Applying HHI in a Triple-Play Merger Context Will be Complicated

The next antitrust review involving any of the larger fixed network providers will provide a challenge, as the evolution of the business into a triple-play business means internet accounts, video accounts and, to some extent, voice accounts. Under such conditions, figuring out the actual market share, or household reach, will involve a bit of work, across the three key service silos.

In the fixed networks business, antitrust reviews have included a number of tools, such as the Heffindahl-Hirshman Index (HHI). But, up to this point, regulators and antitrust officials might not have had to deal with the complexities of an industry that sells multiple products (internet access, entertainment video, voice), with different households buying different mixes of those products.

Also, the video entertainment share analysis is complicated by the significant presence of one independent satellite provider, though the biggest satellite provider now is owned by AT&T.

As a rough rule of thumb, past proposed horizontal cable TV mergers have used a 30-percent test: no single proposed entity could have market share of more than about 30 percent of U.S. accounts, or have networks passing more than about 30 percent of U.S. homes.

Those rules are applied differently in the mobile business, as national reach of the population is not the issue, but rather actual account share.

Some day, it might be even harder, as the difference between the mobile and fixed industry segments might blur quite a lot.

For the moment, the HHI remains a huge barrier for many of the trial balloon mega-mergers being floated.

Can Verizon Justify Much More Investment in Fixed Networks Segment?

Verizon earned $32.3 billion in its fourth quarter of 2016, including about $3.2 billion from its fixed line mass market customers, while earning $23.4  billion from its mobile segment. In other words, all mass market (consumer and small business) revenues represented just under 10 percent of total revenues, while mobile represented about 72 percent of total revenues.

It is quite easy to argue that fixed network operations actually make less sense for Verizon than for most other telcos. Some might even argue whether it would make sense to get out of the fixed network business, if a buyer could be found.

The corollary is that regulatory burdens in the fixed networks area probably do not help Verizon make the case for robust fixed network investment. And that case would be difficult in any case.

Consider that Verizon, in its Fios areas, has 40 percent penetration of internet access services and about 34 percent adoption of its video entertainment services. Given that cable companies have nearly all the rest of the internet access share, while cable and satellite split the video share, it is hard to see how Verizon does much better in its Fios areas, no matter what  it does.

Wireline operating income was $414 million in fourth-quarter 2016, Compare that to mobile segment operating income of $6.3 billion.

Fixed networks are a small part of Verizon’s revenue, cash flow and profit (if any), while Verizon arguably does as well as it possibly could in that area. It is not a recipe for robust additional investment.

source: Verizon

Enterprises Boosting Cloud Spending

Enterprises are increasing their spending on cloud services, analysts at Forrester say. As you would guess, that is going to decrease the amount of spending by enterprises on their own hardware and software.

Since 2013, the percentage of enterprises that have deployed cloud has risen from 10 percent to 33 percent, and 49 percent of enterprises with more than 100 employees now use public cloud, according to Forrester Research.

Analysts at 451 Research predict enterprise information technology staffs will spend an average of 34 percent of their overall budgets on hosting and cloud services in 2017, up from 28 percent last year, with increased reliance on infrastructure, applications management and security.

IDC, meanwhile, predicts that 23 percent of IT infrastructure and application workloads will reside in the public cloud in two years, up from today's 14 percent.

Hybrid cloud management, application development, the internet of things, and a myriad of software innovations are ways existing suppliers will have to work to remain relevant, Forrester says.

source: Forrester

Streaming is the Biggest Change in U.S. Video Entertainment Market, Says FCC

The most significant change in the status of competition in the market for the delivery of video services has been the introduction of Sling TV by Dish Network and DIrecTV Now by AT&T, the U.S. Federal Communications Commission says.

Others might also note the importance of the AT&T acquisition of DirecTV, which vastly expanded the addressable universe of homes AT&T could reach from less than 21 percent to virtually 100 percent of U.S. homes.

One sign of the robustness of competition is that profit margins, which once were as high as 40 percent, had fallen to about 10 percent in 2015, and likely are a bit lower in early 2017.

The FCC says profit margins were 15 percent in 2014 and 20 percent in 2013. That might be unappetizing in one sense, but arguably is meaningful in a context where other legacy services, whatever their profit margins, do not contribute much revenue. Video services represent a huge percentage of potential access provider revenue, if margins are not so high.

By some estimates, internet access gross margins (at least for cable operators) might be as high as 60 percent, while voice services might have profit margins near 20 percent. Telco margins likely are not that robust.

If cash flow matters--and it does--then the revenue video entertainment represents is hard to match, averaging between $80 and $110 a month, per account.

According to SNL Kagan, there were 134.2 million housing units in 2014 and 135 million housing units in 2015. The FCC therefore assumes that cable and satellite companies cover nearly every household in the country.

At the end of 2015, cable suppliers accounted for 53 percent of all subscribers, down from 53.4 percent at the end of 2014. Direct broadcast satellite (DBS) providers accounted for 33.2 percent of subscribers at the end of 2015, down slightly from 33.3 percent at the end of 2014.

Telephone companies accounted for 13.4 percent of MVPD subscribers at the end of 2015, up from 12.9 percent at the end of 2014.

Total subscribers declined in 2013, 2014 and 2015, with the suppliers losing about 1.1 million video subscribers in 2015.

But total video revenue increased from $112.7 billion in 2014 to $115.6 billion in 2015, partly because of rate increases and partly because of subscribers upgrading to higher levels of service.

What Happens at FCC in 2017?

Though it is likely network neutrality rules will be changed under a new Federal Communications Commission, we are likely mostly to see a return to “internet freedoms” rules that emphasize access to all lawful apps, a position we might call “weak” network neutrality, compared to the strong form of net neutrality (best effort only access, no quality of service mechanisms) that has been the recent policy.

At the same time, much of the change will come in the area of “why and how” network neutrality rules are justified, with a likely move away from Title II common carrier regulation and FCC action justified by the Communications Act Section 706 rules.

Separate from the specific network neutrality provisions themselves, there has been debate over the imposition of such rules using either common carrier or “report-making” authority that becomes “regulating” authority.

The other change is institutional. Unlike the recent FCC, the new FCC likely will prefer that consumer protection and potential antitrust issues be overseen by the Federal

Trade Commission, not the FCC.

Expect the FCC to undo both claims of legal authority underlying the FCC’s net neutrality regulations: Title II and Section 706. What has fueled the fight over the last decade is the FCC’s authority, not the core of “net neutrality” itself, says Berin Szóka, TechFreedom president.

We might also see more spending on universal access and support for broadband deployment, with new incentives for deployment in urban areas.

HHI is a Major Reason Why Sprint and T-Mobile US Merger Would Not be Approved

JP Morgan Securities sees a 90 percent chance of T-Mobile US being acquired over  the next five years. That would be part of a consolidation of the U.S. telecom business some believe will be more vertical than horizontal (access providers combining with app providers, for example, more than mobile or fixed operators getting significantly bigger).

The problem with horizontal mergers always is the resulting market concentration. As a rule of thumb, any fixed network access provider (mobile, fixed, cable TV) combination that reaches above about 30 percent of U.S. homes--or has more than about 30 percent market share)  has been denied.

So either regulators will have to argue that cable TV companies and telcos are not in the same business, major asset divestitures will have to happen, regulators will have to scrap the historic screening tools they have been using for antitrust reviews. The U.S. mobile market, using the standard screening formulas, already features a market that is too concentrated.

So one of the hoped-for mergers--between Sprint and T-Mobile US--would lead to even higher concentration, beyond the level regulators have approved in the past.  

To be sure, many would argue that the U.S. market can sustainably support only three leading providers, not four. That has been the issue for European regulators and Asian regulators as well. There is a clear preference for maintaining four leading suppliers, rather than allowing the market to consolidate to three big providers.

That is why some believe the more-likely mergers will be vertical, not horizontal. That would imply a cable company acquiring either Sprint or T-Mobile US--or both-- as those transactions would not further concentrate the market.  For the same reasons, a sale of either Sprint or T-Mobile US to foreign buyers or Dish Network would have a much-easier time of gaining antitrust approval, as those transactions would not further concentrate market power.

That noted, some equity analysts think the odds of a Sprint and T-Mobile US merger now stand at more than 35 percent, up from 10 percent in September 2016, with a 70 percent chance of approval, if announced, JP Morgan analyst Philip Cusick said.

Always looking for profits to be made from big deals, such speculation is to be expected. But it might strike some observers as fanciful. The Heffindahl-Hirshman Index is used globally by regulators to measure market concentration.

To approve a Sprint merger with T-Mobile US, U.S. regulators would have to ignore the HHI, a global test of market power that historically has been used in the U.S. and other global markets. Since the purpose of a horizontal merger is gaining of scale, it is hard to see how any of the big mobile companies could merge with each other. The HHI screen would be violated.

Vertical mergers (cable TV plus mobile), or acquisitions of any big mobile company by international buyers, would not inherently violate the HHI screens.

Telecom is Dying; Distributed Computing is What Comes Next

Telecoms is dying, says consultant Martin Geddes. “The industry that acquires the name “telecoms” is slowly going out of business.”  

That does not mean physical infrastructure is going away. “We still need physical infrastructure,” says Geddes.

“It is the active layer is in the process of being absorbed by the computational cloud borg,” Geddes says, while access and transport are being commoditized. To put it another way, telecom is a form of computing.

“What we are really building is not a ‘telecoms’ network any longer, but an ‘ultracomputer’ or ‘hypercloud,’” Geddes argues.

“Unfortunately for investors, the telecoms business is at the losing end of this change.” Though voice and messaging have been the prime examples so far, there is more to come, he argues.

The next decade will also find “most enterprise access revenue going down the drain.”
 
What is needed are varying and segmented levels of data service resilience and performance, that can be tied (loosely or tightly) to delivery of some kind of application outcome or experience, a theme Geddes has emphasized in the past.

Cloud computing also will have a key impact. “We are seeing rapid growth of the scale, scope and value of giant cloud platforms,” he says.

“Payment for communications is going to increasingly come from the cloud providers and their customers, via wholesale mechanisms,” he says.

 
“This blows up the financial model on which investments in telecoms are presently made,” says Geddes. “The tragedy about to unfold is that telecoms business asset values price in neither the downside risks (you’re now the Uber driver), nor the upside opportunities (you’re the restaurant whose high-margin alcohol sales go up as posh people don’t need to drive home or slum it in a taxi).”
 
“If that wasn’t bad enough, the regulatory system appears determined to pretend that this all isn’t happening,” says Geddes. “We are seeing in a variety of cases where common carriage (and the circuit mentality) is being misapplied to a distributed computing system.”

“The result is that regulators are tasked with regulating an industry that is disappearing and being subsumed into another,” Geddes says.

What replaces telecoms (and cloud) is a distributed computing industry.