The Market-Shifting News You Missed Last Month

Joseph Hogue's picture

Thursday, December 7, 2017 - 2:30pm

by Joseph Hogue

With tax reform zooming through Congress, bitcoin reaching historic heights and the markets continuing one of the longest bull-runs in history, one extremely important headline went largely unnoticed in November.

The potential change in the law isn't as sexy as the 10-fold increase in Bitcoin or the changes to taxes. In fact, many consumers probably don't even know what the existing law does.

That doesn't mean the coming change won't have huge consequences for a group of companies, with some on the winning side as well as a few losers. 

Surprisingly, shares of the companies on both sides haven't moved much since the announcement that the government would seek to change the law. 

That sets the stage to front-run the change, giving you a chance to align your portfolio with the winning side.

I'm talking about net neutrality.

What Is Net Neutrality And Why Should Investors Care?
Net neutrality can seem like a confusing legal and technical topic, but the basic idea and implications are simple.

Laws passed in 2015 reclassified broadband internet as a public utility under the Communications Act of 1934. This was important because it prohibited internet service providers (ISPs) from discriminating how they delivered the service to customers. It required that all websites be delivered equally (at the same rate) to people using the internet.

The law charged the Federal Communications Commission (FCC) with regulating the ISPs and forbade practices like blocking or slowing traffic to certain websites or offering paid prioritization for traffic to other sites.

ISPs fought aggressively against net neutrality because it limited their control over their networks. Content providers were in favor of the law, especially websites with video-heavy content because of the amount of bandwidth required to serve the content to consumers. 

The ISPs continued to lobby Congress against net neutrality and now it looks like the law will be overturned by the new FCC Chairman Ajit Pai. The chairman released a proposal that would overturn net neutrality rules and would only require ISPs to be "transparent" about their practices. The FCC is expected to vote the proposal through on December 14.

2 Winners And 3 Losers On The End Of Net Neutrality
While the internet will probably not look much different for most people after net neutrality is dismantled, it will be a very important change for some companies.

ISPs will have greater control over the data they serve over their networks, including slowing down some content and outright blocking other sites. The idea is that this lessens the workload on the ISPs' infrastructure and reduces costs. The companies could also charge heavy-bandwidth sites a fee for allowing consumers to access their content without delays.

The losers would be the websites that depend on reaching consumers through the ISPs, especially those sites that require massive amounts of data transfer when someone uses their applications or watches a video.

It's not yet clear what this will look like but there will almost certainly be tiered plans for consumers. A budget internet plan would likely block video-centric websites and applications. The ISPs will have broad discretion of which websites they allow in their tiered packages and will likely offer inclusion for a fee.  

Verizon Communications (NYSE: VZ) is the largest wireless provider in the United States, with more than 114 million wireless customers and 5.7 million Fios internet subscribers. The company's network is so powerful that rival Comcast is using it to deliver its new wireless internet service, Xfinity Mobile.  

Verizon could be one of the first to roll out 5G services in test markets next year, boosting subscriber growth and revenue. Shares trade for 13.4 times earnings, which are expected to increase 2.4% over the next four quarters on similar revenue gains. The company is a cash-generating machine, producing nearly $5 billion in free cash flow annually and paying a 4.6% dividend.

AT&T (NYSE: T) is the second-largest U.S. wireless carrier with over 100 million customers, as well as more than 20 million satellite customers through its DirecTV acquisition. The company would almost certainly favor its DirecTV Now streaming service in internet packages over other video streaming competitors.

The proposed merger with Time Warner would significantly boost the company's video content for the streaming service, but has been challenged by the Department of Justice. Even if the merger is ultimately scrapped, AT&T has strong upside potential, with shares trading at just 12.5 times trailing earnings. 

Losers in the change to net neutrality would include internet content and distribution platforms, especially anyone delivering video or applications over the internet. Some of the biggest names in social media and video like Facebook (Nasdaq: FB) and Google's YouTube are probably popular enough to get favored treatment in new ISP plans, but that won't be the case for everyone.

To avoid being shut out of ISP data plans or seeing their website slowed down for consumers, companies will probably need to pay a fee to the network providers. For companies with shares already at extreme valuation levels, the added strain might be enough to send the stock price into a tailspin.

Netflix (Nasdaq: NFLX) would be able to pay ISPs for access and faster speeds -- but it will come at a cost. Management has shrugged off the threat in interviews, but the company missed earnings expectations last quarter and already trades at 190 times earnings. Any additional expenses will weaken profitability and limit earnings growth.

IAC (Nasdaq: IAC) is an internet media company with websites in dating (39% of total revenue), real estate (16%), applications (19%), video (8%) and publishing (13%). The video and applications segments will be particularly affected by a change in net neutrality because of the bandwidth required to show these sites to consumers.

The company's video asset, Vimeo, has yet to find a way to monetize content and is losing money. This is likely to get worse if the company has to pay to have its site accessible to consumers after net neutrality is repealed. Shares already trade for 42 times trailing earnings and net income turned negative last year on a drop in revenue. While earnings are expected to jump 52% in the next four quarters to $4.50 per share, the company missed last quarter's estimate by 34% so a downgrade in expectations would not be surprising.

Shopify (NYSE: SHOP) is an ecommerce platform and hosting company providing the websites and tools for small businesses. The company and its customers might not have the financial capital for access to fast lanes in a post-neutral internet.

Shopify is yet to post a profitable year, though it is expected to report $0.16 per share in earnings over the next four quarters. This puts its current share price at 645 times forward earnings. 

Risks To Consider: Negotiations may still affect the ultimate rules in place around how the internet is delivered to consumers. ISPs will still be net beneficiaries, though limits on how they charge websites and consumers may affect how high the profits will rise.

Action To Take: Position in internet service providers and avoid shares of content companies as the shift away from net neutrality changes the way we pay for the internet.

Editor's Note: Here's a brief tip on making sure you never run out of spending money. It's called "Social Security Insurance." Once you've got it, Social Security could go belly-up and it wouldn't affect your payout one bit. My clients are generating an average of $40,653 per year this way... deposited directly into their account every month. Check it out here.

Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.