June 22, 2014 – US Telecom: Merger Mania! Telecom Bankers Rejoice!

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US Telecom: Merger Mania! Telecom Bankers Rejoice!

Telecom bankers have been busy, with 2 blockbuster deals on the table, and a third expected to follow. We believe that that all 3 will be approved by the FCC and DoJ, albeit with serious conditions. T/DTV is the most straightforward. CMCSA/TWC is more problematic, and will likely come with stricter “net neutrality” rules. S/TMUS challenges the FCC’s bias toward 4 national carriers, but can get done with pledges of aggressive consumer prices and wireless broadband deployment – technology we believe will be competitive with wireline by decade end. These deals, if approved, have the potential to dramatically change competitive balance in the telecom/cable industry, to the benefit of the acquirers. In particular, CMCSA, post-merger, would control 30% of US pay TV subscribers and 35% of broadband households, with very little near term competition. Unchecked, that market power would allow it to extract rents from media companies, internet platforms, and consumers alike, while damping opportunities for innovation – at least until real competition can emerge. We believe S/TMUS, with ample joint spectrum holdings, could see very significant cost and network performance gains, and could challenge not only for VZ and T’s wireless subs, but also, in the longer term, for residential broadband as well. T/DTV would generate typical operating synergies, but we do not see long term strategic advantage in the combination. The clear losers, assuming the deals go through, would be other carriers – VZ, DISH, and perhaps, even T itself – and TV network owners, who would face the far more powerful distributors in negotiations. Depending on the conditions enforced by the FCC, internet companies and consumers could end up losers as well. We also note that a S/TMUS deal would likely delay the FCC’s planned 2015 auction of TV spectrum and, potentially, yield revised rules intended to draw new bidders (GOOG?) into the fray.

The 3 big telecom deals should pass scrutiny. The CMCSA/TWC, T/DTV and likely S/TMUS mergers pose big questions for FCC and DoJ. While the FCC under former Chairman Genachowski notably squelched T’s play for TMUS, new Chairman Wheeler, a former cable industry lobbyist, appears to be much friendlier to the big carriers. CMCSA and T have built substantial political capital in D.C. and are aggressively pressing their cases. S chairman, Masa Son, has already begun lobbying in the press for the yet to be announced play for TMUS, and would have a serious complaint if his deal is rejected after the other two are approved. While our crystal ball is murky at best, we believe that all 3 combinations are likely to be approved, albeit under significant conditions.

T/DTV is 10 years too late. T/DTV, a combination that has been rumored for years, is almost certain to pass muster, precisely because the strategic benefits of the deal are modest. While there are clear operating cost synergies to exploit, and T gains negotiating oomph with the TV nets, the deal is really about bundling pay TV and telecom, a concept that we believe has a limited lifespan, as voice and video transition to the internet. While approval is more than likely, T is promising to roll fiber to an additional 2M households and LTE-based wireless broadband to another 13M in underserved locales. This is red meat for the broadband focused FCC, but unsettlingly similar to unkept promises made to secure its BellSouth acquisition in 2006. No matter, this deal is the most likely to go through.

CMCSA plays the Washington game. The CMCSA/TWC merger should be problematic. The combination will control 30% of US pay TV subs and 35% of residential broadband households, more than 2/3s with no other choice for a connection fast enough to stream HDTV. CMCSA has already shown a willingness to flex its muscles in content negotiations, in strong arming NFLX for connection fees, and in raising prices for consumers. Post-merger, it promises to be worse. Nonetheless, regulators have fixated on a regrettably simple view of market power based on share of the national market rather than on CMCSA’s domination of the territories it serves, leaving room to get the deal done by divesting subs until the combo slips under an arbitrary national threshold. Moreover, CMCSA’s generous D.C. lobbying efforts, led by its CEO and Obama golf partner Brian Roberts, have bought it serious political air cover. With former cable industry lobbyist Tom Wheeler on the Chair of the FCC, approval, accompanied by toothless net neutrality mandates, seems very likely.

S/TMUS will be a tough sell. S Chairman Son has been talking up a potential acquisition of TMUS, arguing that combining the 3rd and 4th biggest wireless carriers is the only way for them to gain the scale needed to really pressure the VZ/T duopoly. The bulked up S would still be smaller than the two leaders, but significant operating synergies would support aggressive pricing and the combined spectrum would facilitate low cost, high performance mobile AND residential broadband services. While FCC Chairman Wheeler has been unequivocal in his preference for 4 national carriers in the past, Son’s arguments have merit, and reports suggest it may be possible to win a majority vote. Winning approval will require walking away from favored status in the 2015 600MHz spectrum auctions, and could carry requirements for network wholesaling, residential broadband build outs or other pro-competitive investments. We also believe that rejecting S after approving well-connected CMCSA and T’s deals would open the administration to charges of crony capitalism that it may want to avoid.

The 3 deals will hurt other carriers and content owners. Post deals, CMCSA will hold ~28M pay TV subs, while T will have almost 26M, together controlling nearly 60% of the US market. This would give the two leaders substantial power in fee negotiations with networks, and over consumer pricing. In residential broadband, CMCSA would have more than 35% national share, with most of its subs having no viable alternative in their local market. Absent strong regulatory curbs or vigorous competition, we would expect CMCSA to squeeze internet content companies, like NFLX and GOOG, for fees while extracting monopoly rents from residential broadband customers. A S/TMUS combo would have 104M subs, still below T (116M) and VZ (122M) but with enough scale to compete aggressively on price and enough spectrum to beat its rivals on data capacity. A network combination would take 2-3 years to implement, but represents a significant threat to T and VZ’s market shares and profitability. We also believe that S, with its substantial 2.5GHz spectrum and expected LTE-A technology development, could be a viable competitor for residential broadband before the end of the decade. We also note that wireless consolidation could see all three national carriers restricted in the 600MHz auctions – an attractive prospect for DISH, and potentially for unexpected bidders, such as GOOG.

For our full research notes, please visit our published research site.

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