A Small Market Gets Smaller

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Sprint (NYSE: S) recently announced a bid for cell phone rival Clearwire (NASDAQ: CLWR), after itself getting a massive cash infusion from Softbank (SFTBF). The number three player in the U.S. cell phone market is acting as a consolidator after larger rivals have had trouble gaining approval for deals.

The Sprint/Clearwire deal comes on the heels of Deutsche Telekom's offer to buy MetroPCS (NYSE: TMUS). Clearly consolidation is taking place. That point gets further support from Sprint's earlier purchase of Virgin Mobil. However, none of these deals, though notable and large, means that the AT&T (NYSE: T) and Verizon (NYSE: VZ) duopoly is coming to an end.

In fact, AT&T and Verizon have been growing relatively strongly of late, while the second tier players have been losing ground. Thus, this looks more like weak players teaming up in a last ditch effort to take on the strongest players. The problem with this logic is that two weak companies joining together doesn't usually result in a strong company. So this deal may be better viewed as second tier companies trying to prolong their slow declines. While Sprint or Deutsche Telekom could manage to pull a rabbit out of their hats, investors are probably better off sticking with the industry leaders.

Dow Members
AT&T and Verizon are both in the Dow 30. You don't get put into the Dow Jones Industrial Average for nothing. The elite group is selected by the editors of The Wall Street Journal as a broad representation of the U.S. industrial sector. The companies in the index are some of the largest and best known around. That the Dow houses both of the dominant cell phone carriers is a statement in and of itself. Note, however, that these companies have changed materially over the last 10 to 20 years, shifting from wire line and long-distance carriers to cellular based providers.

This shifting is important in another way, too, since the committee that selects the companies for the index have had ample opportunity to push AT&T out after the many mergers and acquisitions in its past. Clearly both companies are changing and those changes are viewed as integral to and representative of the changes in the broader U.S. market. This is a valuable insight to glean and another solid reason for sticking with this duopoly if you want telecom exposure.

AT&T today is very different from the AT&T of yesterday. In fact, it is a partial rebuilding of the government mandated breakup the old AT&T suffered in the 1980s. Although it was once known as the only game in town offering wire line and long-distance telephone service, today AT&T provides wireless communications, local exchange services (wire line phone service), long−distance services, data/broadband and Internet services, video services, telecommunications equipment, managed networking, and wholesale services. It is, however, best known for being one of the two largest cellular phone carriers in the United States, and the first to work with Apple (AAPL) to sell and support the iPhone. And the cell phone market is where it's growing fastest.

Verizon is one of the companies spun off from AT&T when it was forced to break up. It offers similar services to AT&T, but breaks its offerings into two broad categories, Verizon Wireless and Wireline. The big difference between Verizon and AT&T is largely ownership, as Verizon Wireless is a joint venture between Verizon (55% owner) and Vodafone (VOD) (minority 45% owner). Although Verizon is the controlling partner, this is a relationship that adds complication to the picture and potentially increases costs going forward, if Verizon buys Vodafone out.

Mutual Strengths
The two companies have a great deal in common with each other. For example, they are the number one and two cell phone carriers in the United States. They both have large consumer customer bases and strong brand names. Moreover, they are both financially strong and have relatively recession resistant businesses.

While both companies are dealing with a shrinking wire line business, their focus on the cell phone arena appears to be the right long-term approach. Indeed, cell phones, which were once considered a luxury, are increasingly considered necessities. In fact, many younger consumers have only their cell phone as a means of communication. Moreover, as video and other digital distribution increase, demand for cellular data over AT&T and Verizon networks is only going to increase.

Stick With The Big Boys
At the end of the day AT&T and Verizon are very similar companies. Their growth profiles, though not impressive, are also very similar and vastly better than the third player (Sprint) on down. Both are yielding around 5%, though AT&T's yield is over 50 basis points higher. Investors interested in this space should avoid Sprint and the other bit players and focus on the big boys.


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ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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