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A Verizon/cable deal may be inevitable

For months, there has been persistent speculation that Verizon Communications Inc. would make a play for a cable operator. And though a deal is far from certain at this point, the persistence of the talk raises important questions about Verizon's future.

On Jan. 26, The Wall Street Journal cited "people familiar with the matter" as saying Verizon CEO Lowell McAdam contacted officials close to Charter Communications Inc. about a possible combination.

Both Verizon and Charter declined to comment on the report, and Reuters was quick to contradict it, citing its own anonymous sources. But what gives weight to the scuttlebutt is the fact that the Journal is far from the first to suggest a potential tie-up between Verizon and a cable company.

Back in November 2016, UBS analyst John Hodulik laid out a range of M&A possibilities, suggesting that either Comcast Corp. or Charter might merge with Verizon. "We have long believed that secular changes in technology and usage would lead to the convergence of the cable and wireless industries," Hodulik said.

More recently, the New York Post cited two sources as saying Verizon could consider buying a cable company in a bid to increase the "demand for its wireless data products."

In an interview, independent tech analyst Jeff Kagan said Verizon must find a way to compete in a world where wireless and video have converged, and the company must do it relatively quickly.

"Over the past several years, we've seen players on all different sides — telephone and wireless and cable television and some others — start to get into each other's business and offer each other's services. In this new competitive world, that's what customers are looking for," Kagan said.

Alex Besen, founder and CEO of the consultancy The Besen Group, agreed. "They need to become a converged communications company offering all the different type of bundled services," he said in an interview.

While both analysts believe AT&T Inc. has responded to this challenge through its purchase of DIRECTV and its proposed acquisition of Time Warner Inc., Kagan said Verizon has not made the same kind of bold moves.

"The moves that AT&T is making seem to be forward-moving; they seem to be what investors want. The moves that Verizon is making don't. They are acquiring has-beens," he said, pointing to Verizon's purchase of AOL and its pending deal for Yahoo! Inc.'s operating business.

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Besen is a bit more positive on AOL and Yahoo, noting that both companies give Verizon content and reach. But Besen also believes Verizon needs something bigger at this point, as AOL and Yahoo lack physical assets like fiber and the customer service capabilities to bundle everything together.

"Maybe [Verizon] can get some content from AOL and Yahoo but bundling the video service is also crucial to compete with AT&T," Besen said.

Kagan said that a deal for Charter or another major cable operator could serve as a shot in the arm, helping the company to innovate and putting it back on a growth trajectory.

"They have to transform if they are going to remain successful, if they are going to remain a player going forward," he said.

Still, Kagan also noted that the cable industry has faced its own hurdles with declining subscribers, so any combination would not be an immediate panacea.

For his part, Recon Analytics analyst Roger Entner said he would view a purchase of a cable operator by Verizon as an admission of defeat.

"If they are going after Charter, then it's basically an admission that their digital strategy is not working as well as they had hoped," Entner said, noting that Google Inc. and Facebook Inc. continue to account for not only the lion's share of digital advertising revenue but also all of the growth in that space.

"That indicates to me that Verizon is not making tremendous inroads here," he said.

While the cable business is "decidedly less sexy" than the new media space, according to Entner, it is also more dependable.

"Yes, there is trouble with being a cable provider and viewers moving over the top. But at least you are going to profit from having a fiber pipe in the home," he said, noting that a cable operator's fixed high-speed data connections would offer Verizon "a reliable annual increase in revenue and profitability."

Unlike Besen and Kagan, Entner does not necessarily believes Verizon needs to buy a cable company to stay competitive, however.

"Verizon could do a DIRECTV Now if they wanted to. They wouldn't need to buy Charter for that," he said, referencing the over-the-top offering AT&T and DIRECTV launched in late 2016. While negotiating distribution rights with myriad programmers would be expensive and time-consuming, so would a major M&A transaction.

Still, if Verizon wants a nationwide video service, Entner noted, "It would be much more logical to buy DISH Network Corp. than to buy Charter" — perhaps adding further grist for the Verizon rumor mill.