US Telecom: Merger Mania! Telecom Bankers Rejoice!

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June 23, 2014

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. 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 frequent 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.

Carrier Consolidation – Six Become Three

In the three decades since the break-up of the Bell System, the piece parts of the former AT&T and the companies that were born to compete with them have been slowly reconsolidating, leading to increasing concentration in the services that they provide. The top 8 pay TV providers control 90% of US subscribers, up from 80% 10 years ago. The top 8 residential broadband companies have 85% of the subscribers, with as many as 60% of US households having only one option for service fast enough to stream video. Wireless is even more concentrated, with the top 4 carriers holding 91% share. In 2003, the top 4 had 66%.

Now, 3 of the biggest U.S. telecom companies are looking to take consolidation a step further. CMCSA, #1 in both pay TV and residential broadband, is buying TWC, #2 in both categories. The combo would then control 30% of pay TV and 35% of broadband subs. T, #2 in broadband, #5 in pay TV and #2 in wireless, signed a deal for DTV, #2 in pay TV. The new T would have 28% of pay TV, 20% of broadband, and 29% of wireless. Reports say that S, #3 in wireless, will acquire TMUS, now #4, becoming #2 in the process with 30% share. It will be up to the FCC and DoJ to decide whether these deals are in the public interest.

Surprisingly, signs are pointing in the direction of approval, perhaps nudged that way by the generous and longstanding D.C. lobbying efforts of CMCSA and T. The T/DTV tie up, rumored for years, is the least controversial, more about the quaint concept of service bundling than of exercising market power, and thus, is almost certain to find approval. CMCSA/TWC will face more vigorous objections based on its domination of broadband within its franchise areas, but will likely agree to fairly toothless “net neutrality” provisions to get approval. S/TMUS has the hardest road, given FCC Chairman Wheeler’s unequivocal preference for 4 national wireless carriers, but the argument that the combination will be a more effective competitive force than the carriers are separately has substantial merit. If the FCC is willing to let CMCSA run roughshod over a third of American households, it would be disingenuous for it to deny S.

Assuming all 3 deals go through, an outcome we feel is more likely than not, the impacts on the TMT landscape could be substantial. The biggest, and most certain, losers will be media companies who will face a duopoly controlling nearly 60% of US pay TV subs and hell bent on keeping programming fees down. Depending on the strength of the net neutrality rules instituted, internet-based companies, like NFLX, GOOG, and AMZN could also be affected. Rival carriers will be hurt – the VZ/T wireless duopoly and DISH (although DISH could have a silver lining if consolidation gives it an inside track to the 2015 spectrum auctions). Longer term, we believe that a bulked up S will eventually use its 2.5GHz spectrum to become a real competitor for residential broadband, spoiling the future hegemony for CMCSA, VZ and T in that market. Finally, we see U.S. consumers as losers from these deals, in particular from CMCSA/TWC, suffering from slow and expensive broadband, and inflexible service bundles that stifle innovation.

The Big Bang – Telecommunications Style

Venerable AT&T was broken into 8 parts by its 1982 anti-trust consent decree with the US Government. Seven newly formed Regional Bell Operating Companies (RBOCs) contained all local wireline telephone franchises, along with the fledgling wireless operations granted to AT&T a year earlier (Exhibit 1). These businesses were deemed natural monopolies, and were tightly price regulated as “common carriers”, with local service rates set to deliver return on capital investment within a narrow range. Beyond the RBOCs, there were a number of sizeable independent telephone companies – like Century Telephone, AllTel, Cincinnati Bell, Southern New England Telephone, Rochester Telephone, and others – that had never been consolidated into AT&T, and were also regulated as common carriers. The name AT&T remained with the long distance telephone business, which also retained the original company’s legendary Bell Laboratories research arm and its Western Electric telecommunications equipment business, later spun out as Lucent. AT&T competed vigorously with upstart rivals MCI and Sprint (which was first merged with local telco GTE before being acquired by United Telecom), driving US long distance prices down -55% during the decade (Exhibit 2). The long distance trio was joined by the start up LDDS, later renamed WorldCom, toward the end of the decade and the aggressive newcomer began buying up other smaller companies to quickly gain scale.

Exh 1: Break up of the Bell System

As the industry moved into the ‘90’s and the Internet arose, new species of competitors emerged. Mid decade, Philip Anschutz boldly invested to pull thick bundles of fiber optic cable along the nation’s railways, launching not only his own long haul telecom competitor Qwest, but also selling excess fiber to MCI, Level 3, Global Crossing and others, bringing an era of hyper competition to the US long haul telecommunications market. At the same time, a number of local players were pulling fiber in cities and suburban office parks, enabled by The Telecom Act of 1996, which essentially deregulated local markets for entrepreneurs. With the free flow of capital investment, CLECs were legion during the bubble era, with MFS, TCG and Time Warner Telecom notable amongst the many. In all, dozens of decent sized companies were playing in the various aspects of wired telecommunications during the back half of the ‘90’s.

Exh 2: Long distance interstate charges for switched access service, 1980-2010

It’s Called Mobile for a Reason

Early thinking about wireless communications lacked imagination. When the first US cellular spectrum licenses were granted, beginning in 1981, the FCC divided the country into 734 geographic territories, each with two 20MHz licenses in the attractive 850MHz band, never conceiving that there would be any value for broad coverage in what was believed to be a purely local market (Exhibit 3). One of the two licenses was granted to the established local telephone monopolist in each territory – mostly AT&T. The second license in the 30 largest metro areas was then awarded from “comparative hearings”, quasi-judicial forums where applicants would argue the merits of their proposals. After those 30 licenses were granted, the remainder of the territories were distributed in a lottery of interested parties. When AT&T was broken up, it allowed its wireless licenses to go with the 7 RBOCs, a decision driven by an infamous McKinsey study that asserted that fewer than 1 million Americans would ever want a “car phone”. In this wild world, with hundreds of rinky-dink operators, many of whom lacked the expertise or resources to adequately build out a cellular network, wireless pioneer Craig McCaw began methodically buying up these small companies to consolidate a national footprint, a process that took many years and several changes of ownership to accomplish.

By 1994, the cellular market had begun to take off and the FCC auctioned off another set of spectrum licenses for the 1900MHz band, once again breaking them into tiny geographic territories (Exhibit 4) These auctions brought a new set of competitors into the market, including Sprint, which was the biggest bidder, but also more regional players like PrimeCo, VoiceStream, OmniPoint, MetroPCS, US Cellular, and others. In addition, the late ‘90’s saw the rise of Nextel, which adapted its fleet dispatch radio service to provide cellular phone service, coming to dominate several commercial applications of wireless telecommunications. Like the wireline telephone market, late ‘90’s wireless was geographically fragmented, with more than a dozen well sized operators.

Exh 3: The FCC’s 734 Cellular Market Areas

Exh 4: US Mobile Wireless Frequencies and Auctions

Big Cable

Pay TV began life with even greater fragmentation than telecom. Early on, the cable build out was ad hoc, with individual municipalities granting exclusive franchises to companies and local entrepreneurs jockeying for favor. Early on, cable service was about offering better reception for broadcast TV, but with the Cable Act of 1984, MSOs were finally authorized to bring an unlimited line-up of channels from outside their local market. With that, the race was on to build out the nation’s cable infrastructure – in the decade between 1984 and 1994 more than $15B was spent connecting 60M households (Exhibit 5). At the same time, the bigger and better managed companies were beginning to consolidate the industry.

In 1992, the FCC granted orbital slots for “Direct Broadcast Satellite” services that could beam TV programming directly to small dishes mounted to residential rooftops. DirecTV began service in 1994, followed by the Dish Network in 1996, adding a wrinkle of competition to the heretofore monopoly business of pay TV. Years later, telephone companies would join the fray with services delivered via fiber optic cabling deployed all the way to homes or with “Digital Subscriber Loop” technology, which could boost the carrying capacity of telephone wiring to handle a television signal. While telcos were plotting their advance on pay TV, cable operators launched a devastating counterstrike, upgrading their coaxial networks to support two-way digital traffic. By the late ‘90’s MSOs were beginning to offer telephone and broadband residential internet service in direct competition with the telephone companies. Ultimately, cable operators were able to siphon off a quarter of the US local telephone lines, and nearly 60% of residential broadband connections (Exhibit 6-7).

Exh 5: US Multichannel Video Customers, 1975-2013

Exh 6: Cable Telephony Customers, 2000-2012

Exh 7: Cable Versus Telecom Broadband Subscribers, 1Q12-1Q14

We Can Build it Better than it Was

Since the Internet Bubble, the telecommunications world has been contracting. In wireless, Verizon was born of the combination of two RBOCs, MCI, GTE, PrimeCo Cellular, and AirTouch, later adding bulked up independent telco AllTel and essentially, completing a national wireless footprint (Exhibit 8). The current AT&T contains four RBOCs, SNET, AT&T Wireless (which had bought Craig McCaw’s wireless business in 1994), and Leap Wireless (Exhibit 9). Sprint bought Nextel, Clearwire, 10 regional affiliate carriers, and Virgin Mobile, a successful branded MVO already running on its network (Exhibit 10). T-Mobile is the agglomeration of VoiceStream, Omnipoint, Aerial, Powertel, SunCom and MetroPCS (Exhibit 11). After the dust has settled, each of these carriers have cobbled together a roughly national footprint, and together they hold more than 91% market share, with the remaining 9% spread across tiny regional players, the largest of which is U.S. Cellular with a meager 4.3M subscribers and less than 2% share (Exhibit 12).

Exh 8: Historical Timeline of Verizon

Exh 9: Historical Timeline of AT&T Wireless

Exh 10: Historical Timeline of Sprint

Exh 11: Historical Timeline of T-Mobile

Exh 12: US Wireless Carrier Metrics, Q1 2014

On the wireline side, wired telephone service barely counts any more – nearly 30% of adults no longer have a wired home telephone and service pricing has fallen dramatically over the years, with long distance essentially free (Exhibit 13). Meanwhile residential broadband is nearly a $50B annual business, with cable operators leading the competition vs. the telephone companies (Exhibit 14). Like wireless, the biggest cable companies have gotten that way through relentless acquisition. Over the past 20 years, Comcast has rolled up 10 multiple system operators, Time Warner Cable has bought 7, Charter has acquired 10 of its own and Cox has added 11. These 4 MSOs now have more than 86% of US cable industry subscribers and about half of residential broadband connections (Exhibit 15). Verizon, AT&T and CenturyLink have another 37% of the broadband market, although many telco broadband connections are not fast enough to support a full HDTV video stream. The concentration of Pay TV services is a bit less acute, owing to the presence of the satellite operators and the growth of telco provided TV services. Here the top four providers – Comcast, TimeWarner, DirecTV and Dish – have about 2/3rds of the market, with the next four – Cox, AT&T, Verizon and Charter – taking another 25% (Exhibit 16).

Exh 13: Adults living in “wireless only” households, 2003-12

Exh 14: US Fixed Broadband Access Revenue, 2011-17

Exh 15: US Broadband Share, 1Q 2014

Exh 16: US Multichannel Video Market Share, 1Q 2014

Please Sir, Can I Have Some More?

In the context of the massive wave of industry consolidation that has played out over the past 15 years, the mega-mergers announced and contemplated this year are not surprising. Comcast kicked things off by announcing its intention to acquire Time Warner Cable in February, after an apparent bidding war with Charter. This deal would combine the nation’s number one and number 2 cable operators to create a behemoth with 34M subscribers. Assuming that Comcast would have to divest nearly 5M subs – likely to Charter – to get under the FCC’s presumed 30% pay TV market share threshold, it would still be more than three times the size of the next biggest cable player. In broadband, depending on the demographics of the subs divested, Comcast’s market share would likely be even higher – perhaps more than 35%. Moreover, because of the limited geographic availability of high speed service from telcos, as many as 60% of Comcast’s broadband footprint would have no other choice for a connection fast enough to watch an HDTV movie on NetFlix (Exhibit 17). Comcast’s public rationale for the merger centers on the considerable operating cost synergies from increasing its subscriber counts by half, including a strengthened position in negotiations for content fees. Unspoken is the possibility of pressing its enhanced market power to drive consumer prices higher and to extract fees from the internet companies being accessed by its captive customer base.

Exh 17: Residential Fixed Connections by Technology

In May, AT&T followed with its plan to acquire DirecTV. The two companies have partnered to provide TV/broadband/wireless bundles since 2009 and analysts had long conjectured an eventual combination, so the deal was hardly a surprise. Given the vastly different distribution mechanisms – satellite and copper telephone wiring – there are modest direct operating synergies to be had in the combination. In Pay TV, DirecTV’s 20.3M subs plus AT&T’s 5.6M U-Verse subs, would put the combination at a 27% share of the US market, a solid number two to Comcast, both far ahead of Dish Network’s 14% and a bulked up Charter with 9% (Exhibit 18). Like Comcast, AT&T touts the cost savings possible from its planned merger, and in particular, better leverage in its negotiations for content. AT&T’s application documentation offers potential cost savings for subscribers that take a full bundle of services, but hints at possibly higher prices for households looking to cut the pay TV cord. Interestingly, AT&T’s agreement with DTV apparently contains an out if DirecTV fails to renew its exclusive contract for NFL’s Sunday Ticket, putting the football league in the driver’s seat as the two organizations work to negotiate an extension to their deal, which ends after this season.

Exh 18: Pay TV Market Shares, 1Q 2014 versus post-merger

Finally, market scuttlebutt has Sprint well-advanced in negotiations to buy T-Mobile, a move to combine the 3rd and 4th place players in the wireless market. Both Sprint Chairman Masa Son and T-Mobile CEO John Legere have openly touted the scale benefits from consolidation, and both have been resolute in stating their intentions to use those benefits to accelerate an attack on the Verizon/AT&T duopoly that has ruled the market for the past several years. A combined Sprint/T-Mobile, which would reputedly maintain the T-Mobile brand and put Mr. Legere in charge, would have rough market share parity with Verizon and AT&T, an extremely broad but mismatched collection of spectrum licenses, and largely incompatible network technologies (Exhibit 19). Reconciling the networks and exploiting the ample spectrum would likely take at least 2-3 years and billions of dollars in capex to accomplish. Still, we believe S/TMUS will have real near-term competitive advantage in wireless data coming from having more unused spectrum, less current network congestion and more recent vintage LTE equipment. Looking farther forward, we believe that the development trajectory of the LTE-Advanced standard, a paradigm shift in wireless base station design that will dramatically lower deployment costs, and Sprint’s massive 2.5GHz spectrum holdings position the company to compete aggressively for residential broadband before the end of the decade.

If all three mergers are allowed to proceed, the resulting market structures would see Comcast as a dominant provider of residential broadband with a monopoly position in many of the markets that it serves – at least until wireless broadband becomes a viable alternative. Pay TV would be an effective duopoly, with Comcast and AT&T controlling nearly 60% of the market. Wireless would be a three-way market, with Verizon, Sprint, and AT&T each with a bit under a third of American subscribers. Not quite back to the days of the Bell System, but certainly getting there.

Exh 19: Carrier Spectrum Holdings Summary

What Does the FCC Say?

Two years ago, the FCC – led by then Chairman Julius Genachowski – thwarted AT&T’s attempt to acquire T-Mobile for itself, a move that would have vaulted it to the #1 market position with nearly 40% of US wireless subscribers. Prior to that, the commission had delivered a fairly long string of rubber stamps for the giant wave of mergers leading up to it, including Comcast’s giant acquisition of NBC/Universal in just the prior year. In 2011, the FCC issued new, tougher rules for net neutrality, requiring that all broadband carriers “have transparency of network management practices, not block lawful content, nor unreasonably discriminate in transmitting lawful network traffic”. These rules were invalidated by Federal Circuit court earlier this year, ruling that the commission lacked the authority to institute such regulation on network operators that have not been designated as “telecommunications common carriers”.

However, since those controversial pro-competitive decisions were delivered, four of the five FCC commissioners have been replaced, including Genachowski. The new Chairman, Tom Wheeler, is the former president of the National Cable and Telecommunications Association (NCTA 1976-1984) and a past CEO of the Cellular Telecommunications and Internet Association (CTIA 1992-2004), posts that he held before moving into venture capital. NCTA and CTIA are the primary lobbying organizations for the cable and cellular industries respectively, and Wheeler’s role was that of a strong, partisan advocate for industry friendly policy. Since taking over the FCC in 2013, he has spoken from an consumer-oriented perspective, but he is viewed as substantially more sympathetic to incumbent cable and wireless carriers than his predecessor.

The rest of the commission, which is appointed by the President and is comprised of two Republicans and three Democrats (including Wheeler), is presumed to follow party lines – typically the Republicans support limited regulation without competitive intervention while the Democrats favor tighter oversight and resist further market concentration (Exhibit 20). Still, one of the new Democrats, Jessica Rosenworcel, has openly expressed concern for the viability of Sprint and T-Mobile as stand-alone competitors, perhaps an indication of support for that possible merger.

Exh 20: FCC Commissioners Profiles and Positions

We note that Comcast and AT&T are amongst the largest corporate spenders on Federal lobbying and are generous contributors to campaigns on both sides of the aisle (Exhibit 21). Comcast Chairman Brian Roberts is a personal friend of President Obama who has racked up seven face to face meetings over the past three years, including a coveted one-on-one golf date in Martha’s Vineyard that was well covered in the press. Comcast also appears ready to lay down on “net neutrality”, a pet topic for Democratic lawmakers, potentially giving the FCC precedent it wants to push reworked rules on the rest of the industry. Note, we believe that net neutrality will be very difficult to mandate through regulation – there are many ways that broadband providers can discriminate amongst internet content providers that are far more subtle than the explicit packet throttling and so called fast-lanes that are often called out by net neutrality advocates. In our view, the only effective way to keep broadband providers from exercising market power against internet content is to establish real competition.

Given all of this, most observers now believe that Comcast/Time Warner Cable will be approved, and we sadly concur. If so, it will be doubly hard for the FCC block AT&T’s deal for DirecTV, which has less acute competitive ramifications and comes on the heels of that stinging rejection in the company’s play for T-Mobile. Industry analysts seem far more pessimistic about the potential for an approval of Sprint/T-Mobile but we believe that it is more likely than not to pass. Chairman Son’s comments on the competitive impact of the merger are compelling. Moreover, many international markets operating with just three national competitors manage to generate more vigorous competition than ours has had with four (Exhibit 22). Arguably, Sprint and T-Mobile have been impotent in really pressuring the VZ/T wireless duopoly – average US wireless bills remain amongst the very highest in the world. T-Mobile’s recent un-carrier campaign has been successful in taking share, but the churn is low and slow while T-Mobile burns cash and makes losses. Yes, the preliminary rules for the 2015 incentive auction of valuable TV broadcast spectrum for mobile communications services were written under the presumption of a 4 carrier national market, but the rules can change and administrative burden is hardly a reason to deny Sprint, particularly if Comcast and AT&T’s deals fly through.

Exh 21: 2012 Lobbying Spend by Cable and Telecom Interests

Expect an approval, with conditions. Certainly Sprint will lose some of the advantages that it had written into the rules for the spectrum auction. Perhaps the FCC will require a hard agreement on “net neutrality” and/or for providing wholesale carriage at low cost for virtual carriers (MVNOs). Maybe Sprint will offer up deployment of wireless fixed broadband service for areas underserved by broadband.

Exh 22: Wireless Market Competitiveness and Population Density by Region/Country

It’s Always Fun Until Somebody Gets Hurt

Obviously, Comcast, AT&T and Sprint all expect long term benefit from these deals once they go through. Of the three, we see the M&A as most beneficial to Comcast, at least in the short run, and least beneficial to AT&T. Sprint’s deal may have the biggest long term impact, but the near term integration challenges may mean that the substantial benefits will take a couple of years to hit the bottom line. We would expect all three stocks to respond favorably when deal approvals are announced.

The increasing concentration of the pay TV market should have troubling ramifications for media companies, who have been pressing for ever higher retransmission fees from system operators (Exhibit 23). Both Comcast and AT&T have highlighted their improved leverage as justifications for their deals, and tacit cooperation between the two could seriously undermine the plans of network executives. Expect longer and more acrimonious negotiations, and don’t presume that either Comcast or AT&T will simply roll over for the networks.

The impact on the broadband market and the internet services that depend on it will depend greatly on both Government regulation and the emergence of real competition. We are concerned that any “net neutrality” rules will be insufficient to really protect against Comcast or AT&T shaking down internet businesses like Netflix for a toll. Still, the FCC, rebuffed by the courts in its attempts to impose net neutrality rules, does retain the nuclear option of designating broadband service providers as “common carriers” as per the Telecommunications Act of 1996 and imposing direct pricing controls. Comcast, which is expected to agree to operating under net neutrality principles as a condition of the deal, could realistically face this sanction if it egregiously violates the spirit of its agreement. We expect Comcast’s moves to collect from internet businesses and to give favor to its own online services will be measured as a result, with very modest, if any, impact on the likes of Netflix, Google, or Amazon.

Exh 23: Broadcast Retransmission Fees, 2009-2018

Ultimately, we remain confident that the trajectory of LTE-Advanced development and the falling costs of network deployment will allow wireless operators to effectively compete for residential fixed broadband (Exhibit 24). A Sprint-T-Mobile combination would accelerate the availability of such services, which would pressure Comcast, AT&T and Verizon for broadband market share and push down prices for consumers. Sprint’s impact on the mobile wireless market could also be profound – lower prices, fewer restrictions, better service and accelerated churn – a significant blow to Verizon and AT&T. Assuming that the FCC retains limits on incumbent wireless operators bidding for spectrum in the upcoming auctions and that the Sprint/T-Mobile combination will be similarly restricted, other companies could enter the mix for the valuable airwaves. Dish Network is an obvious beneficiary, but we suspect that Google could be preparing to bid for spectrum for its own low-cost data focused wireless service.

Finally, we are concerned that the ultimate losers from these deals will be TV and broadband consumers. Monthly cable bills have been growing at a xx% CAGR over the past 20 years – Comcast and AT&T have given no suggestion that they wouldn’t use their beefed up market power push prices higher, particularly given that they can discourage cord-cutting by imposing usage limits on their residential broadband products (Exhibit 25). Broadband prices are already absurdly high relative to the rest of the developed world, and these deals are not likely to change that either (Exhibit 26).

Exh 24: Wireless and Wireline Advances, 2000-2015

Exh 25: Residential Cable Subscribers versus Video ARPU, 2000-2013

Exh 26: Average Monthly Price of Fixed Broadband, 18GB of data 2.5Mbps+

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