Why Verizon Is Interested In Charter Communications

The Wall Street Journal reports that Verizon (NYSE:VZ) is exploring a potential acquisition of Charter Communications, the second largest U.S. cable operator, in a deal that could make the wireless behemoth a force to reckon with in the content distribution and broadband markets. A merger would have some merit, given the scope for revenue and cost synergies and the possibility that Verizon could use Charter’s broadband infrastructure to build out its next-generation 5G services. However, there are risks as well, given that Charter’s high valuation (enterprise value of over $140 billion) could put pressure on Verizon, which already has debt load of about $110 billion. Below we take a brief look at the potential rationale for a deal.

We have a price estimate of $55 for Verizon’s stock, which is 15% ahead of the current market price.

See our complete analysis for Verizon

Growing Exposure To Fixed Line Broadband

While the broader U.S. telecom market is slowing down, demand for high-speed Internet has been growing at a healthy pace, driven by the digitization of the broader economy, expansion of the housing market and a shift from TV to streaming video services. The total number of fixed-line broadband connections in the U.S. grew to 92.5 million as of Q3’16, up by about 3.3% year-over-year. By acquiring Charter, which held about 22% of the broadband market as of Q3 2016, Verizon could emerge as the largest broadband provider in the United States (without accounting for potential divestitures in regions such as the Northeast, where operations overlap). Verizon could also double down on selling bundled services, allowing it to reduce subscriber churn and drive some revenue growth.

Providing Verizon Infrastructure To Build Out 5G

Charter’s wide and dense fiber-optic network could prove valuable for Verizon as it builds out its 5G wireless data services. As 5G services are likely to operate at higher frequencies (28 Ghz, 37 GHz and 39 GHz currently approved by the FCC) compared to 4G, they effectively have a lower range and are more susceptible to obstacles. This means that 5G requires a larger number of smaller cells for greater frequency reuse. Verizon could benefit by using Charter’s vast neighborhood networks to provide connectivity to its cells, giving it an edge over rivals such as AT&T who are also carrying out trials for 5G technology.

Betting On the Future Of TV

The broader U.S. pay TV market is shrinking amid cord cutting in favor of streaming services, and also due to a shift of media viewing habits towards mobile devices. Telecom majors have been looking to capitalize on this shift, with AT&T recently launching DirecTV Now, a streaming TV service, and Verizon launching Go90, an ad-supported video service targeted at millennials, back in 2015. However, Verizon’s efforts haven’t been very successful, and the lack of quality content may be partly to blame. Streaming rights for content are usually very fragmented, making it difficult and potentially expensive for carriers to put together compelling offerings. However, by acquiring Charter, which has the third largest pay TV base in the U.S (18% market share), Verizon could bolster its mobile video offerings, while potentially launching streaming TV. Moreover, Verizon, which currently holds about 5% of the U.S. pay TV market, could reduce its content costs, as it would have greater bargaining leverage with TV networks.

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