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Analysts see Verizon-Comcast combination as a tough sell

Speculation about tie-ups in the cable and wireless space has been on a slow burn for months. But Verizon Communications Inc. CEO Lowell McAdam recently threw new fuel on the fire by saying he was open to discussions with Comcast Corp. and others.

In an interview with Bloomberg News, McAdam said he would consider a deal with Comcast, Walt Disney Co. or CBS Corp. should the CEOs of those companies approach him.

Verizon, Comcast and other participants in the FCC's recently ended 600 MHz spectrum auction are subject to the commission's anti-collusion period, which prohibits all auction applicants from "discussing or negotiating settlement agreements," such as a sale or merger. The quiet period will end April 27.

"Everyone thinks there is pent-up demand and everyone will be rushing to do something," said S&P Global Ratings credit analyst Naveen Sarma in an interview. But he said that the recent uptick in M&A chatter is "a function of the auction ending more than anything else."

Sarma is not convinced a tie-up between Verizon and a cable giant like Comcast or a media company like Disney is imminent.

"I would take this as an off-the-cuff remark that basically fuels speculation," Sarma said, noting that Verizon was also rumored to be pursuing a deal with Charter Communications Inc. earlier this year.

Some industry observers have argued a tie-up between Verizon and a cable operator is inevitable, as such a deal would allow Verizon to move more fully into the video market. It would also provide Verizon with significant fiber assets essential for the rollout of next-generation 5G services. As 5G will depend on a dense network of small cells, local area fiber networks will be needed to provide backhaul.

But Sarma believes that partnerships rather than purchases are a better way for Verizon to pursue video. He also believes there are significant obstacles to a cable/wireless deal.

In particular, he pointed to a "footprint mismatch," explaining that while a wireless operator like Verizon covers the whole country, a cable operator like Comcast or Charter operates in a limited footprint.

New Street Research analyst Spencer Kurn also sees the differences in footprint as a major hurdle.

"From a network perspective, it's important to remember that Comcast and Charter would solve Verizon's capacity needs in about half the country," Kurn said in an interview.

Another major obstacle to a Verizon-cable deal, according to Kurn, has to do with regulators. In recent years, both Comcast and Charter have completed major mergers — Comcast buying NBCUniversal Media LLC and Charter combining with Time Warner Cable Inc. and Bright House Networks LLC — in deals that faced intense regulatory scrutiny. Should Verizon try to buy either Comcast or Charter, Kurn said regulators would likely balk.

"I think [Verizon/]Comcast would come with a high level of political backlash. It depends how antitrust regulators look at the deal, but that transaction would be the most difficult to get through," Kurn said.

A better option for Verizon would be to buy DISH Network Corp., the New Street analyst said.

DISH has a massive stockpile of both high-band and low-band spectrum that Verizon could use to support its network and its move to 5G — spectrum that Kurn noted is not limited to one specific geographic region.

DISH spent a total of $6.21 billion in the 600 MHz auction, buying 486 licenses. A significant portion of the spectrum DISH bought was designated as "Reserve Block" spectrum, meaning it came from the 30 MHz spectrum reserve that Verizon and AT&T Inc. were both prohibited from bidding on. Under the action rules set by the FCC, this spectrum cannot be transferred, assigned or leased long-term to either AT&T or Verizon for six years, unless a waiver is obtained.

But Kurn said the limits on DISH's new spectrum licenses should not eliminate all chance of a Verizon/DISH deal. He estimated that of the $6.21 billion DISH spent in the auction, only about $2 billion was on Reserve Block spectrum.

"It's not ideal, but we think there's close to $80 billion of spectrum value at DISH today so this is just a tiny drop in the bucket," Kurn said.

Sarma, meanwhile, said a Verizon/DISH tie-up would carry its own set of complications.

"DISH is a whole separate issue because you're not getting a network, you're just getting spectrum," Sarma said.

In addition to spectrum, though, Verizon would also presumably get DISH's satellite television service.

"We don't see [DISH CEO and Chairman] Charlie Ergen wanting to sell the company without selling the satellite operations … so that might be a more difficult transaction," Sarma said.

All in all, Sarma sees obstacles for either a cable or a satellite deal for Verizon. He said that if the telco is looking to use M&A to bulk up its network, the simplest solution might be to buy a smaller fiber network owner.

"There are a number of these smaller companies that have dense fiber networks, especially in urban areas, and I think that would be more attractive than buying a cable company," he said.

Neither Kurn nor Sarma expect a Verizon deal with a media company like Disney or CBS.

"Verizon has always positioned themselves as sort of the dumb pipe. They are an infrastructure company," Kurn said, adding that he expects Verizon to stay that way.

Sarma agreed. "We're definitely skeptical about convergence even though everyone is talking about it," he said.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global.