Time to Sell the Telcos?

Includes: T, VZ
by: Dana Blankenhorn

There is a great bearish case to be made today on AT&T (NYSE:T) and Verizon (NYSE:VZ).

First, look at a lifetime chart of the two stocks. Both have done exceedingly well during market peaks, and had their all-time highs during the Internet boom. Both had a second boom in 2006-2007 – they were proxies for peaks of optimism.

So if you think the economy's heading south, as many do today, shorting the telcos is an easy play.

But there's a more secular reason for being negative on the telcos. It has to do with their nature.

Telephone companies sell scarcity. Their business is to sell as little bandwidth as possible for as much as they can. Selling minutes, billing for and collecting on them has been their business since the 1984 Bell breakup. The cell phone business was perfect for them. Once AT&T is allowed to buy T-Mobile (and they will be) the two companies will have turned a formerly competitive market into a comfortable duopoly.

So why am I making a bearish case?

Because of abundance. Abundance is smashing the telco business model to smithereens.

I remember, back in the 1980s, getting multi-page long distance bills I had to parse out to publishers for reimbursement. People don't do that anymore. Voice, as a separate billable service, is circling the drain. Microsoft's (NASDAQ:MSFT) acquisition of Skype, and its integration with Facebook, is the last step in a process that has been going on for years. Voice is a low-bandwidth digital service, not a separate, analog service.

What does that mean for the vast networks of copper both Verizon and AT&T own, and the regulatory infrastructure built to sustain that copper's value? It collapses. AT&T's U-verse has not competed well with cable, and while Verizon's FIOS has, the fixed cost of that additional infrastructure is enormous.

AT&T and Verizon are utilities, not competitive tech companies. They want the full retail price for selling drops of bandwidth. But that's not the direction the market is heading in. Internet service is based on a fixed monthly charge, core bandwidth prices have been falling for years, and value has been moving to higher levels of the stack – toward content and applications, away from the pipes. The two firms' attempts to maintain value through their own data centers is failing because they can't compete in a competitive market where costs are constantly falling.

Skype, through Microsoft, is going to accelerate these changes. By integrating voice with other Internet applications, voice becomes an increasingly small part of an increasingly large whole. And the whole idea of Voice Over IP was, from the beginning, to move calls quickly off the slow, regulated voice networks owned by Verizon and AT&T, onto the faster, unregulated Internet. That transition is now nearly complete.

Something similar is happening on cell phone networks. AT&T and Verizon once thought they could hold consumers in their own app stores, generating ever-higher ARPU (Average Revenue Per User). Well, ARPU is already starting to fall in China and that trend will come here. Carriers are losing control of their phones to retail-oriented software companies like Apple (NASDAQ:AAPL), whose expertise is in selling rather than billing. That trend is going to continue.

AT&T and Verizon sell an increasingly low-cost commodity. Any attempt to maintain a price on a good whose cost is falling is doomed. Not even the government can protect a company forever from its market. Moore's Law is going to win, and the telcos are going to lose.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.