Market commentary: US telecommunications - a sector caught between mergers and new utilities-like rules

Friday was another terrible day for equities across the world, with all indexes closing deep in negative territory, and most markets posting a weekly loss. Overnight Asian markets extended losses, while Australia, New Zealand and China dropping between 0.63% and 1.25%, while the Nikkei 225 closed substantially flat on the day.

Although somehow overshadowed by the opening of the earnings season, two interesting and potentially far reaching news related to the telecommunications sector started to circulate over the past few days: the new neutrality rules introduced by the FCC were signed into law, and the Justice Department seems to close in on recommending Authorities to block the Comcast-Time Warner Cable merger.

Comcast, the largest US cable provider, last year agreed to buy its most direct rival and US second largest cable provider Time Warner Cable for around $45.2 billion, in what analysts, at the time, described as a “game changing” merger. Comcast’s move has indeed provoked an industry consolidation process driven by M&A’s attempts from competitors desperate to find a way to survive, grow or consolidate their positions and market shares within an increasing competitive industry.

Investors did not need to wait long, within a few months form the Comcast’s merger announcement, AT&T agreed to buy Direct TV, US largest satellite contents provider, in a combination worth $49 billion and able to create a rival for the giant cable provider and newly combined Comcast-Time Warner.

However, while the AT&T merger faced modest opposition and has enter the final approval stage, the FCC is more and more oriented to rule against the Comcast’s merger, arguing that the combined entity would have too much pricing power and would extremely reduce competition in the short-medium term.

Analysts will be closely looking at any development in the matter, because a collapse in the Comcast-Time Warner deal is likely to have domino effects across the industry: it will not only prove costly for the parties involved, but it would also prevent smaller cable providers to acquire assets and subscribers at favourable prices that would be made available should the merger been approved.

Additionally, with both Comcast and Time Warner remaining independent, they would most likely deploy capital into smaller, low yield acquisitions with the only intent to maintain and consolidate their respective market shares, instead than using capital to invest in modernisation, infrastructure’s expansion and contents development.

In additions to mergers, the sector is also facing a major regulatory change, since the FCC have also introduced the so called “Neutrality Rule”, which compares telecommunication companies, managing internet traffic infrastructures, to public utilities, and in so doing will prevent these providers to offer priority access and speed to customers willing to paying additional fees.

While this new regulation was welcomed by consumers and contents providers such as Netflix and CBS Corp., it is strongly opposed by the infrastructure providers such as AT&T and Verizon that will no longer be able to discriminate large data consuming users by slowing traffic speeds or enforcing pre-paid data bundles.

As largely anticipated, both Verizon and AT&T have sued the FCC, requesting a Judge to discard the latest “Neutrality Rule”, and analysts will be monitoring legal developments in an attempt to assess what would be the impacts on the entire industry, should the new regulation be upheld in court.

In the meantime, the telecommunication sector has not been the most profitable place for investors: the S&P Telecommunication Services Index has lost 2.47% since April 2014, AT&T, the largest US telecom company, has lost almost 10% over the past 12 months, and Verizon only delivered a 2.73% capital appreciation over the same period.

While telecommunication are typically slow growing, income generating stocks, lower yield acquisitions, the potential negative impacts of the new regulations, and an ongoing price-war within the industry may severely limit dividend increases, and have even prompts a few analysts to question the sustainability of the sector’s historically generous dividend distributions.

This article was issued by Paolo Zonno Trader/Analyst at Calamatta Cuschieri. For more information visit, . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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