by David Dixon & Mike He of FBR &Co.

Introduction:

The surprise Republican election victory and Congressional control of both Houses have significant policy implications for the telecom services sector. We provide our initial thoughts below.

For the last two terms, the Obama presidency and the FCC, currently led by Chairman Tom Wheeler, have been in favor of content companies working against telecom service providers, contributing to telecom service providers generally not earning their cost of capital. We think this reverses under a Republican administration that will be anti-regulation and pro-business. Key areas in play include net neutrality, wholesale interconnection, regulation of business data services, cable set top box reform, broadband deployment, and M&A.

We expect Wheeler to resign before inauguration day on January 20, 2017, consistent with prior FCC chairman decisions after a change in administration. Below, we discuss these key areas in play including business implications.

Discussion:

■ Net neutrality.

Carriers, generally, are not earning their cost of capital as outsized economic value creation continues to move up the stack to the innovative asset-light application layer. Republicans may allow traditional distribution channels to recover a greater portion of costly network upgrades from content companies going forward. Specifically, Republicans may kill Title 2 price-based regulation and endorse zero-rated content, which has been leveraged by T-Mobile, Verizon, and AT&T to help mitigate churn. We think companies that own distribution and content will still not be allowed to discriminate against new media and OTT players, but we expect OTT players to share in the network cost burdens to a greater extent. Positive for AT&T and VZ. Positive for RLECs CTL/LVLT, WIN.

■ Wholesale interconnection.

The Internet’s impact on traditional distribution channels is a major industry issue. Republicans may reverse the FCC’s recent decision to apply more oversight on wholesale interconnection. This has restricted the ability for telecom service providers to charge content providers and share the cost of expensive network upgrades. We expect higher costs for third-party intermediary Internet networks and content companies. Negative implications for CCOI, AKAM, and LLNW.

■ Spectrum auctions.

We think the incentive auction will remain on track. However, the Democrat administration has been guided by Silicon Valley to shift toward an incumbent spectrum-sharing policy platform. We think this may continue, but instead of agreeing to convert narrowband spectrum bands for broadband spectrum use, a Republican administration may instead auction spectrum that has the potential for higher valuation. Separately, Google has driven momentum on the 3.5 GHz “shared spectrum” (CBRS) band, and opposition to the FCC’s April CBRS Report and Order may impact the auction timing and process in 2017. A slower path on the 3.5 GHz spectrum band has positive implications for DISH. For PDVW, we think we still get an NOI, but there is increased probability that a Republican-led FCC administration auctions this spectrum, which is positive for PDVW as the majority owner of this spectrum. Consistent with our published research, we think PDVW is well positioned in all three possible NOI scenarios, including a spectrum auction.

Regulation of business data services. The Wheeler administration has signaled major regulatory price cap pressure coming for an important wireline access segment. There is an attempt to implement this by year-end. A Republican administration may reverse pricing restrictions to be imposed on the $60 billion business data services market, which has been particularly disruptive for incumbent and rural wireline telecom providers. Positive implications for CTL/LVLT, WIN, and AT&T.

■ Cable set top box reform.

A Republican administration may reverse cable set top box reform that favors application service providers by opening this market up to competition. Application service providers are seeking to establish alternative access into the home. Positive implications for cable companies.

■ Broadband deployment.

The National Broadband Plan was a major Obama initiative, driven in part by content company laments regarding the state of fiber deployment across the U.S. Implementation has been costly and slow, and we think NPV remains negative but necessary for telecom service providers to improve their strategic competitive positioning with cable companies. We think a Republican administration may help accelerate the migration to a less costly blend of fiber and fixed wireless, which is at a nascent stage. Fiber deployments have picked up recently, and we think this continues with less Federal pressure on pricing going forward. A lighter touch on net neutrality and wholesale interconnection may stimulate the pace of fiber deployment. Positive implications for DY.

■ M&A.

The FCC and DoJ have opposed major horizontal consolidation in mobile and broadband under a Democrat administration (AT&T/T-Mobile, Sprint/T-Mobile, Comcast-Time Warner Cable) as the industry reaches peak penetration, T-Mobile approaches capacity challenges, and additional capacity spending is hard to justify given industry ARPU pressures. The risk for Sprint is that a cable company buys a soon to be capacity constrained T-Mobile, but we think it is more likely that a cable company buys Sprint (which has a substantial spectrum advantage) or a merged Sprint and T-Mobile compete on a sustainable basis with AT&T and Verizon. The administration change may benefit DISH Networks in that potential combinations may be looked at more favorably. We believe AT&T and VZ could gain approval to buy the company under a Republican administration, though we maintain our reservations that both companies would be interested as they face capacity challenges with an industry at peak penetration, ARPU pricing pressure, and negative NPV associated with investment in additional 4G and 5G-based capacity. Positive for the prospect of a Sprint and T-Mobile merger and the AT&T and TWX merger despite negative election rhetoric.

■ FCC transition timing.

The FCC is directed by five commissioners appointed by the President and confirmed by the Senate for five-year terms, except when filling an unexpired term. The President designates one of the commissioners to serve as chairman. Only three commissioners may be members of the same political party. The President has the power to designate a new chairman from among the five-member commissioners without the need for Senate approval, i.e., Commissioner Ajit Pai or Commissioner Michael O’Reilly. Both Republican Commissioners have been actively opposed on most major issues before the Democrat-led Commission.

–>We expect Wheeler to resign before inauguration day on January 20, 2017, consistent with prior FCC chairman decisions after a change in administration.