Balmoris, an AT&T spokesman, declined to elaborate on the company’s statements. Bob Varettoni, a Verizon spokesman, declined to comment on a possible purchase of Harbinger’s spectrum.
Very Hard Work
Without a sale, Falcone faces a challenging path. He may be able to put together a viable wireless Internet company that uses satellite technology to distinguish itself.
“But it’ll be two or three years of fundraising and very hard work before we find out,” said Gerard Hallaren, research director for TownHall Investment Research in Littleton, Colorado.