The Death Of Net Neutrality Is Bullish For Stocks And America

Includes: NFLX, SPY, T, VZ
by: Gary Jakacky

The Federal Communications Commission, or FCC, recent 2-1 ruling killing net neutrality has led to a very predictable howling and temper tantrum by advocates of "civil liberties" and "freedom of speech." They claim if ISPs such as Verizon (NYSE:VZ) or AT&T (NYSE:T) can slow down or even block (temporarily) transmission of data from websites like Netflix (NASDAQ:NFLX), or alternately charge them a greater fee for bandwidth and speed, the "internet as we know it" will disappear and censorship of sites by content or political flavor will inevitably follow.

In reality, the issue is far different, and remarkably simple. Economics has been dealing with this type of problem for, well, 200 years. Don't tell that to "netizens" who think anything to do with the internet can only be truly understood by Stanford PhDs in engineering. Or of course, by enlightened Washington DC bureaucrats with a firm commitment to being generous with other peoples money.

Back in your college Microeconomics class you probably had a session or two devoted to marginal cost pricing. What this means, without getting into all the cost curves and jargon that put you to sleep in that 8 AM lecture hall decades ago, is that the price a business charges for providing a good (or a service) should be determined by the cost of providing the most recent unit(s); not the average cost of providing all of the units up to that point.

Even in that paragraph the jargon is too thick, so let me give you an example. We all remember the I Love Lucy episode where Lucy wanted a job of her own (more about this in a future article). She ended up wrapping Hershey Kisses. At first it was a joy. When they started coming down the assembly line much faster it was much harder. Lucy would certainly want to be paid more; and the cost of product damage and poorer quality control would certainly rise as well. (darn...I can't remember where those unwrapped kisses went! Can anyone remind me?)

Simple, then. You want 100 boxes of Hershey Kisses delivered by next Wednesday? No problem! What! You have a special order of 1000 boxes gold wrapped and addressed to the Clintons? By tomorrow morning? Sure..but you'll have to pay more.

Why is this such a difficult concept to understand?

Metaphors can be powerful analytical tools. Ever wondered why the expression "information superhighway" has died out? Where I live I-90 is also the Massachusetts Turnpike. When you pass down the exit ramp the toll you pay depends upon the size of your vehicle: trucks pay more than cars. (There have been proposals to surcharge speeders this way as well, but they never make it through the legislature.)

Tolls are designed to at least approximate the different costs imposed by bulky, road hogging vehicles. Many net-neutrality advocates, being progressives, surely are driving small vehicles, even carpooling. Don't they agree road hogs should pay more? Now you know why the superhighway metaphor is so rarely used these days. Equal tolls are no way to run a highway, and equal costs/net neutrality are no way to run the Internet.

Listen to entrepreneur Marc Andreesson on Twitter:

  • In ideal universe I want both net neutrality + fast growing investment in existing&new networks. Not obvious to me how to square circle.

But in this article by Mathew Ingram, he goes on to say,

  • The problem, he added, is that if carriers like Verizon are spending $20 billion or so on their networks every year, they need a certain return on that investment in order to continue doing so.

Wow, what a concept. Return on Investment.

The investment needed to increase bandwidth and speed has to come from somewhere. Microeconomics taught us 200 years ago that this extra expense should be paid by those who use and require it.

Most investors can see how this would be bullish for providers like AT&T and Verizon. The money they need can come from those users who make the expenditure necessary, instead of from all users, which would make internet access more expensive (and at the same time SLOWER) for the vast majority of modest data users such as myself.

Yet, I urge readers to be even more farsighted. This ruling means that even amidst a Washington DC which is drunk with regulatory excess from Obamacare to CO2 emissions to trucking, there exists a growing consensus that regulations need to be enforced in a way which enables companies to recover the necessary costs. Given that such expenses are a major cost of doing business---some (see here) place these costs at nearly two trillion dollars a year---the overall effect on business profits and return on investment would be bullish, indeed.

We've been down this "neutrality" road before, with the same costly foolishness at first, and incredibly pro-consumer results after. Prior to the late 1970s, the "Civil Aeronautics Board" regulated air transport routes as a public utility. Sound familiar? Back then, a flight from New York to Los Angeles cost everyone (drum roll, please...) one thousand four hundred and forty two dollars. The cost now? $268. Do you want fries with that? It might cost you more. You want Cabernet Sauvignon at your plush luxury seat? It might cost you a lot more.

Much the same result for the trucking industry. "Haulage Neutrality" died in the Reagan years also, and no one seems to be mourning over its corpse. Instead, Wikipedia reports that:

  • freeing up the trucking market to permit much more flexible pricing and service arrangements, disciplined by competition-allowed manufacturers to reduce inventories, move their products more quickly, and be more responsive to customers. Consumers indirectly benefited from the more efficient, lower-cost transport of goods.

Can someone please tell me why the death of net neutrality will not lead to the same ideal set of outcomes?

Deregulation was the rage in Washington from 1980 to 2000. Do I have to tell you how much stock prices, and the economy, surged in these two decades?

The consensus on Wall Street is that the decision is bullish for common carriers like AT&T and Verizon, and punitive for net hogs like Netflix. I doubt if the final impact is that simple and urge investors in these sectors to do their due diligence. As the title of my article suggests, the net (no pun intended) effect may be bullish across as a broad range of industries, just as lower costs for shipping and transport did over the last three decades. Diversified ETFs like the SPDR S&P500 Index (NYSEARCA:SPY) may be just fine for most investors.

In my opinion this decision is just a small part of a groundswell of free market reforms Washington will be forced to adopt in the next few years. In a future article I will explain why I believe this means we are in the early stages of a long term, secular bull market.

Disclosure: I am long XLK, XLV, IHI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.