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Pai challenges the notion of government providing a free, open internet

Federal Communications Commission chairman Ajit Pai today laid out his vision for removing broadband access from under Title II regulations imposed in 2015 by a 3-2 Democratic majority on the Commission.  Two decades prior to the Commission’s net neutrality order that imposed Title II regulations, the internet was already free and open. Companies such as Google, Facebook, and Netflix came into being under a non-Title II regime. Title II was an archaic regulation designed in the 1930s for plain old telephone services.

Title II boiled down to a solution in search of a problem, Mr Pai further argued. Rather than energizing a demoralized Democratic Party base licking its wounds from the butt hurt of the 2014 mid term elections, Former president Barack Obama and the rest of his Title II proponents wound up disincentiving $5.1 billion in capital investment and dissuaded companies to not hire or lay off 75,000 to 100,000 laborers.

What particularly caught my attention in Mr Pai’s remarks was his highlighting the belief that Title II proponents have about government and freedom, namely that government was going to guarantee freedom on the internet. A close read of the American Constitution tells you that its framers were concerned about the natural propensity of government to squash freedom. This is why the document put in place checks and balances against attempts to usurp power over individuals. Net neutrality opponents and members in Congress who support continued imposition of the rules confuse “rights” with “freedom.” The rights issued by government are permission slips that say “a person can be, but only up to the limits we allow them to be” versus freedom which is innate.

This is not to say that freedom doesn’t have its limits. You can’t just violate another person’s spectrum without facing the consequences that result from moving into another person’s space. But how those consequences are managed should be left up to the individuals or in the case of broadband, the broadband access providers and their customers. Allow customers and access providers to define the limits, terms, and consequences of their relationship, including price and type of service. In the 21st century, this type of strategic partnership between customer and access provider is very possible.

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Has net neutrality decision impacted trading in the telecom sector?

Today the United States Court of Appeals-District of Columbia gave the Federal Communications Commission a victory, holding that the agency has the statutory authority to reclassify broadband providers as telecommunications companies as opposed to the industry favored status of information service providers. Broadband providers and their supporters have vowed that the fight is not over, telegraphing the probability of obtaining a ruling from the full bench of the appellate court or, going all the way to the United States Supreme Court.

The telecommunications services sector seemed to have shrugged off the ruling. The Thomson Reuters G7 Telecoms Sector Index registered a .06% decline at the end of the trading day. The sectors biggest players, AT&T and Verizon, saw their stock values increase .47% and .80% respectively. The response is not surprising since broadband operators such as AT&T, Verizon, and Comcast have been providing their high-speed access services pursuant to an open internet philosophy for decades. Their primary argument has been that broadband regulation should be conducted with a light touch and that throttling access speeds or discriminating against certain content or websites would be bad for business given the level of competition that they face.

Wall Street, unlike the Commission, has not been afraid to declare how competitive the telecommunications sector is. Charles Schwab analyst Brad Sorensen had this to say in a recent report about the telecommunications services sector:

“The telecom sector is certainly not what it was a couple of decades ago, although some investors may not realize it yet. The days of near-monopolistic control of landlines are long gone. These days the sector is driven by fierce competition, with new ways of communicating continually entering the market, and consistent—and expensive—upgrade cycles. To us, this reduces the traditional defensive appeal of the telecom sector.”

The court avoided the question of market power and deferred to the Commission’s predictive judgment on telecommunications companies willingness to invest in broadband network deployment. Although the sector has long left the monopoly environment existing prior to the passage of the Telecommunications Act of 1996, should traders consider not only a throwback to the regulatory world of the 1990s that the court’s ruling has cemented but reorganization of the sector that resembles the Ma Bell days?

The 1990s were the pre-convergence days. Carriers followed a silo model separating, in the case of larger local exchange companies, their long distance operations from their local exchange operations. In order to avoid the disruption that may ensure from increased complaints regarding perceived throttling, suspected paid prioritization, and misunderstood network management techniques, what if larger carriers like AT&T and Verizon decided to spin off their newly created “utility” pieces and focused on providing backbone, mid-mile, advertising, content delivery, and special access services? State public utility commissions, long shut out of the broadband regulatory game, may now view the courts ruling as permission to re-enter the regulatory fray.

Spinning off the telecommunications component and leaving them subject to state and federal regulation may allow AT&T, Comcast, and Verizon to focus on the content and data business and go head to head with Google or Facebook, edge providers, who, though subject to the Federal Trade Commission’s privacy regulation, don’t have to suffer the FCC’s Title II regulation.

A spin off may be good for traders especially if the utility components are subject to rate-of-return regulation thus providing the certainty of fixed-income behavior while the unregulated portions, while subject to the volatility of competition, may generate higher rewards that come with the greater risk.

It’s still early and in the immediate term broadband providers will be focused on continued appellate court action. The long term potential restructure stemming from this action is something traders should keep in mind.

 

With all the talk of pending recession, why implement net neutrality rules?

So far 2016 has not been the best year for the equity markets. Over the past four weeks the Dow Jones average has fallen almost three percent and year-to-date decline is approximately 8.7%.  The telecommunications, media, and technology sector hasn’t fared much better. The NYSE TMT Index has seen a fall of 13.72% over the last twelve months. In the past four weeks, the index fell 2.38%. Last month the investor adviser firm Charles Schwab rated the telecommunications sector as under-performing due in part to the sectors move away from the steady cash flow of a monopoly land line business to the cut throat competitiveness found in the wireless arena.

Just about the only thing that has slowed down capital expenditures in the digital economy has been recessions. Capital expenditure outlays in the information sector, which includes television, radio, publishing, wireless and wireline telecommunications and internet portals, peaked in 1999 at an annual $120.1 billion. The impact and aftermath of the 2000-2001 and 2007-2009 recessions were the two major economic bumps in the road that caused decreases in capex. After hitting a bottom of $87.7 billion in capital expenditures in 2009, the information sector, of which roughly 74% is made up of wireline and wireless telecommunications, has seen an uptick in investment from $97.4 billion in 2010, to $99.7 billion in 2011, to $105.5 billion in 2012.

This increase in spending has occurred when broadband while broadband has been treated as an information service. But if talk of recession becomes solidified over the next twelve months, a slowdown in spending can be aggravated where a recession is compounded by rules that go back to the depression-era 1930s.

Depression-era rules applied during a pending recession. The irony.

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The FCC needs to change its mindset about capital and Title II

The politics of Washington is not commensurate with capital flow when it concerns broadband investment.  The Federal Communications Commission’s decision to apply Title II common carrier rules has resulted in a decrease in capital expenditures.

It has been reported that during the first half of 2015, AT&T saw a decrease in capital expenditures of 29% relative to 2014.  Charter Communications also saw a decline of 29% relative to 2014 while Cablevision saw capital expenditures fall off by 10% versus last year. CenturyLink was down nine percent while Verizon saw a fall in capex of four percent.

The politics pushing the FCC toward their anti-capital decision was driven by a grass roots group argument that freedom of expression was being challenged by the potential bottlenecks that broadband providers could create.  With narratives that included claims that consumers would not be able to create content on the internet or access the content of their choice, at least the three Democratic FCC members fell sway to it.

Edge providers, like Netflix, also played the “threat to democracy” card, arguing that broadband access providers , via paid prioritization, would discriminate among content providers and deny consumers access to their content.  Netflix, however, has been able to hedge its political bets by paying some of these broadband providers for fast lanes so that video traffic to its subscribers is not congested.

Now the political center of gravity lies in the Congress, at least this week, as the House committee on energy and commerce takes a look at how Title II common carrier treatment of broadband will impact investment.  Given Republican control of the committee, it’s no surprise that the committee’s leadership sees Title II as a burden on investment.  For example, the committee’s majority takes issue with the FCC’s finding that the total annual cost on all broadband providers for complying with the application of the FCC’s Title II rules would be approximately $700,000.  The majority believes the annual cost of compliance could be as much as $52 million.

Having supervised a tariff shop for a state regulator and drafting and filing tariffs as a staff attorney for a law firm, I can assure you that the cost of complying with Title II rules will well exceed the $6.95 per hour that the FCC estimates.  We are not talking flipping burgers here.

Politically, reversing the impact Title II regulation will have on broadband investment is out of the hands of Congress, at least in the short term.  Should a Republican win the White House in 2016 and the GOP maintain control of both chambers of Congress, then investors should expect a new FCC Republican majority to repeal the rules.

A repeal by the Republicans could be moot should the United States Court of Appeals-District of Columbia find that the rules have no statutory basis or that the FCC has not shown why its earlier treatment of broadband as an information service should be abandoned.

The probabilities of a court decision or an election outcome in favor of broadband providers is difficult to calculate but the likelihood of the FCC or the Obama administration changing its mindset about Title II’s impact on capital flows to broadband is definitely zero.  Both the President and the FCC’s three Democrats have invested too much political capital in steering the wrong course.

Congress should not fund a FCC with misplaced priorities

Free Press has been calling on its constituents to encourage the Republican-controlled Congress to vote against a House appropriations bill that would significantly reduce funding for the Federal Communications Commission.  For Fiscal Year 2016, the FCC asked Congress for $388,000,000 in offsetting collections. This represents a $48 million increase over the FCC’s request for Fiscal Year 2015, which ends tonight at midnight.

House Republicans have been blatant about their unwillingness to fund the FCC’s net neutrality regime.  So serious are they about taking the wind out of the so called open internet that they have a budget bill that would provide the FCC with only $314,844,000 for Fiscal Year 2016.  If federal budgets represent national priorities, it is clear that net neutrality is not a priority for the GOP, whose members have railed against how onerous the rules are.

While the rules are burdensome, what is more telling is the FCC’s unwillingness to get out of the narrow vision box.  The FCC is still stuck on the concept of encouraging competitive telecommunications networks.  In the 21st century why would the FCC be concerned about a concept calling for a multiple number of firms providing point-to-point voice communications services via wire or wireline?

What the FCC should be concerned about is promoting the development of the information and data markets that are being created and transacted in over internet infrastructure.   Information and data are the currency being exchanged on digital networks.  Also the returns on stock that investors are seeing should be an indication as to where the economy via the internet is going.

According to data from Morningstar, the telecom services industry saw one-year returns on stock at 8.42%.  Three-year returns were 9.82% while five-year returns were at 9.64%.

In the information technology services industry, one-year returns amounted to 10.93%; three-year returns came in at 10.41%; and five-year returns were 12.16%.

The internet content and information industry saw first-year returns of 17.04%; three-year returns of 23.90%; and five-year returns on 18.70%.

I don’t pretend to be a stock analyst but if the FCC really wants to encourage competition on the internet, shouldn’t the agency promote entry into the higher performing industries?  If the FCC wants to convince me that they are interested in economic growth, their analysis should be based on the current reality of the internet economy and the data and information markets.