- Bidding in the C-Band auction has already surpassed our estimates by a substantial margin, and we expect the auction will have a significant effect on balance sheets for U.S. wireless operators.
- U.S. telecommunications and cable proved to be resilient during the recession due to the increased necessity of mobile and broadband services.
- The traditional live TV bundle will continue to unravel as more consumers opt for less expensive over-the-top (OTT) video platforms, though satellite operators are more vulnerable than cable providers because they do not provide a true broadband product.
- We have a favorable outlook for U.S. cable because of continued healthy growth rates for high-margin broadband services, despite the loss of linear video customers.
- Secular and competitive pressures, along with higher levels of capital spending, could hurt credit quality for U.S. wireless and wireline providers.
Despite the COVID-19 pandemic and recession, financial results for the U.S. telecom and cable industry held up well in 2020 because of the utility-like nature of their products and services. Even with ongoing cord-cutting, cable operators performed well because of increasing dependence on high-margin broadband connections that became even more vital during the pandemic. Similarly, the recession did not substantially affect wireless results because mobile service has become essential to both consumers and businesses. While store closures reduced foot traffic and pressured handset revenue, this trend had little effect on profitability because device sales carry no margin to the carriers. We originally expected more of an impact from COVID-19 on wireline companies, though results fared better because of rising bandwidth demand as business customers were forced to improve their remote networking capabilities while small and midsize business (SMB) customers benefited from government stimulus payments, which enabled them to continue paying their telecom bills.
Against this backdrop, there are several risks for the U.S. telecom operators (telcos) as we head into 2021.
- C-Band auction: Excessive spending in the 3.7-4.2 gigahertz (GHz; C-Band) spectrum auction, which has already exceeded analysts' estimates.
- Capital expenditure (capex): Higher levels of capex will likely result in lower levels of free operating cash flow (FOCF) and higher leverage for U.S. wireless carriers.
- 5G network deployments: Wireless operators will try to differentiate their 5G networks with aggressive promotions, which could result in higher carrier churn and margin compression.
- Competition from cable and Dish Network Corp. and mature market conditions: New entrants and mature wireless industry conditions could constrain top-line and customer growth.
- Secular industry declines: For U.S. wireline issuers, secular industry pressures and competition from cable will affect top-line performance while higher capex for fiber deployments will likely result in lower free cash flow generation and rising leverage over the next year.
- A prolonged recession: U.S. wireline companies could be hurt if a recovery does not materialize in 2021, especially among SMB and larger enterprise customers.
Conversely, we believe growth from broadband revenue in U.S. cable will outpace video subscriber declines and expected pressure on SMB customers. Greater contributions from broadband and lower revenue from video should also enable modest margin expansion for the cable providers, though wireless startup costs associated with expanded retail presence and low-margin mobile virtual network operator (MVNO) agreements will likely constrain significant improvement. We also have a favorable outlook for the telecom infrastructure segment, which comprises data center, fiber, and tower operators. These issuers should benefit from increasing demand for data and video consumption from residential, mobile, and business customers. That said, execution missteps from mergers and acquisitions (M&A) and providers with significant exposure to SMB customers could result in deteriorating credit metrics and lower ratings.
U.S. Economic Outlook: U.S. Telecom And Cable Issuers Have Been Largely Recession Resistant
For our telecom and cable ratings, we focus on economic indicators that we believe most correlate with consumer demand, including real GDP, unemployment, personal consumption expenditures, and housing starts (table 1).
|Key Economic Indicators For The U.S. Telecommunications And Cable Industries|
|Real GDP growth (%)||2.9||2.2||(3.9)||4.2||2.4||2.6|
|CPI inflation (%)||2.1||2.2||1.6||1.9||1.9||1.9|
|Unemployment rate (%)||3.9||3.7||8.4||6.7||5.7||4.7|
|Real consumer spending (%)||3.0||2.4||(4.4)||4.9||3.1||2.9|
|Housing starts (mil.)||1.2||1.3||1.3||1.3||1.4||1.4|
|a-Actual. e--Estimate. CPI--Consumer Price Index.|
Under our baseline assumption, S&P Global Ratings economists expect a slow recovery, with a 25%-30% risk of a recession starting in the U.S. over the next 12 months. We expect real GDP to decline 3.9% in 2020 and grow a modest 4.2% in 2021.
As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
The U.S. telecom and cable sector has demonstrated its resilience in the face of weak economic conditions in 2020. Broadband and wireless services are embedded in everyday life, and the adoption of in-home broadband has accelerated during the pandemic. However, business customers could look to reduce their information technology (IT) spending by shifting to cloud-based networking technologies, which carry lower price points. Similarly, SMB customers benefited from government stimulus payments in 2020, with another round of $325 billion in forgivable loan relief earmarked for 2021, though tightening restrictions related to COVID-19 and/or a weaker economic recovery could force many of these customers to scale back operations or go out of business altogether. That said, the Federal Reserve's push to lower interest rates has enabled many of these issuers to refinance or extend debt maturities and fund M&A and capital spending projects.
U.S. Telecom And Cable Ratings Trends Are Negative
Rating trends among U.S. telecom and cable companies were largely negative in 2020. We downgraded 20 and only upgraded eight. This ratio, however, was much better than that of most other corporate sectors. Further, it was comparable with those from 2018 and 2019, which were challenging years for the industry. Downgrades were largely concentrated at the lower end of the rating scale. We lowered multiple ratings to the 'CCC' category from 'B-', primarily issuers that were already highly leveraged and depended on solid business conditions to meet their debt obligations. About 20% of rated issuers either have a negative outlook or are on CreditWatch negative, compared with 30% at year-end 2019. About 88% of U.S. telecom and cable issuers are speculative-grade, including two-thirds in the 'B' and 'CCC'/'CC' categories. Ratings in these categories largely reflect secular industry declines, intense competition, debt-financed M&A, and, in some cases, refinancing risk.
In 2021, we expect rating trends among U.S. cable providers to be relatively stable as broadband growth offsets the loss of lower-margin video customers. Conversely, we expect some rating pressure in other subsectors, stemming from secular industry declines, intense competition, mature industry conditions, tepid growth, and rising investment in network infrastructure among wireless, data center, and fiber providers, which could trigger further downgrades. That said, a long period of low interest rates and healthy capital markets could enable even low-rated issuers to refinance upcoming debt maturities.
Key Themes For 2021
C-Band auction could result in higher leverage for the wireless carriers and Dish. Bidding for spectrum in the C-Band auction has already blown past our previous high-end estimate, with $80.5 billion of gross Federal Communications Commission (FCC) payments and about $94.5 billion--including relocation and clearing payments--to the satellite operators, as of the most recent round of bidding. Our original forecast had assumed total proceeds would be anywhere from $21.5 billion to $39 billion based on a valuation of $0.25 to $0.45 per megahertz (MHz) per person (POP).
With 280 MHz of contiguous spectrum, we believe that demand has been exceptionally strong because the C-Band is the largest swath of contiguous mid-band spectrum to come to market. We view mid-band spectrum as crucial for 5G wireless network deployments because it offers good throughput for transmitting mobile data and video. Additionally, advances in antenna technology will likely improve coverage.
The C-Band auction could have important credit implications for the wireless carriers and Dish, based on demand we have seen in the auction. We expect Verizon Communications Inc. to be the big winner in the auction, given its limited portfolio of mid-band spectrum and its push over the past couple years to reduce leverage in order to give itself greater financial capacity to acquire new licenses. An upgrade for Verizon (BBB+/Positive/A-2) mainly depends on how much it spends and our forward-view of operating performance. We believe Verizon has capacity of about $10 billion-$15 billion for spectrum purchases while still maintaining leverage at about 2.5x in 2021 and 2022 because of its strong FOCF generation and modest EBITDA growth. That said, given the current state of bidding, we believe Verizon could spend a lot more in the auction, though we have no knowledge on its level of bidding to date. This could lead to weaker credit metrics over the next couple years and leverage that might not support an upgrade. For example, assuming Verizon spent $35 billion in the auction, we forecast that adjusted debt to EBITDA would increase to 3x, which is substantially above our threshold for a higher rating. While the purchase of spectrum licenses is positive for Verizon's competitive position, returns are uncertain and likely several years out. Additionally, the company would be increasing leverage at a time of rising competitive intensity related to 5G upgrade cycles, which could hinder the pace of debt reduction over the next few years.
Although T-Mobile US Inc. has a strong mid-band spectrum position from its acquisition of Sprint, we expect it to participate in the auction so that it can maintain its mid-band competitive advantage relative to AT&T Inc. and Verizon. At the same time, we believe it also has capacity at the 'BB' rating to spend at least $10 billion-$15 billion in the auction. We currently expect its leverage to be about 4.4x in 2020 and decline to 4.2x in 2021. But, if the company spent $10 billion-$15 billion at the auction, we forecast leverage would rise to the high-4x area in 2021, which is still below our 5x downgrade threshold. Furthermore, as synergies increase and integration expense winds down over the next few years, we believe T-Mobile has good prospects to reduce leverage and improve FOCF generation.
In our view, AT&T has put itself in a difficult position. Given the company's aggressive acquisition strategy over the past five years and weak performance from some of its acquired assets, which has contributed to higher leverage and a heavy debt burden, we believe AT&T has less financial flexibility at the 'BBB' rating to acquire spectrum for its 5G network build. While AT&T is trying to shed some noncore assets to bolster its liquidity for the auction, we do not believe there are many attractive monetization opportunities, and there are few that would enable substantial leverage improvement.
For 2020, we expect AT&T's adjusted debt to EBITDA to be about 3.6x. Assuming flat EBITDA for 2021 and no asset sales and using a hypothetical plug of $20 billion in spectrum purchases and other incremental investments, we estimate adjusted leverage could exceed 3.75x, our threshold for a lower rating, but the company would have good prospects for leverage improvement over the longer term, assuming it allocates free cash flow to debt repayment. However, because several of AT&T's business lines are exposed to secular or macroeconomic pressures, the company's 2021 EBITDA trajectory is uncertain, and that will follow an estimated 7%-9% decline in 2020. Specifically, revenue from AT&T's video business is expected to fall more than 10% in 2020, which will contribute to sharp EBITDA declines in the entertainment segment.
At the same time, results at subsidiary Warner Media LLC have been weak because of the pandemic and recession. Improvement in 2021 will depend on a recovery in advertising revenue and the company's ability to monetize the Warner Bros. movie slate through its hybrid distribution model as it releases these movies concurrently in theaters and on HBO Max because of the pandemic. AT&T is also investing in programming for HBO Max, which will be dilutive to EBITDA over the next few years. Much of Warner Media's success will depend on driving customers to HBO Max and keeping churn low, both of which are uncertain. As a result, maintaining stable EBITDA this year will depend on growth in its wireless business, which is the largest contributor to revenue and cash flow. If AT&T is not successful, weakness in its other business segments could contribute to another sharp EBITDA decline in 2021, resulting in leverage exceeding our estimates and less flexibility to invest in spectrum and other growth areas.
We estimate that Dish has capacity for about $5 billion in debt-financed spectrum purchases before breaching our 6.5x debt-to-EBITDA downgrade trigger in 2021, under our base-case operating assumptions. However, our rating on Dish depends on several other factors, including but not limited to the cadence of wireless network capex, size of 5G wireless startup losses, size of tower lease adjustments to debt, its pay-TV EBITDA trends, future spectrum purchases (potential AWS-3 reauction and 800 MHz from T-Mobile), and emergence of financial or strategic partnerships. We arrive at our estimated debt capacity in the 'B' rating based on the following base-case assumptions (which are all highly uncertain and could change and alter the cushion in the existing rating):
- Pay-TV EBITDA declines of 10%-15% in 2021;
- Wireless startup losses of $200 million-$300 million in 2021; and
- Wireless capital spending of about $1.5 billion in 2021.
Given the high level of bidding so far, we believe it's possible that cable companies could also be active in the auction. Comcast Corp. and Charter Communications Inc. are bidding together through a joint venture to maximize efficiency given their regional nature, as both may have operations in specific license areas. Our base-case forecast includes $2 billion-$4 billion in cable spending as a way to offload traffic on network in densely populated areas and improve economics of current wholesale agreements with wireless carriers. However, Charter has financial flexibility to spend significantly more by pulling back on share repurchases in 2021. We have assumed $12 billion in share repurchases in our model that would still keep leverage below 4.5x. For Comcast, we expect that as long as both NBCU and Sky recover after the pandemic, leverage will decline to 2.7x in 2021. Under these assumptions, Comcast could spend as much as $15 billion in the auction and still keep leverage around our downside trigger of 3x in 2021.
|U.S. Spectrum License Auctions|
|Valuation||Estimated gross proceeds (mil. $)|
|Timeline||Spectrum band||MHz||Low||High||Low||High||Actual proceeds (mil. $)|
|Nov. 14, 2018||28 GHz||850||0.005||0.03||315||1,887||703|
|April 17, 2019||24 GHz||700||0.005||0.03||1,092||6,522||1,989|
|Feb. 6, 2020||37, 39, 47 GHz||3400||0.006||0.01||6,365||10,880||7,562|
|July 2020||3.5 GHz (CBRS)||70||0.1||0.3||2,205||6,825||4,586|
|December 2020||3.7-4.2 GHz (C-Band)||280||0.25||0.45||21,490||38,682|
|MHz--Megahertz. GHz--Gigahertz. CBRS--Citizens Broadband Radio Service.|
A slower vaccine rollout and prolonged economic weakness could delay recovery. While U.S. telecom and cable has performed reasonably well during the pandemic, an extended economic downturn in 2021 could have a greater effect on operating and financial results. In wireless, mobile devices have become a necessity for most people, and consumers are very unlikely to cut wireless services. That said, if the economic recovery is delayed, much of the postpaid subscriber and service revenue growth over the past couple years could reverse. For example, consumers could look to save money by moving to lower-margin prepaid plans or less-expensive postpaid plans. At the same time, business customers could reduce headcount to preserve margins, which could hurt subscriber trends because a large portion of postpaid customer growth has come from the proliferation of second handsets as companies distribute smartphones and tablets to their employees for work. A partial mitigating factor is the potential for a more permanent work-from-home environment where mobile devices become more critical and increase demand for wireless data.
We would expect more of an effect on wireline companies with exposure to business customers. While revenue from SMB customers has held up well since March 2020--when the pandemic became prevalent in the U.S.--because of government stimulus, contributions from this segment could come under pressure in 2021 from a prolonged economic downturn as SMB customers scale back operations or go out of business altogether. At the same time, larger enterprise customers could cut IT spending or shift to less-expensive cloud-based networking technologies.
Cable operators are capitalizing on demand for faster, more reliable internet service. While the rate of broadband subscriber growth may decelerate in 2021, long-term industry trends favor cable and expect high-speed data (HSD) penetration to rise. Even in a recessionary environment, we believe churn is unlikely to accelerate because the internet is one of the last services consumers will drop. Therefore, we are projecting mid-single-digit percent EBITDA growth in 2021, despite the potential for SMB revenue declines in a second wave of business closures.
5G wireless deployment strategies take shape but with limited benefit in 2021. U.S. wireless carriers are deploying 5G networks across the country, but most of the buildout consists of a small allocation of low-band spectrum. T-Mobile is using its 600 MHz spectrum and now covers about 270 million POPs with 5G service, while AT&T is using its 850 MHz spectrum and covers about 205 million POPs.
That said, spectrum deployment strategies differ, which affects user experience and download speeds. For example, while T-Mobile has greater 5G coverage, its use of low-band spectrum diminishes performance, in our view. However, the company plans to use its vast holdings of 2.5 GHz spectrum along some millimeter wave (mmWave) spectrum to create what it calls a "layer cake" that we expect will enhance coverage and speed. The company expects to cover 200 million POPs with mid-band 5G by 2021. Verizon, in contrast, is using its vast amount of mmWave spectrum to provide superior speeds in denser urban markets. However, mmWave spectrum lacks good coverage, thereby limiting Verizon's deployment of its "wide-band" 5G service to urban centers. Therefore, the company is using dynamic spectrum sharing technology for coverage to more than 230 million POPs in the U.S., though data speeds are substantially slower, which underscores its interest in the C-band auction.
U.S. wireless carriers have not provided any 5G subscriber numbers, and it seems that device penetration has been low. However, this will likely change following the launch of four new iPhone 12s from Apple. The carriers do not plan to charge more for 5G, but they are trying to upsell customers to higher-tiered data plans.
Overall, we believe cash outlays for 5G will likely be substantial, including the acquisition of spectrum licenses in mid-band auctions, including the C-Band auction, and higher capital spending to build out these networks, including fiber builds and small cell densification.
At the same time, we believe returns on these investments will be slow to materialize. We question consumers' propensity to spend more for faster data speeds on their devices. And, most of the Internet-of-Things and enterprise opportunities are likely several years away. While 5G fixed wireless offers some potential to monetize investments at an early stage, the technology is still unproven, and it will be difficult to take share from cable broadband, which can already provide 1 gigabit per second (Gbps) service to its customers.
5G Fixed Wireless Risk To Cable Is Manageable
We believe that 5G fixed wireless is a manageable risk to cable because significant uncertainty exists around the ability for wireless carriers to demonstrate technology at scale, whether signals will be fast and reliable enough for most consumers, whether a wireless network can handle in-home broadband traffic loads, and a growing in-home broadband market that can largely offset potential market share losses to wireless providers. Still, at the margin, competition from 5G fixed wireless could put some pressure on cable earnings over the next three to four years if wireless carriers successfully execute communicated strategies, which vary by operator:
- T-Mobile has committed to build at least 50% of the U.S. population by 2025, with a goal of capturing 10 million in-home broadband customers. It will use mostly low- and mid-band spectrum with speeds of at least 100 megabits per second (Mbps).
- Verizon plans to capture 6 million-9 million customers over the next five to eight years using mmWave spectrum, passing 30 million homes with speeds of up to 1 Gbps. This strategy could be modified depending on the amount of C-band spectrum it purchases in the auction.
- AT&T has not quantified its plans, but management views fixed wireless as a potential replacement for cable.
We do not believe the number of cable broadband subscribers will be lower five years from now than it is today, but 5G fixed wireless could slow the pace of growth. Assuming wireless companies achieve their subscriber targets, 5G fixed wireless customers would account for about 20 million-25 million homes (about 20% of current U.S. homes). We believe many of these potential 5G fixed wireless customers may reside outside the cable ecosystem today. For starters, in-home broadband penetration in the U.S. stands at only about 83%, which we expect to gradually eclipse at least 90% over time, likely adding at least 8 million–12 million in-home broadband customers to the market. Furthermore, new home formation of 1%-2% per year could add another 6 million–12 million broadband homes by 2025. Finally, speed and reliability challenges may limit wireless market share gains to lower-value cable customers or customers who currently have slower copper-based service provided by incumbent wireline phone companies, which total about 15 million-20 million customers.
We believe the largest risk from 5G fixed wireless could be in the form of limiting cable margin expansion, through pricing pressure. Cable will have a speed and reliability advantage over new competition, but the potential exists for wireless pricing discounts, given the cheaper last-mile deployment costs, particularly if wireless operators view 5G fixed wireless as a way to subsidize necessary investments to support 5G mobile. More competition could make it more difficult for cable to monetize increasing data usage, especially if there is a cheaper option available with service speeds that are good enough for many consumers.
However, there is still uncertainty regarding the ability for wireless operators to demonstrate this technology at scale. Verizon could have trouble covering 30 million homes using mmWave spectrum, given its propagation challenges and potential interference issues. T-Mobile's speeds of at least 100 Mbps may not be as competitive in five years. It is also unclear whether a wireless network can handle the traffic generated in the home, which is above 600 gigabytes (GB) per month for the average nonvideo customer according to Charter, and that figure is rising rapidly (at a normalized rate of about 20% per year). Initial plans for 5G mobile users are throttled at a fraction of this amount, including 50 GB for Verizon's and T-Mobile's top-tier plan and 100 GB for AT&T's top-tier plan.
Telco Capital Spending Is Poised To Soar
We expect U.S. telco capex to increase about 6%-9% in 2021 as new mid-band spectrum is made available and companies upgrade their networks to accommodate the growing demand for mobile data and video. We base our forecast on the following factors:
- The FCC completed several spectrum auctions for mmWave licenses, which the carriers will begin to deploy. High-band spectrum requires a significant amount of cell site density, which will result in higher capex.
- The buildout of mid-band spectrum, including spectrum from the Citizens Broadband Radio Service (CBRS) and C-Band auctions, though capex for the latter will likely be more heavily weighted after 2021.
- Deployment of fiber for wireless backhaul and broadband connections. Several telecom providers, including AT&T, Frontier Communications Corp., Windstream Holdings Inc., and Consolidated Communications Holdings Inc. plan to upgrade their networks with fiber to the home (FTTH) for broadband service.
- T-Mobile will build out the 2.5 GHz spectrum band it acquired from Sprint and the 600 MHz band it purchased in the broadcast incentive auction.
Exits from bankruptcies and new transactions provide a new lease on life for wireline companies. Secular industry declines, aggressive competition from cable, and missteps from acquisitions/transactions pushed two U.S. wireline companies into bankruptcy while credit quality deteriorated for the sector overall over the past several years.
After a year and a half of court proceedings, Windstream finally exited Chapter 11 bankruptcy in September 2020. Frontier is on target to exit bankruptcy in April 2021. Although it benefits from larger scale, CenturyLink Inc. (doing business as Lumen Technologies) cut its dividend in February 2019 and used its excess cash flow to reduce debt and invest in its network. It also revised its leverage target to 2.75x-3.25x from 3x-4x. While the company made inroads in its debt reduction plan in 2019, top-line pressures and lower EBITDA have delayed its leverage reduction plans. Debt to EBITDA was about 3.6x on a reported basis as of Sept. 30, 2020, down only slightly from 3.7x at year-end 2019. Facing large debt maturities, Consolidated Communications also cut its dividend in April 2019 and allocated its excess cash flow to debt reduction to put itself in position to refinance its capital structure in September 2020. As part of the refinancing, it secured an equity investment from Searchlight Capital that enabled it to reduce debt to fund its FTTH buildout. Cincinnati Bell Inc.'s pending buyout by Macquarie Infrastructure and Real Asset will also consist of a large equity investment that will enable it to reduce its debt on a reported basis, though these investments come in the form of preferred stock, which we treat as debt, and therefore, our adjusted leverage is essentially unchanged.
These transactions are giving wireline companies a new lease on life as they look to ramp up their investment in fiber to better compete with the incumbent cable providers. Both Frontier and Windstream had highly leveraged balance sheets, and their exits from bankruptcy substantially reduce their debt burden. Equity investments from sponsors in Consolidated Communications and Cincinnati Bell demonstrate the longer-term value of fiber as the best conduit for transmitting data. That said, their residential business is still declining because their legacy copper-based broadband service is losing share to the incumbent cable providers. Similarly, their share of SMB customers has eroded as cable become the dominant provider in this market.
Ultimately, the only way for U.S. wireline operators to effectively compete is to invest in fiber, though these investments push up capital intensity, resulting in negative FOCF and higher leverage in the near term. The goal is to reach a penetration level with fiber that stabilizes the top line and EBITDA, though achieving coverage with fiber can take several years. Conversely, if wireline telcos don't invest in their networks, they can generate healthy levels of FOCF in the near term, but they will continue to lose share, resulting in sharp revenue and EBITDA declines that could ultimately render their capital structures unsustainable.
Cord-Cutting Will Persist As OTT Options Proliferate
The trend of consumer defections we have witnessed in recent years has been driven largely by rising programming costs, primarily from networks that carry sports. These networks, such as ESPN, typically carry minimum penetration guarantees in contracts that limit distributors' abilities to create customized video packages for consumers. As a result, some non-sports fans have concluded that the traditional TV bundle is too expensive and left the ecosystem. In response, media companies have raised prices further to make up for lost affiliate revenue, which inevitably must be passed on to consumers. This has forced more non-sports fans to exit the bundle. We believe this trend will continue.
However, we believe the traditional live TV bundle will continue to unravel, as more direct-to-consumer (DTC) options become available. As the number of cord-cutters grows, programmers are being forced to compete for these customers. To do so, they are increasingly moving some of their best content to their DTC platforms. This redirection of content away from the traditional bundle not only improves the quality of the DTC substitutes, it simultaneously starves the traditional ecosystem of fresh content, making the traditional ecosystem less appealing, though the migration of content to DTC platforms could ultimately make these services more expensive.
We believe the combination of rising prices and lower-quality general entertainment content will result in an acceleration in cord-cutting for the next several years. This could prove particularly acute in a recessionary environment, leaving only sports enthusiasts and higher-income households as unlikely to defect.
We believe satellite providers are more vulnerable to rising programming cost trends than cable providers because they do not provide a true broadband product to deliver streaming video alternatives. Typically, the competing cable company will offer a bundled price discount if consumers opt to subscribe to both internet and video services. Furthermore, Comcastand Charter both have significant scale when negotiating with programmers, so satellite providers lack a significant cost advantage against these two providers that collectively cover about 80% of the U.S. Therefore, we believe it will be increasingly difficult for satellite providers to compete in scaled cable markets.
As the internet becomes more essential for Americans, cable providers continue to take share from slower digital subscriber line (DSL) internet providers. This trend is bad news for satellite TV providers because there are two primary reasons to switch to cable internet from DSL:
- Need for faster internet to stream apps that substitute for satellite TV.
- Need for faster data speeds for video conferencing, remote learning, online gaming, smartphone applications, etc. This transaction point could prompt satellite TV customers that previously had DSL to reevaluate their traditional video provider. In most cases, there are substantial savings from switching to cable TV. We saw evidence of this when Charter bucked the industry trend by growing TV subscribers in 2020, attributing most of it to market share gains from satellite.
Democratic Administration Presents Opportunities And Threats
We believe the increased importance of high-speed internet, coupled with rising broadband prices, means cable operators could come under increased regulatory scrutiny. While the implementation and enforcement of government-mandated price caps represent two of the biggest long-term threats to the industry, we view price regulation as unlikely over the next two years mainly because competition for broadband still exists even in rural cable markets, based on the FCC's definition of minimum speeds of 25 Mbps for downloads and 3 Mbps for uploads. If the FCC were to change these minimum thresholds, the case for rate regulation could be strengthened because competing copper-based internet services typically max out at 50-100 Mbps.
Under the new administration, net neutrality will emerge as a priority, but how it's addressed will be important. We see two paths:
- Congress enacts a law enforcing the tenants of no blocking, no throttling, and no paid prioritization of traffic. Lawmakers could go further and introduce a framework for pricing regulation and oversight. This would be the more permanent solution to the ongoing net neutrality controversy because it makes a challenge difficult on constitutional grounds. However, it is unclear how high this ranks on congressional priorities. We believe this is the less likely of the two paths.
- The FCC reverts internet service providers (ISPs) to the more heavily regulated common carrier designation under Title II of the Telecommunications Act of 1996. This provides the government with a means to enforce net neutrality concepts, but it also gives the FCC the authority to regulate price. If Congress does not pass net neutrality legislation, we believe this outcome is inevitable. However, this path is less of a threat to cable operators, given it will be time-consuming to draft an order, the decision will likely be appealed, and a future administration can flip back to Title I. Historically, when ISPs operated under Title II, the government did not regulate prices.
Separately, we believe broadband affordability and availability will come under greater focus under the new administration. This provides opportunities for cable operators, as well as manageable risks. Now that Democrats will control the Senate, there is greater likelihood for increased spending on infrastructure, including broadband. For example, the Moving Forward Act (MFA), passed by the Democrat-controlled House of Representatives in July 2020, provides some insights into key broadband priorities that could gain more traction under the new administration. This massive $1.5 trillion infrastructure proposal includes $100 billion to promote competition for broadband infrastructure to underserved rural, suburban, and urban markets--prioritizing communities in persistent poverty--though final passage of an infrastructure bill is uncertain and subject to negotiation.
Most broadband money in the MFA would be allocated toward improving broadband availability in unserved markets or underserved markets where ISPs 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 threaten local phone companies in underserved copper-based markets.
In certain cases, money could be allocated to overbuild mid-tier service (less than 1 Gbps). We view this as a manageable risk to incumbent cable operators because funding priority goes 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.
Democrats could also aim to enhance low-income subsidies to make broadband more affordable, which we would view as a positive for cable operators. 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.
Finally, we believe tax reform is more likely with Democratic Senate control. We expect President-elect Joe Biden's 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 because of this, given companies' tax-planning efforts and financial policy changes would likely offset reductions in cash flow.
We envision a few moderate effects on our adjusted U.S. telecom and cable 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 because of our tax-effecting those obligations at the higher corporate rate; and
- Funds from operations--EBITDA minus cash interest minus cash taxes paid--hurt by more cash taxes paid.
That said, the effect 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 and for companies that made acquisitions with significant net operating losses. For large investment-grade issuers, we would not expect a significant effect on adjusted leverage because lower free cash flow would mostly be offset by lower tax-adjusted unfunded pension obligations.
Despite the COVID-19 pandemic and recession, wireless results have held up well. We expect service revenue for the industry to be essentially flat to slightly down in 2020 and margins to be stable from 2019 levels. For 2021 and 2022, we expect service revenue growth to be about 2%-3% as economic conditions improve, though maturing industry conditions, 5G network deployments, and incremental competition from cable and Dish will likely constrain growth. At the same time, higher take rates of new 5G devices and competition should be largely offset by improved spectral efficiency from 5G technology and cost-reduction initiatives, resulting in very limited margin expansion over the next couple of years for AT&T and Verizon. Conversely, T-Mobile's EBITDA margin has historically lagged that of its peers given its smaller scale. However, projected synergies of $6 billion and its improved scale should drive significant margin expansion over the next couple years. Still, we believe T-Mobile's profitability will always lag those of its peers because the company leases fiber from third-party providers for wireless backhaul, whereas AT&T and Verizon own a larger portion of their fiber network.
Apple's recent launch of the iPhone 12, which is 5G enabled, has triggered aggressive promotional activity from the wireless operators. We expect this trend to continue in the near term as the carriers look to differentiate their 5G wireless networks, which could lead to higher churn and upgrade rates. We expect T-Mobile, following its acquisition of Sprint, to remain competitive on price over the next year, though potential integration challenges could derail its ability to take share, and its willingness to keep prices low longer-term is unclear.
|T-Mobile Rates Relative To Verizon (%)|
|Low tier||Middle tier||Top tier|
|Source: Company data.|
|T-Mobile Rates Relative To AT&T (%)|
|Low tier||Middle tier||Top tier|
|Source: Company data.|
Our industry outlook is further clouded by the sale of Sprint's prepaid business and spectrum to satellite TV operator Dish, which plans to use its own spectrum to build out a nationwide network. At the same time, incumbent cable providers Comcast, Charter, and Altice USA Inc. have launched their own wireless operations through MVNO agreements. Combined, these cable operators have accumulated about 4.8 million mobile lines since launching their service two years ago. While competition from cable could ramp up over the next couple years, the low-margin profile of MVNO agreements in a very scale-intensive industry suggests that the effect on wireless operators will be modest and that cable providers could struggle to gain traction in the marketplace.
The U.S. wireline industry faces secular and competitive headwinds as these companies look to reshape their asset mix. Revenue is declining because of aggressive competition from cable, which continues to take share in the residential and SMB markets. While investments in fiber should help wireline companies better compete with the cable operators, achieving top-line stability will take time, and in the near term, we expect that substantially lower levels of FOCF will result in higher leverage.
Despite greater demand for bandwidth because of the pandemic, revenue in the consumer segment declined in 2020 because of market share losses to cable, cord cutting, and voice access line losses. We expect overall consumer revenue to decline in the mid-single-digit percent area in 2021 as a result of these secular trends.
In the SMB market, much will depend on additional stimulus payments and vaccine distribution, which will enable the economy to open up more fully this year. Still, cable operators are taking SMB market share from the phone companies and expanding their capabilities through network upgrades. Therefore, we expect revenue declines in the SMB market to mirror performance in the residential segment, and we are projecting mid-single-digit percent revenue declines in 2021.
While cable is targeting larger business customers, we still believe wireline companies face less risk in the enterprise segment, and therefore, we expect low-single-digit percent revenue declines this year, assuming the economy improves. This category is less likely to churn than smaller business customers, and it isn't subject to significant competition from cable. Still, we believe new cloud-based technologies such as software-defined wide area networks (SD-WAN), which are used to connect enterprise networks, pose a threat to the industry because they are more flexible, open, and cheaper than traditional WAN technologies.
We have a favorable near-term view of the cable industry because of continued healthy growth rates in high-margin HSD revenue. Although it may be difficult to replicate the very strong residential HSD growth from 2020 because consumer demand for broadband accelerated during the pandemic, we expect profitable SMB revenue to return double-digit percent growth for many operators if the economy rebounds. In general, we expect high-single-digit percent HSD revenue growth for the next two to three years from a balanced mix of annual HSD subscriber growth and average revenue per user (ARPU) increases. Subscriber growth will come from deeper penetration of existing homes, population growth, and market share gains from weaker competitors that offer inferior data speeds over copper-based infrastructure (which still accounts for about 15%-20% of the market). Annual ARPU increases come from both modest price increases and customers migrating to more expensive, faster-speed tiers.
There has been a fundamental shift in the cable industry competitive dynamics over the past several years that the pandemic has accelerated. Americans increasingly rely on fast internet connections to watch TV online, conduct virtual business meetings, interact socially, and educate remotely. We believe the shift toward higher-speed broadband will persist beyond the pandemic, which accelerated inevitable trends toward cable broadband. We view this product mix shift toward high-speed internet connections--and away from pay-TV--favorably for the cable industry, considering that overall earnings and cash flow are rising at very healthy rates and the majority of EBITDA now comes from a very predictable source.
We also believe that rural cable operators could benefit the most from these shifting dynamics because they face less competition for high-speed internet and have historically been disadvantaged by video scale. This is now less important than in the past because speed and reliability of internet speed are increasingly becoming the most important competitive advantage. We believe we are approaching an inflection point for more rural providers that have historically lagged in penetration because of less-favorable consumer demographics. Small, rural cable providers often participate in lower-income markets, which has contributed to lower HSD penetration rates than commanded by larger diversified peers such as Comcast and Charter (which have operations in both urban and rural markets). We believe rural markets tend to lag in terms of high-speed internet adoption, in part because DSL and satellite video had been good enough to meet the connectivity needs for these consumers. Therefore, the trade-off for faster, more expensive internet may not have been that attractive to a demographic that skews older and has lower income and lower-than-average data requirements. As the pandemic has accelerated the structural shift to high broadband connectivity throughout the U.S., we believe that copper-based competitors offering 50–100 Mbps, may no longer be sufficient for many households in the future. Furthermore, as satellite TV becomes more expensive, the plethora of streaming TV alternatives could be a catalyst for rural consumers to switch to high-speed cable to save money on their TV bills.
Over the longer term, as national broadband penetration reaches maturity at more than 90% (compared with about 83% today), revenue growth will depend more on price increases. We believe this greater dependence on price leaves the industry more exposed to potential regulatory changes and 5G wireless competition.
Retail Data Centers: Data center operators represent a diverse group of companies whose value proposition, strategy, and outlooks vary significantly. Undoubtedly, long-term growth in data traffic will drive greater need for communications infrastructure housed in these facilities. However, shifting technology and the ever-increasing influence of cloud-based service providers will continue to distinguish between interconnected facilities that provide an attractive ecosystem, in our view, and various other business models that will find it more difficult to differentiate themselves. We believe operators with more exposure to customers in COVID-19-affected sectors that lack carrier diversity and rely more heavily on managed services could see continued churn, lower EBITDA, and potential downgrades in 2021.
Satellites: Our rated U.S. satellite providers include service providers of in-flight connectivity, satellite phone communications, and in-home broadband. We no longer rate wholesale provider Intelsat, which is in Chapter 11 bankruptcy. While a few of our niche, rated satellite players could continue to see ratings upside, our views on the competitive environment are becoming increasingly negative. Over the next few years, we anticipate a dramatic step up in available capacity to test demand strength and potentially increase pricing pressure. Furthermore, the increase in government subsidies supporting the development of rural high-speed internet will likely significantly reduce the addressable market (about 10 million-12 million homes) for satellite broadband providers over the next decade.
The industry could face oversupply from new very high-throughput satellites (VHTSs) and low-earth orbit (LEO) entrants. The VHTSs in development (Hughes and Viasat both expect to launch in late 2021 to early 2022) will drastically increase the amount of available bandwidth over the Americas. Although this will enable faster internet speeds and ease issuer-specific capacity constraints, there is the potential for price compression if the subscriber base doesn't grow.
There are also several LEO constellations in development that aim to target the global in-home broadband market. Among the five LEO constellations in development, SpaceX's Starlink is the furthest along and is the most immediate threat of the new LEO operators, having launched 600 small satellites since May 2019. Starlink might achieve scale in a more cost-effective manner than traditional LEO players, given its vertical integration with SpaceX's launch platform. Starlink announced a beta program through which it is selling receivers for $500 (likely heavily subsidized) with a $100-per-month subscription, which is competitive with Viasat and Hughes. If Starlink's beta test is successful, it could begin to slowly peel away retail customers from Viasat and Hughes.
Still, Starlink is a nascent business with several uncertainties. For starters, it's not yet clear how the business plans to develop the required ground-based architecture. Starlink's satellites appear to use bent-pipe architecture, which means the satellites can't communicate with one another. This will require a significant number of costly ground stations to distribute broadband globally, restricting the available high-speed, low-latency capacity to onshore uses (though SpaceX could develop and implement inter-satellite laser links in the future). The LEO business case is challenged by the inherent inefficiencies of stranded capacity over oceans because LEO satellites travel around the Earth (as opposed to Viasat's and Hughes' geosynchronous satellites, which operate from a fixed position). This also creates design challenges because the antennae to receive signals from moving targets are much more expensive today.
Towers: As T-Mobile's network investment picks up steam this year following a pause in 2020 because of its merger with Sprint, U.S. tower operators are mostly poised to see higher domestic leasing activity in 2021. We expect aggregate domestic tower leasing revenue growth of 5.5%-6.5% in 2021, up from about 5% in 2020. T-Mobile is accelerating its buildout of the 2.5 GHz spectrum band it acquired from Sprint to support its 5G expansion, facilitated in part by a new 15-year master lease agreement with American Tower Corp., which will speed up spectrum deployments on its sites. At the same time, we expect that consistent network spending from AT&T and Verizon will contribute to higher domestic revenue growth this year. Further, strong demand in the C-Band auction bodes well for additional network spending from the carriers, though initial deployments will likely occur late in 2021 and drive more substantial growth in 2022. Similarly, we expect that Dish's 5G network build, which will initially benefit Crown Castle International Corp.--the first tower operator to sign a master lease agreement with Dish--will contribute more substantially to revenue growth next year. Given that its towers are mostly located in more densely populated urban and suburban areas and it can provide fiber transport, Crown Castle was well-positioned to win business from Dish, considering the satellite TV operator's requirement to cover 70% of the population with 5G by mid-2023.
Notwithstanding the healthy demand environment in the U.S., churn from T-Mobile's decommissions of the acquired Sprint sites will be a near-term headwind. We expect a modest uptick in churn this year, though we anticipate that larger churn events will begin in 2022, when American Tower expects it will reach its peak for merger-related disconnects. American Tower has the least amount of leasing revenue exposure to T-Mobile at about 4% of total property revenue, which will run off over the next three to four years. Crown Castle derives about 5% of its total site leasing revenue from T-Mobile and has a large renewal in 2023 (average of five years remining on its contracts), though its agreement to lease up to 20,000 sites to Dish provides a partial offset. SBA Communications Corp. has the most exposure as 7% of its total revenue, with most of the at-risk leases coming up for renewal after 2023 (average remaining term is four years).
Growth trends in international markets ebb and flow where risks to performance are heightened as a result of the COVID-19 pandemic, industry consolidation, country risk associated with economic and political instability, operating risk pertaining to laws and regulations, and currency fluctuations. American Tower's operations in India are under pressure from elevated churn due to consolidation and regulatory penalties imposed on the carriers. That said, we believe American Tower's acquisition of Telxius Telecom S.A. could help reduce its sensitivity to some of its riskier and less stable emerging markets while providing good growth potential in Europe. American Tower and SBA have also seen less investment activity in Brazil because of lockdowns and difficulties deploying network equipment during the pandemic. We believe pandemic-related effects will weigh on international leasing activity during first-half 2021, causing growth to slow somewhat compared to prior years. We believe these headwinds will continue to weigh on international leasing activity in 2021, though we think that COVID-19-related effects should lessen over the course of the year as vaccines become more widely available and operating conditions improve.
Despite some of these near-term headwinds, our longer-term view for the tower operators remains favorable because they are poised to benefit from healthy demand from rising mobile data and video traffic, growing wireless penetration in international markets, and overall robust investment by carriers in their wireless networks.
Fiber: Most independent U.S. fiber providers we rate underperformed our expectations in 2020 because of installation lags during the first half of the year and reduced demand from corporate SMB customers as a result of the pandemic.
Despite these challenges, fiber industry fundamentals remain favorable, in our view, because of rising demand for bandwidth, which benefits these issuers. Demand continues to be driven by mobile data traffic, enterprise connectivity and IT outsourcing to data centers and the cloud, wireless backhaul and carrier network densification, migration of media content to OTT, and connected devices. In addition, given the recurring revenue business model with multiyear contracts and relatively low exposure to SMBs for most operators, we view COVID-19-related risks as manageable. In 2021, we expect overall revenue growth for the industry to be in the low- to mid-single-digit percent area, and we expect some margin expansion from improved economies of scale. That said, we expect capital spending to remain elevated, resulting in negative to low levels of FOCF over the next year.
This report does not constitute a rating action.
|Primary Credit Analysts:||Allyn Arden, CFA, New York + 1 (212) 438 7832;|
|Chris Mooney, CFA, New York + 1 (212) 438 4240;|
|Secondary Contacts:||Justin D Gerstley, CFA, New York + 1 (212) 438 1890;|
|Ryan Gilmore, New York + 1 (212) 438 0602;|
|William Savage, New York + 1 (212) 438 0259;|
|Bradley Mills, New York + 1 (212) 438 1438;|
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