Over recent years there has been a steady yet meaningful change in the communications and broadcast industries. More and more, traditional cable operators and fixed line phone companies are stepping on each other's toes and gaining traction providing their competitor's traditional services.
This trend began with the advent of the internet, as both phone companies and cable providers started offering dial up and DSL service to connect customers, forcing these formerly separate industries to compete. Over the last 5 years this competition has intensified with cable providers offering home phone service, and phone companies offering cable (although expanding traditional phone lines to cable and internet has required a significant build-out of fiber optic cable).
The growth of "Triple Plays" and bundled service offerings has been commonplace, as these incremental offerings cost significantly less and allow meaningful expansion of each firm's average revenue per user (ARPU). This shift is shown clearly by the graphs of Comcast (CMCSA) and Verizon (VZ) below with the number of Video, Internet and Phone subscribers converging, with each company's new users increasing and the number of users for their conventional services declining.
The internet has accelerated this process as traditional phone service is now competing with VoIP, and substitutes for cable are now being delivered online by companies such as Netflix (NFLX), Amazon (AMZN) and Hulu. For customers with internet access the value added by a home phone line is decreasing toward zero and the value added by cable is decreasing toward the cost of the content (with content owners such as Disney (DIS) and Viacom (VIAB) still doing a fair job of monetizing content).
Over time data transmission is becoming commoditized, and it is less about what is being transmitted (whether it is a conversation, a movie, a show or online content) and more about other aspects of how it is sent, such as reliability, convenience and speed. Two areas where this trend has not yet been fully established are satellite providers and mobile telecom.
Satellite companies DISH (DISH) and DIRECTV (DTV) have been unaffected by this shift, primarily due to their customer concentration in rural areas. Because it is unprofitable for cable and phone companies to build out to these areas, DISH and DIRECTV operate in a relatively low competition environment for their customers. These factors have enabled satellite companies to maintain stable or slow growth so far (as shown below), despite the more dramatic shift in business model for cable and phone companies.
Unfortunately, satellite is poorly positioned to sell their customers phone and internet services as these uses would be an inefficient use of spectrum (just look at the high cost of satellite phone service relative to mobile phones). Satellite companies could rent space on cell towers to alleviate this cost issue, but the upfront equipment and rent costs would be highly prohibitive and would lead to meaningful losses until a critical mass of customers could be poached from the larger incumbent wireless providers (who benefit from switching costs). In my opinion the only way a satellite company would be able to offer mobile phone and internet would be through a joint venture with or acquisition of a current mobile operator.
So far mobile telecom providers have been a big beneficiary of data commoditization, as these firms are able to offer phone and data through the same cell towers and existing (as well as some newly purchased) spectrum. Over recent years mobile internet growth has been spectacular with AT&T's (T) data traffic growing 20,000% between 2006 and 2011. Data revenue growth has also grown impressively over this period, and currently makes up roughly 40% of AT&T and Verizon Wireless' revenues while growing at a current 20% clip (data revenue share growth shown below).
This rapid growth has put a strain on networks, and these companies are scrambling to keep up by purchasing spectrum and expanding their more spectrum-efficient 4G networks. Future data growth will likely be lower for smartphones, as they already account for roughly 50% of the total postpaid phone base, with more data growth coming more from new devices such as tablets and mobile hotspot products, which account for 8.1% and 12.7% of Verizon and AT&T's connections, respectively, despite barely existing only a few years ago. Mobile telecoms should continue to benefit from the growth of new innovative products, making future growth hard to predict but implying a strong growth trajectory.
In the context of data commoditization it is worth asking why wireless carriers don't yet offer a service competing with cable as it would undoubtedly be a significant revenue opportunity. There are a number of obstacles which need to be overcome in order for a widespread rollout of mobile video services to be effective.
First, added infrastructure would need to be added and agreements with content owners would need to be made. Secondly, transmission costs may need to decrease further (cost per unit data has declined rapidly in recent years) for an unlimited video service to be economically viable, as an unlimited plan would be necessary to compete with satellite. Most importantly, spectrum availability has been tight during the data rollout and wireless carriers would need to have extra capacity to provide reliable video services.
Most of these issues can be solved relatively easily through increased investment, but the issue of spectrum constraints is regulated by the FCC in the US and other government entities in other jurisdictions, making this a potential limiting factor. The other obstacles seem to imply that a roll out of video services could occur as soon as the next 3 to 5 years as cost per MB continues to decrease and data growth begins to slow and mature. A lack of spectrum could, however, push back the time frame that a video rollout could begin.
If wireless carriers are able to overcome these issues, the largest near-term area of opportunity is likely to come from competing with satellite providers in rural areas. The service would be functionally similar to satellite; it would involve sending video content over spectrum to a receiving device. The major differences would be that the data could be sent by cell towers instead of satellites and could be received by devices similar to mobile hotspots which, unlike satellite dishes, wouldn't require line of sight.
Competing in rural areas would allow mobile telecoms to gain incremental revenue and profits by leveraging their relatively underutilized rural towers and spectrum (making spectrum less of a constraint). Mobile operators also successfully reach rural customers with their mobile hotspot product, which would allow them to cross-sell cell phone and data services to these customers as a "Mobile Triple Play."
It may be that this trend has already unofficially begun, as a large number of customers use online content services such as Netflix on mobile devices to satisfy an, as of yet, unfulfilled need.
Another point in favor of mobile operators is that mobile delivery of phone, data and content is far more convenient. Because of this added convenience mobile services may continue to steal market share from fixed line and cable companies over time.
Mobile phones have already begun to gain market share at the expense of home phone service, but so far this trend hasn't yet been established for internet service revenues as both mobile and fixed line internet service has been growing strongly. As long as mobile data costs and speeds continue to improve, at some point mobile data will start to grow at the expense of DSL and other home internet services as consumers switch to the higher value, mobile service.
The same sort of situation is likely to occur with cable and other paid video content, although this scenario wouldn't occur for some time. In the future, we may view traditional cable and internet service as a relic of the past, just as many people view home phones this way today.
Finally, looking internationally, many emerging markets reflect these technological shifts. Many emerging economies simply never built home phone lines and only use mobile phones. Similarly in emerging markets many people's only source of internet is through their cell phone. In these markets it may never be economically viable to build nationwide infrastructure to connect homes to cable and internet.
In developed markets where infrastructure (satellites, cable lines, fiber lines) has already been built, the incumbent operators may find themselves in a situation where they need to find ways to monetize increasingly obsolete assets. This situation could lead to a situation where both the number of users and the revenue per user is declining, similar to the current state of AOL's (AOL) online subscription service. If this situation occurs I wouldn't want to be the person holding the bill.
Looking at the current market trends and valuations I believe that:
Cable operators are currently a hold. With strong current revenue growth in phone and internet service and some uncertainty as to whether mobile could meaningfully steal market share in their core markets, this would be a risky short candidate at present (but may be worth shorting in the future). Firms which have significant content ownership, such as Comcast, also mitigate these risks through earnings diversification.
Satellite operators are a sell. These firms are experiencing a number of risks beyond those expressed in this article which aren't fully reflected in valuation. DISH and DIRECTV are currently plagued by increasing content and promotional costs, high debt levels, and slowing growth. Couple these factors with added competition and this sector could be a perfect storm of value destruction in coming years.
Selective wireless carriers are buys. This suggestion is complicated by the fact that major companies such as AT&T and Verizon are still weighed down by large wireline businesses which will continue to deteriorate despite wireless growth. Another important factor is that scale is important in the wireless industry, as the companies with the highest market share tend to earn the majority of industry profits.
2 of my favorite companies in the sector are AT&T and Vodafone (VOD). Both companies earn the majority of revenue and earnings from mobile, trade at low valuations and have top 1-2 market shares in their markets (AT&T is #2 in the US; Vodafone owns 45% of Verizon Wireless, which is #1 in the US, and has dominant positions in Europe, India and Africa). Vodafone also has a near term catalyst, as Verizon CEO recently discussed acquiring Vodafone's stake in Verizon Wireless and stated a takeover of Vodafone as a whole is possible (discussed here).