AT&T Inc. (T) Stock’s Relationship with Facebook and Alphabet: Friends, Enemies or Both?

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Major telecom companies, like AT&T Inc. (NYSE:T), have a complicated relationship with tech companies like Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL).

Telecoms envy Facebook and Alphabet’s profits and stock performance. Since January 2009, Alphabet stock is up 460%, while AT&T stock rose only 49%. And telecoms like AT&T particularly resent the fact that internet companies like Alphabet and Facebook gained these profits while piggybacking on the equipment the telecoms spent tens of billions of dollars installing. You wouldn’t be able to access websites such as this one or Facebook without the help of a telecom, such as AT&T.

On the other hand, when people access Facebook or search Google, they are using data, which means more business for telecoms.

But tech companies hurt telecoms when they cannibalize their revenue with apps like Viber and Messenger and WhatsApp. Using WhatsApp is cheaper than sending a text message, and has caused text message volume to decline.

Storm Clouds on AT&T’s Horizon

But that’s not all. Alphabet and Facebook now are looking to compete with the core business of telecom providers such as AT&T. Alphabet’s Project Fi, in collaboration with Sprint Corp (NYSE:S) and T-Mobile US Inc (NASDAQ:TMUS), will free users from signing a contract with a single network. This allows users to switch between networks depending on which one has the best signal quality.

And that’s not all. Alphabet has more projects, including Project Loon and Google Fiber, in the works. These also threaten telecoms like AT&T. And Facebook is doing likewise, with Free Basics, Express Wi-Fi and the Aquila drone project.

Why are tech companies like Alphabet and Facebook doing this? Why don’t they just stick to their core businesses, search and social networks?

Well, Alphabet and Facebook derive most of their revenue from advertising. More people receiving access to the internet means more people viewing ads, and more revenue for Alphabet and Facebook’s core businesses. If people can’t access the internet, they can’t bring the two companies revenue.

Alphabet and Facebook want to see more people using the internet, and if this means using drones or balloons to bring access to remote regions, so be it. With greater availability of bandwidth, traffic on their websites will go up.

So are Facebook and Alphabet threats to T stock? Well, yes, in some ways. But in other ways they may help telecoms like AT&T by pioneering open-source hardware and software-defined networking. They have their own reasons for doing so, and this could help AT&T by lowering the cost of equipment which AT&T uses.

Facebook/Alphabet vs. T Stock: Friends

In an article I wrote in November, I discussed Facebook and Alphabet’s efforts to develop open-source networking equipment. Currently, companies like Cisco Systems, Inc. (NASDAQ:CSCO) make money by selling proprietary hardware and software to telecoms and internet providers like AT&T.

Networking equipment has been described as a “black box,” where hardware and software are bundled together by the same vendor. Software from other companies might not run smoothly on one company’s hardware. Companies like Cisco can earn high margins on these proprietary products. Routing equipment has not yet been commoditized like other hardware, such as servers.

But the development of software-defined networking and network functions virtualization could change this. These trends involve using open-source software and hardware instead of more expensive proprietary versions. Telecoms like AT&T can then save money by switching to cheaper, interchangeable “white box” switches and routers.

Alphabet and Facebook are taking advantage of this, and making their own networking equipment.

Facebook developed its own SDN switch, the Wedge, and open-sourced the Linux-based software to go along with that, FBOSS. It made the design for the Wedge available to the public through the Open Compute Project. Customers can order this from contract manufacturers, which sell it at a low margin, cheaper than Cisco’s products. Facebook also released an open-source transponder through the Telecom Infrastructure Project, which focuses on networking hardware for telecoms.

Facebook hopes that releasing these to the public will speed up innovation, which will in turn benefit Facebook, a major hardware user.

Similarly, Alphabet built its own massive software-defined network.

How does this benefit AT&T? Well, GOOG and FB are pioneering a technology which promises to lower costs for T stock. Through its Domain 2.0 program, AT&T is taking advantage of software-defined networking and network function virtualization. Last year, AT&T announced its intention to virtualize 75% of its network by 2020. These technologies allow it to do more with less. They appear to be reducing capex at AT&T, which would boost free cash flow and raise T stock. It also expects SDN and NFV to save it money on operating costs.

Facebook/Alphabet vs. AT&T: Enemies

But GOOG and FB also may harm T stock by getting into the telecom business.

GOOG’s Project Fi connects users to the network with the best signal at the moment, whether that’s Wi-Fi or 4G LTE offered by T-Mobile and Sprint. Normally, mobile phone subscribers must go with one service: AT&T, Verizon Communications Inc (NYSE:VZ), or others. This could force telecom operators to improve their signal quality in order to compete.

Alphabet also offers Google Fiber, a high-speed fiber optics service available in some select cities in the United States. AT&T must feel threatened by this; last year AT&T and Comcast Corporation (NASDAQ:CMCSA) sued Nashville after the city voted to approve Google Fiber.

Alphabet is also working on the previously mentioned Project Loon, an effort to deploy telecom equipment in balloons 20km from the earth’s surface. Since the equipment in a balloon is higher off the ground than an LTE tower, it can provide a greater area with internet access.

Facebook is doing likewise with the Aquila drone, Facebook Express Wi-Fi and Facebook Free Basics. Free Basics brings internet access to 200 million people in countries like Brazil and the Philippines.

Impact on AT&T

The harmful effects of Facebook and Alphabet on AT&T stock may be a bit overstated.

Facebook has expressed its intention to work together with telecoms to roll out 5G technology. Nick Fox of Alphabet has stated that Alphabet’s intention is not to compete with telecoms and put them out of business. Indeed, Alphabet is cooperating with three telecoms in Indonesia to test Project Loon.

And Alphabet and Facebook may be doing telecoms like AT&T a favor by bearing some of the risk in these ventures. Telecoms are more conservative than Facebook and Alphabet and wouldn’t want to bear these risks on their own. Telecoms like AT&T may benefit from the more efficient deployment of telecom equipment via balloons, which cover a wider area than towers.

Also, many of these regions the two are targeting are regions without much internet access. Facebook and Alphabet wouldn’t be threatening AT&T by bringing internet access to regions in Africa, where T stock derives little if any revenue.

But some of these undertakings, such as Google Fiber and Project Fi, will probably be a headache for AT&T and holders of T stock.

So it seems Facebook and Alphabet could best be described as AT&T’s “frenemies.”

As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/03/att-inc-t-stock-friends-enemies/.

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