AT&T has some expensive legal bills to pay facing down the Justice Department’s objections to its recent expensive acquisition of Time Warner, Inc. But no worries, AT&T’s wireless customers will be helping to pick up the tab after another major hike in an “Administrative Fee” that will raise at least $800 million a year for the phone company.

BTIG Research analyst Walt Piecyk caught AT&T hiking its Administrative Fee twice during the last quarter, now reaching $1.99 a month, billed to every post-paid wireless customer.

AT&T introduced the fee in 2013, claiming it would cover some of AT&T’s costs connecting phone calls and managing its wireless network. It started at $0.61 a month, then increased at some point to $0.76.

Although AT&T received negative press after introducing the fee, for most customers it is just one of several barely noticed charges applied in a separate section of monthly bills usually reserved for mandatory government fees and taxes. Many customers assume the fees are mandated by local, state, or federal governments, but in fact many are actually conjured up by AT&T and pocketed by the company. Most analysts believe companies create these fees to raise revenue without the perception of raising rates.

“The Administrative Fee helps defray certain expenses AT&T incurs, including but not limited to: (a) charges AT&T or its agents pay to interconnect with other carriers to deliver calls from AT&T customers to their customers; and (b) charges associated with cell site rents and maintenance.” – AT&T

Customers are now noticing the $1.99 Administrative Fee and complaining about it, after the company nearly tripled it over the last three months.

Fees and surcharges paid by a typical AT&T wireless customer in Illinois.

“In April of 2018, the Administrative fee increased to $1.26 and in June it rose again to $1.99,” Piecyk writes. “We believe the increase applies to all post-paid phone lines other than perhaps some large enterprise contract customers. We have confirmed that it does not apply to pre-paid lines after some customer service reps incorrectly told us otherwise last night. We believe this fee is included in AT&T’s reported service revenue and ARPU despite AT&T’s accounting change last quarter, which stripped regulatory fees and taxes out of both revenue and cost of service.”

Piecyk calculates that if 85% of AT&T’s 64.5 million postpaid wireless customers are now charged the fee, it will result in $800 million of incremental service revenue annually.

Piecyk is skeptical AT&T needed the money to cover cost increases.

“It’s hard to believe that interconnection costs have increased in the past six months enough to justify this fee increase,” Piecyk writes. “In fact, wireless operators have been crediting LOWER interconnection costs when explaining why their cost of service was in decline. Not surprisingly, we don’t recall any reductions in Administrative Fees by AT&T or its peers associated with reductions in interconnection expenses.”

Tower fees, also mentioned by AT&T, may have increased slightly, but as compensation for building out FirstNet, a public safety/first responder-prioritized wireless network, taxpayers are reimbursing AT&T $6.5 billion of FirstNet’s construction costs, despite the fact FirstNet will also benefit AT&T’s ordinary paying customers who will share the benefits of AT&T’s network expansion.

AT&T’s Administrative Fee hike will play right into the hands of T-Mobile, which has an advertising campaign blasting other wireless companies for sneaky fees. (0:45)

Delrahim

The top antitrust regulator in the United States partly blames CNN for helping AT&T and Time Warner outmaneuver the Justice Department and win approval of their merger, despite antitrust objections.

“We have some of the best and most dedicated public servants who tried this case, but we don’t have the same resources available to us,” Makan Delrahim, assistant attorney general of the United States and chief of the Justice Department’s Antitrust Division told Marketplace Morning Report. “We don’t have a 24-hour dedicated news channel to go out and spin your case to the American public and judges and others as some merging parties might.”

CNN is owned by Turner Broadcasting System, Inc., a division of Time Warner, Inc.

Delrahim admitted the government “is often the underdog in a lot of these cases, and we’re still considering our next steps and whether or not the government will appeal.”

AT&T and Time Warner clearly do not believe the government will further pursue the case, treating the merger as a done deal as the two companies move forward on combining their assets.

Delrahim complained about the judge handling the case, whose ruling excoriated the government’s case and strongly urged the Justice Department to not contemplate an appeal. In Delrahim’s view, the judge gave favorable weight to evidence from the two companies and dismissed much of the evidence the government presented.

“I think eight out of 10 judges may have treated this case differently,” he concluded.

Delrahim expressed his general frustration with government antitrust regulators attempting to impose various deal conditions and limitations designed to mitigate a transaction’s anti-competitive harm in the marketplace.

“If there’s a substantial lessening of competition, that’s the legal test, then the transaction is illegal,” Delrahim said. Instead of that simple test, the antitrust division often tries to rescue troublesome transactions with deal conditions he calls “microengineering an industry which is dynamic,” and in his view, is contrary to the role Congress assigned to the Antitrust Division. “I think the role is you go in, if there’s problematic aspect of a transaction, you divest and you let the market decide what the prices are now.”

“So the idea is: the greater the competitive process, the better the price ultimately will be, or the better the products will be for the consumer. And that’s where you have fair competition in the marketplace,” he added. “Our job is to police that. It isn’t to keep companies from getting too big. If they’re better at what they do, if customers like what they do, more power to them. The free market system encourages that. And we shouldn’t punish them once they have reached a certain level of success. If they are too big though, they also got to be careful. They can’t take anti-competitive practices that harms competition, which ultimately harms consumers.”

New York’s top telecommunications regulator has called Charter Communications a purveyor of fake ads, deception, and broken promises and has again called into question how much longer the company should be allowed to do business in New York State.

The New York State Department of Public Service/Public Service Commission today sent a letter to Charter Communications CEO Thomas Rutledge condemning Spectrum’s false and misleading advertising campaigns and the ongoing deception of New York consumers about its expansion efforts. The letter warned Rutledge Charter must immediately cease and desist airing fake ads about the company’s efforts to expand critical broadband service across the state. The letter also warns that if the misrepresentations and unacceptable way Spectrum conducts its business in New York does not stop, the company could find itself out of business in New York State.

“The situation regarding Charter/Spectrum is getting more serious with each passing day,” Department CEO John B. Rhodes said. “Not only has the company failed to meet its obligations to build out its cable system as required, it is now making patently false and misleading claims to consumers that it has met those obligations without in any way acknowledging the findings of the Public Service Commission to the contrary. Access to broadband is essential for economic development and social equity. Charter/Spectrum’s intentional deception of New Yorkers must end now.”

So far, Charter has ignored the Public Service Commission’s June 14 order demanding Charter indicate full and unconditional acceptance of the 2016 merger agreement and the terms it contained. The deadline for Charter or its attorneys to respond is this Thursday, June 28, 2018. If the deadline passes with no response, the Commission warned it may rescind, modify, or amend the approval order granting the merger, file a lawsuit in the Supreme Court of New York to potentially cancel the merger, and fine Charter for being out of compliance with state law.

Letter from New York regulators to Charter Communications (click image to download or view complete letter).

Charter’s Fake Ads

Rhodes

The letter accuses Rutledge of knowingly misleading New York customers in its advertising and printed materials that claim Charter has fully complied with — and exceeded — its commitments to New York under a merger agreement with the state allowing Charter to acquire Time Warner Cable systems. The letter emphatically states these representations are demonstrably and materially false.

State regulators pointed to Charter’s historic and systematic pattern of false advertising, noting a 2017 lawsuit filed by New York’s Attorney General over the company’s inability to provide advertised speeds has survived several company challenges in court and is moving forward.

The Merger Itself is in Peril

Charter will face the possibility of additional legal troubles as the PSC refers Spectrum’s latest conduct to the Attorney General’s office for possible further legal action. State regulators also suggested Charter was materially deceiving investors in violation of federal securities laws by not disclosing the company’s failure to honor its commitments to New York and warning investors the merger itself was now in significant peril if it is revoked in New York.

Regulators have also put Charter executives on notice that in advance of a possible penalty action by the Commission against the company directly, it further demanded that Spectrum produce records regarding its false representations and preserve all documents, including email, text messages, voice mail, recordings, and other documentation relating to its advertising claims.

A Record of Failure in New York

According to a PSC investigation and a Public Service Commission order, Spectrum missed its required December 16, 2017 build-out commitment to extend its network to pass additional residences and businesses by 12,245 passings. Spectrum also failed to cure, as required, its earlier failure by March 16, 2018. For these two failures, Spectrum was ordered by the Public Service Commission to forfeit $2 million. These failures came on top of earlier failures by Spectrum to meet its commitments. The PSC argues Spectrum has not met a single build-out deadline since the approval of its acquisition of Time Warner Cable in 2016.

The PSC stated that, instead of working to meet its commitments to New York, Charter executives have ignored state regulators as Spectrum knowingly continued to advertise and publish false claims that the company is exceeding its mid-December 2017 commitment made to New York by more than 6,000 locations and is on track to extend the reach of advanced broadband network to 145,000 unserved or underserved locations by May 2020. Both claims are patently false, claims the PSC.

“Spectrum’s failure to meet its build-out commitments hurts unserved and underserved New Yorkers, leaving them without a key public utility service crucial to their future success and well-being,” the regulator wrote.

“Spectrum’s publication of claims that it knows are false harm all consumers who rely on honest and accurate information in choosing suppliers from among competitors,” the PSC wrote. “And when Spectrum continues to advertise and publish false claims even after being directed not to by its governmental regulator, it demonstrates deliberate disregard and lack of respect for the Public Service  Commission, the rule of law, and regulation in New York State. Accordingly, in the name of customers and potential customers, the Department called on Spectrum to set the record straight by advertising and publishing the truth that the company has been found by the Public Service Commission to have failed to keep its buildout commitment to New York State.”

Charter Communications produced this video incorporating similar elements used in its advertising targeting New York consumers. Charter does not mention its investment in rural broadband in New York is not altruistic. It was a core condition the company agreed to as part of a settlement with the New York Public Service Commission to approve the acquisition of Time Warner Cable in 2016. (1:36)

If Comcast’s $65 billion all-cash offer for 21st Century Fox is accepted, America’s largest cable operator will also be among the world’s largest corporate debtors, owing $170 billion in all.

Comcast will borrow as much as $85 billion to cover the acquisition of Fox, plus an additional $27.5 billion to cover the buyout of the United Kingdom’s satellite operator Sky.

Excluding banks, Comcast will be the world’s second most-buried-in-debt corporation, outdone only by AT&T, according to Moody’s.

Comcast’s all-cash offer to snatch Fox away from its corporate arch-enemy Disney, also bidding for Fox, is remarkable for a company with only $6 billion of cash on hand. Comcast will have to borrow most of the money for the buyout, in addition to covering Fox’s existing $20 billion in debt. The result will be a 1980s style leveraged buyout that is likely to result in a significant downgrade of Comcast’s credit rating. Moody’s has already warned the company of exactly that.

Some Wall Street analysts see the transaction as particularly unusual for Comcast, a company that has avoided massive debt. Some suspect the generous cash offer for Fox is being driven by personal animosity between Comcast CEO Brian Roberts and Disney CEO Robert Iger, originating more than a decade earlier when Comcast attempted a hostile takeover of Disney, and failed.

Many investors are clearly worried about the growing debt levels of several large telecommunications companies, which remind some of two spectacular corporate failures at the end of the dot.com boom, when MCI-Worldcom and Global Crossing were both brought down by accounting scandals and bankruptcy in an effort to hide their debts.

There are fears that a decade of unprecedented low-interest rates, business-friendly regulatory policies, and a stabilized economy have allowed companies to grow complacent about the risks of debts from blockbuster mergers that are now bigger and more expensive than ever. Companies may be overconfident that their huge, debt-financed deals can be managed with low interest loans and frequent refinancing and bond sales to until debts can be paid down. But some analysts warn that if there is a downturn in the economy, easy credit will be hard to get, and interest rates will be significantly higher. Because highly leveraged companies are bigger credit risks, bondholders will likely demand a better deal for themselves.

The Wall Street Journal reports global corporate debt (excluding financial institutions) now stands at $11 trillion, and those companies are now 30% more leveraged than they were just before the start of the financial crisis of 2007. Wall Street expects several additional merger deals in the telecommunications and media sectors this year, which will likely raise debt levels even higher.

The unprecedented level of debt has not escaped the notice of the Federal Reserve. Asked whether the United States is in a “credit bubble,” Fed chief Jerome Powell said last week that officials are “watching” elevated levels of corporate leverage.

AT&T and Comcast officials told the Journal any fears are unwarranted; they are different from most companies because their respective debts are expected to be repaid quickly with higher levels of cash generated by their businesses. AT&T claims it could apply the $8-10 billion of its anticipated free cash flow from the merger with Time Warner to reduce debts, although that could threaten shareholder perks like dividend payouts and share buybacks, as well as customer-focused network upgrades.

Investors that used to treat AT&T and Comcast stock as a safe haven are not anymore.

“We are getting a lot of calls,” Allyn Arden, a telecom and cable analyst at S&P Global Ratings, told the Journal after both S&P and Moody’s cut their respective ratings on AT&T bonds last week to a level just two notches above the junk-debt category.

AT&T CEO Randall Stephenson downplayed the concerns of Wall Street over the additional debt.

“This thing delivers quickly,” he told CNBC. “Within four years, we’ll be back to our normal levels of debt.”

Where will AT&T and Comcast get the money to pay down their debts? Captive customers could be one source. Both AT&T and Comcast are planning to continue raising rates, particularly on internet customers, providing a lucrative shot of extra revenue. By gaining control of deep content libraries, both Comcast and AT&T will be able to hike licensing fees on that content as well.

Spending priorities: mergers & acquisitions, not upgrades.

Since 2012, two of the country’s largest phone companies spent enough money — $281.4 billion — to wire at least three-quarters of the  nation with fiber-to-the-home service and deliver vastly improved rural internet access to the rest of the country. Instead of doing that, AT&T and Verizon used the money to buy their competitors and content creators including AOL and Yahoo.

A 2017 Deloitte Consulting analysis estimates the United States will need between $130 and $150 billion in investment over the next 5–7 years to upgrade at least 75% of homes and businesses to fiber to the home service, with the remaining 25% serviced by technologies including 5G that are capable of delivering broadband speeds greater than the federal minimum standard of 25/3 Mbps.

AT&T could almost deliver the country a major broadband upgrade all by itself, having spent $138 billion on mergers and acquisitions in the past six years. Verizon could have easily handled the entire cost, but instead spent its $143.4 billion on business deals, including $130 billion to buy out former Verizon Wireless partner Vodafone. Among independent phone companies, things look equally bad. Frontier Communications is saddled with so much debt after acquiring former AT&T customers in Connecticut and Verizon customers in more than a dozen states, it has been forced to suspend its shareholder dividend and has been only able to make token investments in network upgrades for its mostly copper wire infrastructure in its original “legacy” service areas and a mixture of copper and fiber in acquired service areas. Both CenturyLink and Windstream have refocused many of their business activities on the commercial services marketplace, including the sale of hosting, business IT services, and cloud server networks.

More recently, both AT&T and Verizon have raced into content company acquisitions, buying up AOL, Yahoo, and Time Warner to offer their respective customers additional content. The phone companies are diversifying their business interests away from simply offering phone lines and internet access. At the same time, many of these acquisitions are depleting resources that could be spent on critical network upgrades.

The article in Light Reading claims the telecom industry’s traditional financial model of borrowing money to build networks and upgrade others is broken, because telecom companies now prefer to spend money acquiring other companies instead. Although AT&T has, in recent years, been more aggressive than Verizon in deploying fiber to home service, both companies have resisted committing large amounts of capital to a territory-wide fiber buildout, preferring to spend smaller sums to incrementally upgrade their networks in selected areas over the next decade. But the merger and acquisition teams at both companies are far less cautious, given the go ahead to pay handsomely for companies that often have little to do with providing telephone or internet service.

Light Reading reports AT&T’s debt climbed from $59 billion in 2010 to $126 billion at the end of 2017. Verizon’s debt increased from $45 billion to $114 billion. But those acquisitions have done little to attract new customers. Both companies’ operating cash flows have barely budged — $39 billion annually at AT&T (up from $35 billion) and Verizon’s actually declined from $33 billion in 2010 to $25 billion in 2017.

Mergers and Acquisitions (2011-2018)

AT&T

• 2012: AT&T buys $1.93 billion worth of spectrum from Qualcomm.
• 2013: AT&T buys Leap Wireless (Cricket) for $1.2 billion.
• 2014: AT&T pays $49 billion for the DirectTV, issuing $17.5 billion in debt in April.
• 2015: AT&T buys out assets from bankrupt Mexican wireless business of NII Holdings for around $1.875 billion.
• 2018: AT&T pays $207 million to acquire FiberTower.
• 2018: AT&T is cleared to merge with Time Warner in a deal valued at more than $84 billion.

Verizon

• 2011: Verizon acquires Terremark for $1.4 billion.
• 2014: Verizon buys out Vodafone’s 45 percent stake in Verizon Wireless, valued at $130 billion, with a mixture of stock and debt.
• 2015: Verizon buys AOL for a deal valued around $4.4 billion.
• 2017: Verizon acquires Yahoo Internet assets for $4.5 billion.
• 2017: Verizon buys spectrum holder Straight Path Communications for $3.1 billion roughly double rival AT&T’s offer, to build up 5G spectrum and footprint.

The more debt (and debt payments) that pile up at the two companies, the less money will be available to spend on fiber upgrades. In fact, there is evidence these companies are hoping to further cut costs in their core landline network operations. Some regulators have noticed. Verizon was forced to make a deal with New York regulators requiring the company to spend millions replacing failing copper-based facilities and upgrade them to fiber and remove or replace tens of thousands of deteriorated utility poles. Verizon faced similar action in Pennsylvania.

AT&T has spent millions lobbying the federal government to permanently decommission rural America’s landline network and replace it with a wireless alternative, while also working to replace the current regulated telephone network with deregulated alternatives like internet and Voice over IP phone service.

Wall Street analysts have occasionally questioned or at least expressed surprise over some of the phone companies’ odd acquisitions:

• Verizon acquired Terremark to beef up its cloud-based and server-hosting businesses. But shortly after acquiring the company, Verizon began replacing top management, sometimes repeatedly, and ultimately divested itself of its data center portfolio, including Terremark, just five years later.
• AT&T bought DirecTV to help it reduce wholesale TV programming expenses for its U-verse TV subscribers. But DirecTV has lost more than one million satellite TV customers since AT&T acquired it in 2014, despite new marketing efforts to convince would-be U-verse TV customers to choose DirecTV instead.
• Verizon saw value in web brands that were major players more than 18 years ago but are mostly afterthoughts today. The company spent almost $9 billion to acquire Yahoo and AOL, and their low quality content portfolios, which rely heavily on clickbait headlines, advertiser-sponsored content, and articles designed to maximize mouse clicks to boost the number of ads you see.

“The telcos are trying to diversify into content when they should instead be focused on their core business — building networks and charging for value-added technology,” said Scott Raynovich, founder and principal analyst at Futuriom. “It’s clear they see content as part of the value-add but customers so far don’t seem to be reacting that way. It’s clear they are allergic to paying higher prices for bundled content.”

AT&T and Verizon’s customers are not clamoring for more content deals. When surveyed, most want better internet service at more affordable prices.