Lots of sturm and drang can be expected as this proposed mega-deal wends its way through the regulatory minefields in Washington. The year will be filled with lots of loud and well-financed arguments from both those in favor of and those against approval. Politics in this case will count more than economics - much more so than even in last summer's bitter American Airlines-US Airways (NASDAQ:AAL) contretemps with the Department of Justice.
From an investment perspective there will be lots of smoke and mirrors and a period of greater than usual uncertainty about whether to buy, hold or sell.
On the surface, at least, the deal has all the earmarks of a bold and powerful positioning of Comcast (NASDAQ:CMCSA) (NASDAQ:CMCSK). The company has tried to cover its political bases with relatively generous contributions to the President and his party. And the Comcast team appears to have sung all the right songs when it comes to Washington lobbying and golfing invitations.
Yet, as a distant observer, it's hard to see this all ending up entirely well for either of the companies. The most misleading myth of all is that this deal will provide the new and larger version of Comcast with greater so-called leverage against the broadcast networks and other important content providers.
Really? Let's take a recent example such as when CBS (NYSE:CBS) and Time Warner Cable (NYSE:TWC) squared off against each other last summer. TWC had the better case in arguing that the increased fees demanded by CBS would be passed along to subscribers in the form of higher cable bills. But CBS largely came away with what it wanted because ... drum roll please ... subscribers had a direct business relationship with TWC, not with CBS. So the complaints came pouring into Time Warner's bucket, not CBS's.
In view of this does anyone really believe that Comcast will have more leverage against the content guys? Even upon completion and with 30% of all U.S. cable subs, this is not a national footprint. And were Comcast-TWC to try to play hardball against the broadcast networks and other content providers, it will be the Comcast complaint lines that will be overheating. People will start to drop cable, move to DISH Network (NASDAQ:DISH) or Aereo or some other distribution platform and do the same as they did last August to TWC in the dispute with CBS. If push comes to shove, the political blowback on Comcast will in such a situation be overwhelmingly negative. So, in my opinion, the greater leverage argument is false.
A second smokescreen is that there are no overlapping ZIP codes in cable coverage and besides, Comcast is willing to preemptively appease the antitrust gods by selling off 3 million subs. Isn't that so generous of them? The 3 million drops will probably be of the subs most expensive to service and of the least profitable systems. So Comcast gets to benefit by shrinking the total combined sub package by less than 10% while probably enhancing earnings. This is a minor detail as these things go. Cable is the high technology of the last century, so getting rid of low-profit subscribers is a smart strategy for the company but irrelevant as a deal point.
The largest issue, however, involves the broadband services which under the merger will ultimately cover perhaps 40% or more of the US - supposedly without any competition on prices and service quality. This gatekeeper stranglehold high rent monopolist theory is compelling on the surface. But it also might not hold as much water as the anti-merger crowd believes.
Again, it gets back to politics - especially local politics. There will be glad-handing and horse trading galore as Comcast has to reach into its deep pockets to perhaps help pay for things like, in New York, the de Blasio soak-the-rich pre-K school plan. This placate-the-locals-to-get-the-deal-blessed, in other circumstances also known as paying tribute, might end up costing Comcast untold dollars while it gums up the entire approval process.
Also, for argument's sake, let's just suppose for a moment that the merged Comcast/TWC tries to fully implement the stranglehold monopolist strategy. You can be certain then that the regulators and Congress will be besieged by complaints that can only invite further unpleasant government scrutiny and regulatory interference that constrains the company's freedom to grow profitably. Prices set too high will also invite competition from new technologies. Verizon (NYSE:VZ) and AT&T (NYSE:T) are unlikely to let such an opportunity to gain new customers pass them by.
Of course, this is all intertwined with the nettlesome "net neutrality" issue. Comcast is here again trying to play nice by promising that it will not favor traffic on the net through differential pricing. Indeed, to get the NBC-Universal deal approved, they've already pledged to maintain neutrality until early 2018.
But this seems to be just plain stupid as it only helps reassure Netflix (NASDAQ:NFLX), Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), Hulu and a slew of other bandwidth-eating hogs that they are secure in their cost structure assumptions for at least another four years. It is not clear, though, how such neutrality pledges help Comcast investors. If you invest billions of dollars on infrastructure and then charge the same price to those who gobble huge quantities (and thereby degrade the service for everyone else) as to those who use it sparingly you are probably destroying shareholder value. That's because it then becomes much more difficult to earn in excess of the cost of capital related to Internet infrastructure investments. So rather than stimulating better and faster service, the neutrality sop that transfers financial benefits to other companies likely ends up harming Comcast subscribers and shareholders. (See also the excellent analysis, as usual, by Prof. Damodaran in "Comcast Bids for Time Warner Cable: Synergy, Reverse Synergy or Ego Trip?").
The Silicon Valley venture capital folks, by the way, insist that without neutrality new upstart companies will not be able to emerge because, if and when the deal goes through, they'll have to pay Comcast/TWC a royal ransom. This argument doesn't make any sense to me either. My guess is that the major VCs still hold large stakes in companies like Google, Amazon and Netflix and don't want to see their stock values suffer from eroded margins.
Although I'm generally disposed toward approving such deals without major conditions - government bureaucrats are notoriously ham-fisted and arbitrary and the bloated merged companies ultimately tend to fall apart of their own weight and management problems - I can see the point of those who fear that the combined Comcast-TWC will exert monopoly pricing power. Unlike in the airline business, in which the basic assets are mobile (and which I wrote about in "The Department of Justice Flies in the Wrong Direction"), cable and Internet infrastructure is not movable and it takes far longer for competition and technology to have a competitive impact in these areas. Still, there will likely be many conditions and reasons for Comcast/TWC to exercise restraint.
In summary, my impression is that this deal - notwithstanding all the presidential golfing, lobbying connections and fundraising parties - will encounter great political resistance and turbulence and is far from being a sure bet to be completed in the form that's currently anticipated. Comcast will yet have to be extremely contrite and careful in raising prices. And it will probably have to spend and borrow more than expected to upgrade service quality - which for both companies is considered as being among the worst in the industry. While doing so, the capital markets might also not be quite as friendly as they are now (See "Fed Crash Cooking Done: First Course Being Served").