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FCC Bids Adieu to Net Neutrality - Legal Battle Looms

Zacks Equity Research
The primary issue related to the Net Neutrality controversy is that can high-speed broadband (Internet) be treated as a public utility like phone, electricity, gas, water etc.

Yesterday, in a landmark decision, the U.S. telecom regulator Federal Communications Commission (FCC) repealed the Net Neutrality laws that it had imposed under the Obama regime.

Ever since President Trump elected existing Republican commissioner Ajit Pai as the chairman of the FCC in January 2017, the fate of Net Neutrality was at stake. Nevertheless, Net Neutrality supporters are preparing for legal battle. We expect this subject to remain a hot cake in the 2018 telecom space.

On Feb 26, 2015, the FCC under the chairmanship of Tom Wheeler adopted Net Neutrality implying an open-Internet atmosphere, which will prohibit ISPs (Internet Service Providers), especially the telecom and cable TV operators, from discriminating against applications. So far, these companies were allowed to restrict any device, application, service, or content from running on their respective networks.

Proponents of Net Neutrality argued that the law bans common ISP practices such as data traffic blocking, slowing any data traffic and paid prioritization. Content developers have to pay hefty sums to ISPs for accelerated data transfer, which they eventually transferred to end users. In this situation, implementation of Net Neutrality by FCC was a huge positive for several web-based application and content developers, especially the start-up companies and general consumers. (Read: FCC’s Net Neutrality Rules: Who Benefits the Most?)

Opponents of Net Neutrality have argued that several billion dollars of investment for high-speed broadband network which the ISP’s spend will be significantly jeopardized if discriminatory pricing is disallowed and it would eventually result in loss of jobs for the economy. (Read: FCC Plans to Repeal Net Neutrality: Who Gains?)

Irrespective of the arguments of the two sides, some important socio-economic policy related issues are also involved in the Net Neutrality controversy. We will now try to understand those:

Is Internet a Public Utility Under Title II?

The primary issue related to the Net Neutrality controversy is that can high-speed broadband (Internet) be treated as a public utility like phone, electricity, gas, water etc. Telecom is a major infrastructure product. Can Internet be classified as an essential service for livelihood for which the bulk of the investment is coming from private sector?

Net Neutrality laws reclassified Internet as a public utility under Title II of the 1934 Communications Act instead of section 706 of the 1996 Telecommunications Act. The reclassification is associated with strong control mechanism.

Importantly, these regulations were applicable to both mobile and fixed broadband networks. The reclassification of the Internet called for a radical change in the way the government treats high-speed broadband service. This gives the FCC increased control over the ISPs.

Private Investment Key

In the last 20 years, private sector has invested a mammoth $1.5 trillion to install communications network throughout the United States. A group of 63 smaller service providers, the majority of which serve rural areas, have given an estimate that they invest more than $70 billion every year on enhancing and expanding their networks, which raised rural broadband connectivity by a whopping 117% in the last 10 years.

This enormous expenditure took place primarily due to not-so-stringent rules implemented by the regulator. Due to this exponential deployment of telecom network, the web-based applications and solutions developers are flourishing.

Per a recent study by USTelecom, investment in broadband infrastructure declined from its peak at $78.4 billion in 2014 to $77.9 billion in 2015 and $76 billion in 2016. According to USTelecom, the reclassification of broadband as a public utility under Title II of the 1934 Communications Act has resulted into precipitous lower investment in broadband infrastructure.

Control Mechanism vs. Private Investment

The champions of Net Neutrality argued that strong regulatory measures are required to ensure free availability of Internet to everyone. If ISPs are allowed to practice paid prioritization, a method through which content developers strike deals with ISPs for fast and smooth transmission of their data traffic, then only a handful of large web-based content and application developers will benefit.

This will have a negative impact on start-up companies resulting in less innovation and competition. General consumers will also be affected since established content and application developers will ultimately raise their price to recoup the extra charge they pay to the ISPs.

On the other side, opponents of Net Neutrality argued that the basic rule of the neo-classical economic theory is left to itself the market will be able to bring back equilibrium. The equilibrium is achieved when marginal utility equalizes marginal cost. If multi-media application generates more demand than simple text message, users need to pay accordingly. Similarly, ISPs will reach equilibrium when marginal revenue equals marginal cost. If an application requires more bandwidth consumption, then the users should pay more for that.

Moreover, establishing Internet fast lanes become necessary in some critical scenarios. Remote healthcare applications and self-driving cars will require high-speed secured broadband connections with exceptional reliability.

In these situations, FCC’s soft regulatory policies will enable ISPs to better serve the nation. The current FCC's less-restrictive regulatory attitude may also pave the way for new merger and acquisition deals between ISPs and online digital media companies.

Politics Matters

Look at the voting pattern of the FCC when it adopted Net Neutrality and when it abandoned it. On both occasions, the result was 3-2. The Democrats were at the helm of FCC when the regulatory body adopted Net Natality, while Republicans are in power now. Ajit Pai strongly argued that a light-touch regulatory measure generated higher investment in the overall telecom industry.  
Even when the former FCC under the chairmanship of Wheeler adopted Net Neutrality, Republican senators were not in favor of this directive. These groups believe that a slight law reformation under section 706 of the 1996 Telecom Act will be enough to enforce Net Neutrality.

Trump himself is a strong critic of Net Neutrality. He has stated that he wants to do away with nearly 75% of all governmental regulations during this term as the President. A new FCC headed by Pai, exercising lesser restrictions, certainly augurs well for the ISP industry.

The regulator’s sole concern will be transparency of ISP practices. This will ensure that consumers can buy service plans best suited to them. Also both large and SMB (small and medium business) enterprises can avail instant technical information for product innovation. The Federal Trade Commission (FTC) will be in charge overseeing ISP practices for the protection of consumers’ online privacy.

Who Will Gain as FCC Revokes Net Neutrality?

There is little doubt that the ISP industry will be the major beneficiary after FCC dismantling Net Neutrality. Leading ISPs including AT&T Inc. T, Verizon Communications Inc. VZ, Comcast Corp. CMCSA and Charter Communications Inc. CHTR strongly criticised Net Neutrality rules. AT&T carries a Zacks Rank #4 (Sell). However, Verizon, Comcast and Charter have a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Bottom Line

The primary viewpoint of Net Neutrality proponents is that choice of content should be left to the consumer. No discrimination should be allowed in treating contents. An open Internet should be the backbone for product innovation in a free-market environment.

On the other hand, the opponents of Net Neutrality argue that a light-touch regulatory measure will generate higher investment in the overall telecom industry. That will pave the way for web-based service providers to flourish.

We are waiting for a legal solution to this controversy in 2018.

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