by FBR Media & Telecom Staff
We see 2017 as the year when telecom and media sing “kumbaya.” We see the regulatory stance under the Trump Administration as supportive of M&A, causing investors to increasingly discount the possibility of more combinations. We see this becoming a meaningful, investable, multiyear theme for the group—helpful for potential targets, and possibly threatening for those left single.
■ TMT outlook: kumbaya. We see AT&T’s (T) acquisition of Time Warner (TWX) closing and setting a template for future deals. While investors have reasonably pushed back on the merits of content/pipe combinations by citing a dearth of synergy at CMCSA/NBCU, they forget synergies were constrained by regulations that we see going away in a Republican FCC. So we see potential for cable companies to gain more freedom to use their own backhaul facilities to favor in-house 5G services, driving more cable/wireless mergers. We also see wireless/wired operators gaining freedom to favor in-house content, with such things as 0-based data service and performance advantaged private nets, or by charging rivals more for data access/performance. That should drive more telecom/content mergers, like T/TWX and Sky/Fox, helpful for big content brands that could be seen as in the cross-hairs for the next big deal, such as CBS. Internet video services unattached to a physical plant, like NFLX, Google/YouTube, and AMZN Prime Video, could face new competitive hurdles. The environment also seems poised for a loosening of constraints on local media combinations, which could spark more duopoly-driven asset swaps by TV station owners or expansion of national TV station footprints by broadcast nets, helpful for TV station equities like TGNA.
■ Media & leisure outlook: fundamentals improving. The entire media group would benefit from what seems to be the most likely tax reform, as outlined in our report published on December 16. We see the currently modest pressure on affiliate fees potentially easing slightly, driven by cord-cutting moving toward “app-shaving.” We see income-challenged millennial cohorts migrating away from dropping pay TV altogether and toward embracing the new, low cost virtual bundles, like DirecTV Now. TV advertising will have to comp recurring lifts in 2016 from political and Olympics but should benefit from a stronger economy. Normal weather would be positive for theme parks after a tough summer 2016. Regional ski resorts also have easy comps versus a historically bad season in the Northeast/Midwest last year.
■ Telecom services outlook. We increase our view on the telecom services sector from Underweight to Overweight for 2017 driven by potential valuation upside from regulatory relief, tax reform, and M&A activity under a Republican Administration. We see higher likelihood of an Sprint/T-Mobile combination but less likelihood of a wireless acquisition by a cable company in the near term as their in-house services can be disruptive to wireless valuations ahead of a deal. A politically influenced DOJ may be necessary given the extensive public record justifying four nationwide wireless providers and a limited economic versus legal admin skill set. The ongoing broadcast incentive auction will likely wrap up in early 2017, with final proceeds likely much lower than expectations as the industry continues the shift to higher bands, leveraging a lower-cost, software-centric technology cycle, which we believe will drive up spectrum reuse and drive down valuations for high-band spectrum. We expect a capex investment shift from efficiency-driven automation to edge security and analytics engines that evaluate unstructured data from the device to the application server. Legacy capex trends will again be ugly as telecom network returns on incremental capital investment remain negative, which is driving a change in investment strategy across the industry.
Will cable enter the wireless space in the near term?
The combination of an intensely competitive wireless environment, negative incremental returns on invested capital, and organic disruption from cable companies to the wireless sector should discourage a near-term wireless acquisition by cable companies, in our view. However, we believe cable will gain greater leverage over the wireless sector over time, and a wireless asset or partnership is likely in the medium to longer term to augment delivery of profitable content to customers beyond their footprints. In the short term, we think cable companies prefer to better understand their impact on the wireless business model. Ahead of an acquisition, we think they will focus on testing the disruptive capabilities of their in-home and in-building assets as they incorporate LTE on commodity spectrum bands into their hardware. In the meantime, Verizon and AT&T continue to diversify away from a fiercely competitive wireless access market into content and are positioning their respective companies to manage the next wave of wireless network usage by pivoting to a lower-cost dark fiber–rich distributed compute platform. We expect additional M&A activity in both content and dark fiber in 2017. Sprint’s firmer footing suggests there is potential to make another attempt at a merger with T-Mobile US. We believe a second merger attempt could pass regulatory muster under a business-friendly Republican-led Administration.
Will a rollback of regulatory restraints under the new Trump Administration spark more M&A over time?
We believe so. Trump’s early FCC brain trust is populated by free market enthusiasts who seem diametrically opposed to the Obama Administration’s embrace of constraints like net neutrality and the threat of Title II–backed rate regulation. To us, this suggests that wireless and cable companies will gain new freedoms to leverage their investments in wired, wireless, and content assets for their own benefit. We see this favoring more mergers of wireless companies with those owning physical plants, such as cable companies, and more mergers of wireless and cable companies with content companies.
Editor’s Note: We strongly disagree with many points made above by FBR, especially related to M&A, which we feel is incredibly destructive to the telecom industry, results in less competition and higher prices for consumers and concentrates too much power in the acquiring company, e.g. AT&T if they take over Time Warner.
According to a January 5th Bloomberg article:
Donald Trump remains opposed to the megamerger between AT&T Inc. and Time Warner Inc. because he believes it would concentrate too much power in the media industry, according to people close to the president-elect, who has been publicly silent about the transaction for months.
Trump told a friend in the last few weeks that he still considers the merger to be a bad deal, said one of the people, who asked not to be identified because the conversation was private. Trump’s chief strategist, Steve Bannon, is also opposed to the deal, another person said.
It remains unclear whether Trump would try to influence the regulatory review of the merger, either by pushing officials to impose conditions or to block the deal entirely. The transaction, which would combine the biggest U.S. pay-TV and internet provider with one of the largest creators of TV programming, will be reviewed by the Justice Department and possibly by the Federal Communications Commission.
Trump, who takes office Jan. 20, has nominated Senator Jeff Sessions, an Alabama Republican, to lead the Justice Department, and hasn’t named a successor to departing FCC Chairman Tom Wheeler.
In October, before the election, Trump said his administration wouldn’t approve the merger, saying, “It’s too much concentration of power in the hands of too few.” He cited the deal as “an example of the power structure I’m fighting.”