Here Comes the Fourth Telecom Competitor

Editor's note: You're probably familiar with names like AT&T and T-Mobile. What you may not know is that the telecom industry has razor-thin margins. And as Joel Litman, chief investment officer of our corporate affiliate Altimetry, explains, one of the world's largest companies is threatening to turn up the heat in this sector even further...

America's telecommunications industry got a bit too complacent...

At least, that's what Federal Communications Commission ("FCC") Chairman Brendan Carr says... and it's why he wants more pressure in the system.

Carr has long argued that the "Big Three" – AT&T (T), Verizon Communications (VZ), and T-Mobile (TMUS) – need another strong competitor. He thinks it's the best way to ensure that service keeps improving and prices remain in check.

For years, Washington wanted that challenger to be satellite provider EchoStar (ECHO). But that dream didn't last long.

As we'll cover today, though, competition is coming – from elsewhere.

The dominance of the Big Three telecom providers may be facing a more serious threat. Before we get to that, let's look at why EchoStar didn't make the cut...

The FCC's four-player plan dates back to Sprint's merger with T-Mobile in 2020.

For that deal to be approved, regulators required Sprint to carve out its Boost Mobile business and hand it over to EchoStar... setting EchoStar up to become the market's fourth major player.

EchoStar had acquired billions of dollars' worth of 5G spectrum. Think of spectrum as lanes on an invisible highway that carry data to your phone. There are only so many lanes available, making each one a highly valuable asset.

The acquisition of Boost (and its spectrum) was supposed to help EchoStar build a stand-alone 5G network. But the build-out fell short of regulators' expectations.

Carr opened a probe into EchoStar's progress last year, arguing that it was moving too slowly. The scrutiny ended after EchoStar agreed to sell its 5G assets to AT&T and SpaceX (SPCX).

Said another way, EchoStar has completely abandoned its wireless ambitions. Its core satellite business filed for bankruptcy at the end of June.

It was the end of the long-running dream of a major government-backed telecom carrier.

But it wasn't the end of EchoStar's spectrum. On the contrary, it was just the start...

SpaceX Could Become the Big Fish in a Small Pond 

Enter SpaceX – Elon Musk's satellite darling, which held a behemoth IPO last month.

Back in May, SpaceX scooped up a big chunk of EchoStar's spectrum.

And two weeks after the June IPO, Bloomberg reported some interesting news... SpaceX is talking with Charter Communications (CHTR) about launching a wireless phone business.

That's a big potential threat to the Big Three telecom giants. Charter already has millions of Internet subscribers... And SpaceX has the satellite infrastructure to provide coverage in current dead zones.

Together, they have the capital and the customer base to force a massive price war.

Unsurprisingly, the market got spooked. T-Mobile, AT&T, and Verizon all saw their stocks slide in the back half of June.

Carr framed that sell-off as proof that competition among wireless service providers was becoming fiercer.

It was good news for consumers... but not so much for shareholders.

The Embedded Expectations Analysis ("EEA") framework we use at Altimetry makes the problem clear...

The EEA starts by looking at a company's current stock price. From there, we can calculate what the market expects from the company's future cash flows. We then compare that with our own cash-flow projections.

In short, this tool tells us how well a company has to perform in the future to be worth what the market is paying for it today.

Take a look at the chart below. It shows profitability, via the average Uniform return on assets ("ROA"), for the Big Three telecom providers.

Telecom returns sat near 6% in the early 2010s. But that average has since dropped to around 4%. And the market thinks this sector's Uniform ROA will remain in this range in the future...

The cost of capital for these carriers is roughly 5%. So the industry is already operating around breakeven – even without a fourth telecom giant in the mix yet.

That's a low bar. And it leaves little margin for error.

SpaceX is a unique threat...

It has satellites... spectrum... a strong entrepreneurial culture... and a track record of funding long-duration infrastructure projects.

If it launches wireless service with Charter, the Big Three will have another rival chasing the same customers.

Telecom stocks sold off as regulators encouraged this new wave of competition. They want to force the industry into a pricing war to benefit consumers.

But investors sit on the other side of that dynamic. The larger carriers were already earning around the cost of capital. A new competitor with satellite assets and a national brand would narrow their path to profitability.

Since the sell-off at the end of June, the Big Three have seen their shares bounce back, but this recovery is likely temporary. SpaceX entering the fray will dial up the pressure in this market.

And the Big Three don't have much room to absorb another pricing fight.

Regards,

Joel Litman

Editor's note: Wall Street's institutions don't get caught by surprise. When they see a sector losing steam, they cash out and invest elsewhere. This creates new opportunities for investors who can spot those market flows early. Now, Joel's research suggests that Wall Street is starting to move out of tech and into another group of stocks... See why he says you need to move your money before August 12.