Net Neutrality: Reining in the Dumb Pipe Oligopoly

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The Title II reclassification of broadband reflects a sea change in policy and is a substantial threat to the long term growth and profitability assumptions at the core of cable and telco valuations. The overwhelming public support for restraints on wireline and wireless carriers trumps the aggressive industry political spending, and even without explicit price controls, the proposed action would create an empowered FCC clearly aligned to act on the interests of consumers. We do not expect legal or legislative challenges to bear fruit, given the firm FCC mandate in law, the weight of public opinion, and the growing ability of the internet community to drive political action. We also believe that the perspective reflected by this proposal makes it unlikely that the FCC will approve the pending CMCSA/TWC merger.

FCC proposes to reclassify broadband as a Title II utility. The action would set strict prohibitions against blocking, throttling or paid prioritization, add oversight to interconnection agreements, and provide a mechanism to intervene in carrier behavior deemed harmful to consumers. The proposal forbears price regulation, universal service obligations/fees, and network unbundling – historical aspects of telecom regulation particularly objectionable to carriers. On its face, the move would have little impact on the near term sales or profits of cable or telco companies.

FCC can act aggressively to protect consumers. The proposal includes a catch-all that empowers the FCC to intervene against carrier conduct that harms either consumers or internet content providers, with a clear mechanism for receiving and adjudicating complaints. Moreover, having already reclassified broadband as Title II, the commission would be positioned to reverse its forbearance of price controls or network unbundling more easily in response to aggressive moves by carriers.

The law and public opinion will thwart industry challenges. The FCC’s proposal appears on firm legal ground, based on its historical mandate and affirmed by the Telcom Act of 1996. Moreover, public sentiment is overwhelmingly in favor of it, a key factor in Chairman Wheeler’s about face on reclassification over the past 9 months. The defeat of the industry backed SOPA anti-piracy legislation by a grass roots internet campaign was early testament to the changing political calculus that will now play against cable/telco interests. Political air cover for unfettered broadband pricing is an artifact.

Cable/telco stocks threatened. Current valuations hinge on rising prices and exceptional margins for residential broadband service. With a newly empowered FCC and overwhelming consumer opposition, we believe that investor assumptions for the long run performance of cable and telco stocks are unwarranted. While we do not expect near term results to be affected, news flow and longer term revisions will work against the stocks and we advise rotating out of them toward the internet names – NFLX, GOOG, AMZN, etc – that will benefit from the proposed regulation.

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

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