Following an impressive performance in 2017, investment grade (IG) corporate bond spreads have decreased to near pre-crisis lows.
The March Consumer Price Index report highlighted a curious culprit for soft price data in the U.S.: wireless telephone pricing. The Wireless Telephone Services Index fell 7 percent in March – the largest one-month decline ever for that Index. Wireless pricing fell further in April, down 1.7 percent month-over-month.1
Most cellphone users will attest that the major U.S. wireless carriers – Verizon Communications Inc., AT&T Inc., T-Mobile US Inc. and Sprint Corp. – are engaged in furious price wars. Figure 1 explains why. At the start of the decade, Verizon held a sizable lead in coverage and could charge higher prices. As years went on, AT&T improved its network quality, followed by Sprint and T-Mobile. Due to this quality convergence, Verizon and AT&T have lost subscribers to smaller providers with more aggressive pricing, and the wireless carriers are competing on price rather than on quality.
Given stiff competition in wireless networks and weak pricing trends, rumored and confirmed mergers have both come forth as the major carriers aim to diversify their businesses away from wireless. For example, in October, AT&T announced its $85 billion acquisition of Time Warner Inc. to diversify AT&T’s revenue mix into content. This announcement followed AT&T’s $49 billion purchase of DIRECTV in 2015 to diversify into pay TV. Also, Verizon is snagging Yahoo Inc. for $4.5 billion to acquire its search, communications and digital content products.2 Most recently, in late May, the New York Post reported that Charter Communications Inc. rejected an acquisition proposal from Verizon “in recent months.”
The OTT Race
In addition to potential M&A growth in the Telecom sector, Cable sector M&A could also tick higher, primarily due to rising demand for over-the-top (OTT) video services that has led to subscriber declines in traditional pay TV.3 This trend has prompted some pay TV providers to offer their own OTT service, and could potentially prompt some to scoop up an existing OTT provider.
Alternatively, some cable companies (such as Charter and Comcast Corp.) are responding to greater competition by announcing plans to launch their own wireless services,4 with the goal to offer customers a “quadruple play” covering pay TV, internet, phone and wireless services. To that end, Charter and Comcast last month announced an agreement to work together on wireless logistics and technology. Both companies said they would not do any material M&A in wireless for one year without the other’s consent. The agreement underscores the hefty investment required for cable companies to build and maintain their own wireless networks, as Charter and Comcast are taking time to dip their toes into wireless before potentially attempting to acquire a wireless service provider.
Additionally, some Cable sector M&A has taken place by cable companies simply aiming to become bigger players. For example, in May 2016 Charter completed its acquisitions of Time Warner Cable and Bright House Networks to expand Charter’s coverage footprint and build scale.5
The Long Distance Call
- We expect M&A activity to continue within and between cable and telecom companies as the industries continue to converge and adapt to the evolving competitive environment. Some significant M&A may be delayed due to the Comcast and Charter agreement.
- M&A could cause leverage to rise in the sector. However, for mergers in the space, we consider higher leverage in light of benefits from diversifying business risk.
- We are closely monitoring Verizon as, contrary to its rival AT&T, the company has yet to significantly diversify itself away from wireless. Additionally, S&P Global Ratings revised its upgrade threshold for Verizon to require leverage of 2.50 times (versus 2.75 times) due to the company’s substantial exposure to the competitive wireless industry (roughly 70 percent of revenues, per S&P).6 As a result, Verizon said it would not be able to return to its previous A3/A- credit ratings by the 2018-2019 timeframe previously laid out by the company (Verizon is currently rated Baa1/BBB+).7 While Verizon’s management has said that the company prefers to grow organically, the extended timeframe could provide them with flexibility for debt-financed transactions.
- We note that deals being referenced in most headlines are very large, and it is tough to see them getting past regulatory hurdles – unless the new regulatory administration significantly loosens the reigns on M&A approvals. Nonetheless, all potential deal activity will be important to monitor going forward as it is likely to influence the long-term creditworthiness and sustainability of the domestic Communications sector.
 Bureau of Labor Statistics, as of April 14, 2017 and May 12, 2017.
 Company filings, 2015-2017.
 TiVo 3Q16 Video Trends Report, from 2013 to 2016. OTT services, such as Netflix, Hulu or Amazon Prime, are alternative platforms for content outside of traditional pay TV.
 Charter and Comcast each have reseller agreements with Verizon, but are now exploring the launch of their own wireless services.
 Company filings, 2016 and 2017.
 S&P Global Ratings, as of May 3, 2017.
 Verizon Communications Inc., Form 8-K, for the period ending May 4, 2017.
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