In the upcoming U.S. election, some are speculating that Democrats might be able to both win the presidency and take control of the Senate--a so-called blue sweep. Such a scenario could provide a rare opportunity for Democratic policies to become enacted. We believe the biggest risk is the potential for price regulation of cable providers, while the potential for increased funding for broadband provides some opportunities for operators to benefit. Below we answer some specific questions about how a blue sweep could affect the sector.
These include questions around:
- Pricing regulation and net neutrality.
- Broadband availability and affordability.
- Impacts of tax reform.
- Antitrust/U.S. Department of Justice (DOJ) impact on the merger and acquisition (M&A) environment.
Frequently Asked Questions
Could cable operators be subject to price regulation?
We believe the increased importance of high-speed internet coupled with rising broadband prices means cable operators could come under increased regulatory scrutiny. The implementation and enforcement of government-mandated price caps represent the biggest threat to the industry long term, although price regulation is unlikely over the next two years, in our view.
Historically, the threat of pricing regulation has been tied to net neutrality--concepts of no blocking, no throttling, and no paid prioritization of internet traffic. Net neutrality was enforced via classifying cable operators as common carriers under Title II of the 1996 Communications Act, which provides the Federal Communications Commission (FCC) with the potential to regulate pricing. Currently, cable operators are classified as information services under Title I, subjecting them to less regulation, and does not prohibit net neutrality principles.
Under a Democratic administration, we believe net neutrality will emerge again as a top priority, but how it is addressed will be critical. We see two paths:
- Congress enacts a law enforcing net neutrality, likely only possible under a Democrat-controlled House of Representatives and Senate. Lawmakers could go further and introduce a framework for pricing oversight and regulation. This would be the more permanent solution to the ongoing controversy, as it makes a challenge difficult on constitutional grounds. However, it is unclear how high this ranks on Congressional priorities.
- The FCC reverts to Title II. If Congress cannot pass legislation around net neutrality, we believe this is inevitable. However, this path is less of a threat to cable operators given it will be time-consuming to draft an order, it will likely be appealed, and a future administration can flip back to Title I.
We believe under either scenario, price regulation is unlikely to be enforced over the next two years because penetration rates do not yet support monopolistic market conditions in rural markets. Cable operators compete primarily with incumbent phone companies that typically offer discounted prices for inferior speeds. For many customers, competing copper-based digital subscriber lines (DSL) might still serve their data needs, but maximum speeds are typically limited to below 100 megabits per second (Mbps).
However, we believe these cable operators may be subject to price regulation if high-speed cable internet becomes the only viable option for most consumers given exponentially rising data usage. This is becoming evident as cable broadband subscribers have increased nearly 25% since 2016, in large part due to market share gains from DSL. As a result, industrywide incumbent cable market penetration has risen to about 50% (from 43% just four years ago), and we expect this trend to continue.
The case for price caps is strengthened by high barriers to entry in less densely populated markets, considering substantial capital requirements. This creates the potential for price gouging with increased penetration. Average revenue per user (ARPU) has risen 28% industrywide since 2016, in large part due to consumers opting for faster, more expensive speed tiers (that DSL cannot offer) as opposed to cable operators raising prices. Therefore, we believe this supports the thesis that competing DSL service is becoming less viable.
Conversely, in more densely populated competitive urban markets, we believe the threat of pricing regulation is lower as market forces can help keep prices down. In these markets, typically there are either cable over-builders or incumbent phone providers with fiber-to-the-home infrastructure (about 25% of the U.S.) that offers competitive speeds. In fact, Altice USA Inc. management recently pointed out that high-speed-data ARPU is 15% lower in its more urban Optimum footprint (which has 50% overlap with Verizon Fios) than its more rural Suddenlink footprint despite Optimum customers having higher average income and higher average data usage.
Will broadband availability and affordability be addressed by Congress?
We believe affordability will come into greater focus under a Democratic administration, which provides opportunities for cable providers as well as manageable risks. While closing the digital divide is an area of bipartisan agreement, there is a variety of ways to do so. These often pit broadband availability against affordability for government funding.
We believe the Moving Forward Act (MFA), passed by the Democrat-controlled House in July 2020, provides some insights into key broadband priorities that could gain more traction in a new administration, particularly if Democrats take control of the Senate. This massive $1.5 trillion infrastructure bill includes:
- Delivering affordable high-speed broadband to all parts of the country by investing $100 billion to promote competition for broadband infrastructure to underserved rural, suburban, and urban markets, prioritizing communities in persistent poverty.
- Closing other gaps in broadband adoption and digital skills, and enhancing payment support for low-income households and the recently unemployed.
Most broadband money in the MFA would be allocated toward improving broadband availability in unserved markets or underserved markets where internet service providers offer speeds of less than 100 Mbps. This could be an opportunity for cable and telecom providers to apply for grants to expand service into markets that cannot justify an adequate stand-alone return. Conversely, this could present a threat to local phone companies in underserved copper-based markets.
In certain cases, money could be allocated to overbuild mid-tier service (less than 1 gigabit per second, Gbps). More specifically, 25% of total broadband availability funds would be allocated to states, prorated on population size. If no area within a state has less than 100 Mbps, then funds could be directed to increase competition in markets where the incumbent provider offers service at speeds below 1 Gbps. We view this as a manageable risk to incumbent cable operators because funding priority is given to unserved and underserved areas, and most rated cable operators have upgraded their networks to allow for 1 Gbps speeds across most of their footprints.
Separately, Democrats will likely aim to enhance low-income subsidies to make broadband more affordable, which we would view as a positive for cable operators. More specifically, the MFA would create a $9 billion Broadband Connectivity Fund separate from the Lifeline program (which allows for low-income mobile wireless or in-home broadband subsidies, but not both).
Finally, the government could mandate cable operators offer a basic speed tier option at a low price, which we would view as largely neutral to cable providers:
- On the positive side, it could broaden the addressable market by encouraging consumers to sign up for service they otherwise wouldn't have due to cost constraints. Over time, these customers could move to faster, more expensive speed tiers. Early indications from operators including Charter Communications Inc. show an acceleration in broadband revenue from the government-mandated free 60-day internet trial as most consumers have opted to stay on as paying customers. However, it is unclear whether this trend can be sustained without the government relief to consumers from the second quarter of 2020, particularly considering these customers tend to have weaker credit scores.
- Conversely, it could dilute the reputations of cable operators, which typically compete on speed and reliability, if they are forced to offer lower-quality service that management teams have otherwise opted to strategically avoid.
Will a corporate tax rate change affect issuers' credit profiles?
We expect the Biden proposal to raise the corporate tax rate to 28% from 21% would have mixed consequences on S&P Global Ratings-adjusted ratios. We don't foresee rating changes solely on this, as companies' tax-planning efforts and financial policy changes would likely offset reductions in cash flow.
We envision a few moderate impacts on our credit metrics, including:
- Increased net debt metrics because of reduced accessible cash given higher cash outflows related to higher taxes.
- Decreased adjusted debt from lower post-retirement adjustments due to our tax-effecting those obligations at the higher corporate rate.
- Funds from operations--EBITDA minus cash interest minus cash taxes paid--hurt by more cash taxes paid.
That said, the impact of a higher corporate tax rate will likely be minimal on credit measures for telecom and cable issuers at the lower end of the rating scale or for companies that made acquisitions with significant net operating losses. For large investment-grade issuers, we would not expect a meaningful impact on adjusted leverage as lower free cash flow would mostly be offset by lower tax-adjusted unfunded pension obligation. For example, excluding the impact of spectrum purchases in the upcoming C band auction on credit metrics, we would expect leverage for both AT&T Inc. and Verizon Communications Inc. to be roughly the same in 2021 under a higher tax rate as our base-case forecast. However, we also expect free operating cash flow for both companies would be about $1 billion-$2 billion lower in 2021.
The timing of any change to tax law is uncertain, even with Democratic control of Congress. Given the stress brought on by the COVID-19 pandemic, economic recovery may prove a greater priority than corporate tax reform. Some Senate Democrats have pushed back against the immediacy of stand-alone tax legislation, citing priority of fiscal stimulus and pandemic relief bills.
Will M&A be more difficult under a Democratic administration?
In general, the DOJ will likely be more enforcement-oriented. Still, we believe most cable M&A deals would be approved outside of a Comcast Corp.-Charter merger, which could face objections given such high broadband concentration.
The current DOJ reportedly still objects to a merger between Dish Network Corp. and DirecTV given the lack of high-speed internet options in rural markets. We would not expect that position to change under a new administration. If broadband availability improves in rural markets, we believe a merger is possible, although this would likely hurt the business case for both operators. They rely heavily on a lack of ability for rural customers to stream competing video services.
- U.S. Corporate Tax Policy Post-Election Won’t Likely Affect Ratings, Regardless Of Election Results, Oct. 19, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Chris Mooney, CFA, New York (1) 212-438-4240;|
|Secondary Contact:||Allyn Arden, CFA, New York (1) 212-438-7832;|
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