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Experts to Senate Committee: Net Neutrality Legislation Could Further Undermine Investor Confidence in Telecom
[March 15, 2006]

Experts to Senate Committee: Net Neutrality Legislation Could Further Undermine Investor Confidence in Telecom


TMCnet Associate Editor
 
Four financial experts working in the telecommunications and cable industries told members of the U.S. Senate Commerce Committee yesterday that the proposed “net neutrality” legislation now under consideration in Congress could have the “unintended consequence” of hampering investment in telecom on Wall Street, if adopted during this year’s short legislative session.

The committee asked the four experts for their input as it prepares to re-draft the Telecommunications Act of 1996, which is now largely obsolete due to dramatic changes in the telecommunications industry (particularly the shift of voice and video services to the Internet) during the past decade. Committee Chairman Ted Stevens (R-Alaska) said at the close of the hearing that the committee expects to start drafting the revised bill “shortly after Easter” (April 16).

The four analysts who spoke didn’t say they are opposed the concept of “net neutrality” – the principle that everyone, everywhere, should have free and unfettered access to all that the Internet has to offer. However, they did say that the net neutrality legislation now before the Senate imposes too many restrictions. They called for a “light regulatory touch” - and “regulatory certainty” - saying that this is the best way for Congress to bolster investor confidence in telecom.


“As we look at net neutrality, as it is currently construed, I believe it will dampen enthusiasm for investments even further and will trigger a host of unintended consequences,” said Craig E. Moffett, vice president and senior analyst at U.S. Cable and Satellite, Broadcasting. “Mandated net neutrality will further sour Wall Street’s taste for broadband infrastructure investments, make it increasingly difficult to sustain necessary capital returns, and would likely mean that consumers alone would have to foot the entire bill for whatever network investments do get made. Conversely, from a Wall Street perspective, allowing a multiplicity of payers – that is advertisers and web service providers – to support network investments would greatly bolster the business case and would offer the prospect of better returns and consumer choice in the end.”

Two weeks ago, Sen. Ron Wyden introduced the Internet Nondiscrimination Act of 2006, a bill which was essentially drafted in response to a proposal from the major U.S. telecommunications companies (including BellSouth, AT&T and Verizon) to create a “two-tiered” Internet. Specifically, what the Bells are proposing is the creation of a second tier for the express delivery of voice and video signals, which are increasingly congesting the “pipes” of the Internet (pipes which the major carriers have made major investments in). A controversial aspect of this proposal is that the carriers want to charge service and content providers “access fees” in order to be able to use the new “fast lane.”

Opponents of the “two tier” proposal have said it will hurt the “free and open” nature of the Internet, because it will skew competition. They argue that smaller service and content providers which can’t afford the access fees will, in essence, be priced out of the market - and the larger companies which can afford the fees will have an advantage in that their content will be delivered to their customers in the fastest and most efficient manner possible. Opponents also point out that allowing a second “paid” tier will likely result in network operators prioritizing some content over other content - and that, they say, flies in the face of “net neutrality,” – the very thing which they claim has led to the Internet’s huge success.

But the four experts who spoke before the Senate Committee yesterday painted a much different picture. They pointed out that creating a second tier doesn’t necessarily mean that consumers will be “blocked” from content. Furthermore, they said allowing for the creation of a second tier will help promote innovation in networking - and that innovation, just as much as competition, has played a major role in the Internet’s success.

“In my view, the success of U.S. carriers … will be critical in giving the equipment makers the opportunity to develop and improve the technology of the future,” said Luke T. Szymczak, vice president, JP Morgan Asset Management. “After [the equipment makers] help the U.S. carriers [build new networks], they can sell this equipment and technologies to carriers around the world.”

In order to achieve “regulatory certainty,” issues such as national video franchising, “cable a la carte,” and network neutrality will need to be resolved, the analysts said.

The analysts pointed out that during the past decade the major U.S. carriers and cable companies have sunk billions into upgrading their networks – yet they haven't yet seen full returns on those investments. They said if the major carriers don’t get to recoup on their future investments by charging access fees to companies like Google and Yahoo, then consumers “will end up having to foot the bill” for network upgrades. That, in turn, will lead to a reduction in consumer broadband adoption, which in turn will hurt equipment makers, service and content providers, network operators and, ultimately, investors.

“There is a high degree skepticism [on Wall Street] that the substantial investment underway at the ILECs to bring broadband networks to the home will deliver a satisfactory return on the incremental investment.” Szymczak said.

Moffet added that “the cost of these networks is far beyond what the returns of these new services can provide.”

Bourkoff pointed out that the cable industry has spent $90 billion during the past decade to upgrade its networks for the delivery of digital video and voice services, but due to increased competition from the major carriers, cable’s share of pay TV has gone from 95 percent in 1994 to 63 percent today. Yet the cable industry, he said, is potentially on the cusp of its most operationally successful period, with bundled voice, video and data penetration close to 20 percent in some markets.

Despite this success, “cable companies’ share prices remain depressed, with valuations that are at or near historical lows,” Bourkoff said. Investors, he said, see cable as a gamble, mainly because of “regulatory uncertainties” in video franchising and the emergence of new competition from the major carriers. Adding to this risk, he said, is the $80 billion of industry debt waiting for a return.

“As the committee reviews issues related to video franchising, I stress the importance of maintaining a level playing field among all operators while allowing consumer preference to dictate changes to current models,” Bourkoff said. “Uncertainty among investors will persist if the rules pertaining for obtaining video franchise fluctuate based on the nature of the new entrants.”

Kevin M. Moore, wireline telecom analyst and managing director at Wachovia Securities, said “regulatory certainty and stability” is the one thing Congress can provide in order to boost investor confidence in telecom.

“We believe that Wall Street’s biggest desire is to minimize the need to constantly reevaluate the role of regulation in its investment decisions,” Moore said. “We have enough to worry about in considering the rapidly changing competitive and technological environment.”

Like the other three analysts, Moore, too, called for “minimal regulation” – but clarified that “this is not a request to eliminate regulation – but for it to take a minimalist form.”

“In the past 10 years I believe we’ve seen a direct correlation between regulatory instability and regulatory complexity,” he said. Pointing to the inadequacies of the Telecommunications Act of 1996, he stressed that whatever regulatory policies are adopted by the Senate, they must be flexible enough to allow for changes in technology in the future.

“We all agree that the 1996 Telecom Act did not contemplate many of the subsequent technological developments,” he said. “I think it’s important that we agree now that we cannot imagine what will happen over the next 10 years. It is critical that any new regulatory framework takes this uncertainty into account and is sufficiently flexible.”

Moore also called for “technological consistency” in whatever legislation is drafted.

“I believe that regulation must not be overly application specific – in other words, it cannot overly-differentiate between voice, video and data,” he said. “A 2006 Telecom Act that is application specific - and does not account the movement of voice and video data to the Internet and wireless technology - could become unstable within a few years of enactment.”

Bourkoff said in his opinion, Congress might be taking up the issue of video franchising and net neutrality “too soon” because there are so many developments occurring in telecommunications right now, and it remains unclear where the industry is headed.

“As media consumption over the Internet develops at a rapid pace, I believe it is too early to introduce regulation on key issues such as a la cart pricing and packaging, and on net neutrality, as the market is still in its early stages,” he said. “In fact, the broader media and communications sector is perhaps at its most dynamic stage of evolution, as media content is available across multiple platforms under various pricing structures. Changes are occurring at such a frenetic pace that any possible regulation today carries the risk of stunting this innovation if it does not build in enough flexibility for the complexion of the sector in the coming years, if not months.”

Sen. Stevens asked the four experts how the Senate should go about meeting the needs of investors while at the same time protecting consumers.

“You all seem to think that if we try to protect the consumer, we’re going to hurt the investor - is that right?” he asked.

“I don’t think that’s the case,” Moffet replied. “What I mean is, we have to be careful as we try to protect the consumer – protecting the investors and protecting the consumers is the same thing – because a great deal of consumer welfare here comes about because of creating additional choice – and that means fostering investment. It’s important to recognize that a light touch, from a regulatory perspective, is probably the best outcome. But that doesn’t assume no regulation. Probably the most unobtrusive path to consumer welfare is probably the best one.

Patrick Barnard is Associate Editor for TMCnet and a columnist covering the telecom industry. To see more of his articles, please visit Patrick Barnard’s columnist page.

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