Will Genachowski's Telecom Gambit Pay Off?

by: Roger S. Conrad

This week Federal Communications Commission (FCC) Chairman Julius Genachowski dropped a bombshell on the nation’s communications industry. His proposal: A new regulatory regime for heretofore largely untethered broadband communications.

At the heart of the chairman’s move is the concept of “net neutrality.” Championed fiercely by the leaders of Internet commerce such as Amazon.com (NASDAQ:AMZN) and Google (NASDAQ:GOOG), net neutrality holds that all products, services and devices should have free rein of all Internet networks.

Genachowski advocates a new regulatory framework based on five key guidelines:

  • Consumers are entitled to access any legal Internet content, regardless of how they access the Internet.
  • Consumers are entitled to use any Internet applications or services, again regardless of how they access the Internet.
  • Consumers are entitled to connect to any devices, with the caveat that they won’t harm the network they’re using.
  • Network owners can’t block or slow competitors’ online services.
  • The same rules apply to both wireless and wireline networks.

The first four of these are “principles” adopted by the FCC under the Bush administration. The fifth is a new one and has already drawn intense criticism from industry.

To date the communications industry has fought hard against formalizing net neutrality rules. Cable giant Comcast (NASDAQ:CMCSA) has blocked in court the FCC’s attempt to punish it for restricting certain customers’ high-volume downloads that were slowing its network.

If Comcast eventually wins the day, it would strike a severe blow to the FCC’s ability to regulate broadband networks the way it once did conventional copper wires. And similar suits can be expected from the wireless industry should the FCC move too dramatically.

Ironically, industry has already begun to adopt the FCC’s net neutrality principles as a matter of good business. Verizon Communications’ (NYSE:VZ) move to open its network to competing devices hasn’t happened fast enough for some.

And there have been numerous complaints about the exclusive deals between major equipment makers and network owners, i.e. AT&T (NYSE:T) and Apple’s (NASDAQ:AAPL), Verizon and Research in Motion’s (RIMM) Blackberry and Sprint Nextel (NYSE:S) and Palm’s (PALM) Pre.

Some of these have been from smaller carriers who claim they’re increasingly squeezed out of the market because the majors have locked up the best devices. Other complaints are from the likes of Google, which now claims AT&T and Apple conspired to exclude one of its prized applications from the 3G iPhone.

But the days of companies closing off networks to all but proprietary devices have been rapidly drawing to a close for some time. Network owners are finding that consumers do have choices. The only way to stay viable for the long-term is to maintain network reliability and give customers the opportunity to use the most popular devices, applications and services. To do otherwise is to risk extinction.

Network owners have long argued against regulations enforcing net neutrality on the grounds that they must be able to control traffic to maintain reliability. Customers that hog bandwidth with exceptionally large needs, they argue, slow down service for everyone else. Consequently, they should be made to pay more for their usage in the same way that consumers of electricity pay for more for higher usage.

Even that concern, however, is likely to become increasingly moot thanks to the deployment of ever-faster technology and hardware. Verizon’s FiOS network, for example, can download content at a rate of 50 megabytes per second (MBPS), versus just 15 MBPS for the typical coaxial cable network used by cable television providers.

Ten songs with a total of 50 megabytes of memory can be downloaded in just eight seconds, or more than three times faster than cable broadband. Uploads are more than 10 times faster.

Meanwhile, in wireless, the rollout of Long Term Evolution (LTE) is being accelerated. That will dramatically ramp up available speeds for both uploads and downloads from the current 3G technology used. It will also for the first time enable seamless flow between CDMA and GSM networks. And its ability to absorb new devices and applications will also greatly expand network capabilities.

In an interview this week Verizon Wireless’ technology chief Tony Melone announced his firm would roll out LTE nationally “as close to all at once as possible.” The company expects it to available to as many as 100 million potential users next year and the rest of the country within two to three years.

It will also enable seamless flow for the first time between Verizon Wireless and 45 percent owner Vodafone (NASDAQ:VOD), with considerable upside for global connectivity and especially for business.

Almost alone of major US corporations, communications giants like AT&T, Comcast and Verizon have continued to plough billions of dollars into upgrading their networks. That’s in large part because demand for their services has continued to mushroom amid the explosion of global connectivity, a trend that hasn’t stalled despite the worst recession in decades. It’s also because the investment is dramatically widening the difference in quality between their networks and those of smaller competitors.

AT&T and Verizon already serve some 80 percent of total US wireless customers. Moreover, No. 3 provider Sprint is still losing customers, despite profit-sapping price cutting and the launch of the splashy Palm Pre. No. 4 T-Mobile--a unit of Deutsche Telekom (DT)--is also flagging.

That’s one big reason why Deutsche Telekom is rumored to be preparing a bid for Sprint, though as the latter has pointed out any deal would face considerably regulatory hurdles. And with AT&T and Verizon continuing to spend nearly $20 billion a year each, their dominance will only grow.

More than anything else, this growing dominance is probably what’s induced Genachowski to introduce these proposals now, weeks after he moved into his new job. The five-member FCC is made up of three members of the president’s own party and two of the opposition, meaning that the chairman does have a 3-to-2 Democratic majority to back his moves. And in fact the other two Democrats have already expressed broad support for this initiative.

Even a cursory glance at a long-term price chart for the communications giants--AT&T, Comcast and Verizon--reveals general under performance dating back to the late 1990s.

The Big Three held up better than the broad market during last year’s market crash and have generally recovered to pre-meltdown levels. That’s in large part because their businesses have remained so solid. But the recent talk of tighter regulation has again brought out the bears, who have also voiced concerns that the recession is at last catching up to this business.

This, however, is not the time to draw too many conclusions. That goes for both what the FCC will eventually do as well as how what it does will affect the giants.

For one thing, Genachowski has laid down broad principles. But even he has argued for a light touch in wireless, even stating in this week’s speech that wireless may be exempted from some of the new rules.

And none of these proposals have anything to do with rates charged for services or other business practices, which for example have hurt telecoms in New Zealand and the European Union.

The FCC will meet to harden these proposals in October, at which time we’ll get a better idea of the particulars. But with the FCC’s two Republicans expressing deep skepticism about the need to do anything, Genachowski will run a big risk of invoking major opposition in Congress if he announces anything too radical.

Another consideration is that, after 28 years of conservative Republicans and one moderate Democrat appointing judges, there aren’t too many courts that will enforce wholly new regulations issued solely from the executive branch. That’s the clear message from the FCC’s repeated failures in recent years to attain judicial enforcement its idea of the 1996 Telecom Act.

The upshot is anything deeply opposed by industry is going to have to be passed as legislation, as the Telecom Act was. And, although net neutrality does have its staunch advocates in Congress like Congressman Ed Markey (D-MA), it also has a large number of skeptics, including virtually every Republican and a good number of Democrats as well.

Moreover, as history shows, the closer the midterm elections get, the less likely major legislation, regardless of the size of the ruling party’s majority. And this time around the majority has its hands full with not one but three major pieces of potential legislation: carbon regulation, health care and financial sector reform.

Ramming through a highly controversial bill affecting one of the few US industries still prospering and hiring people looks dubious at best.

That makes compromise likely. We’ll see new regulations placed on both wireless and wireline networks that will no doubt make Google happy. But they’ll almost certainly either be loose or lightly enforced enough to get industry’s acceptance.

We don’t have all the answers here. But odds favor the Big Three continuing to be very profitable in coming years, with growth reaccelerating as the global economy inexorably recovers.

Moreover, there’s no better discounting mechanism than the stock market, which for communications is already pricing in the bad news and none of the good. That’s a formula for investor profits and a reason to buy, not head for the hills.