Communication Services: SpaceX Has Renewed Uncertainty Across the Sector, Especially Telecom

The SpaceX IPO in mid-June has fueled rampant speculation about the future of the communications services sector. While the firm is best known for launching rockets, its Starlink service has rapidly gained broadband customers globally, generating solid profits. Starlink also promises to provide seamless wireless service directly to traditional phones using spectrum licenses it plans to acquire from EchoStar, the firm behind the Boost Wireless business. The excitement around SpaceX has added to the pressure on shares of Comcast and Charter, which have struggled in recent years to grow their broadband customer bases, while also pushing AT&T, Verizon, and T-Mobile to multi-year lows. However, we don’t expect Starlink to radically alter competitive dynamics in broadband or wireless, serving instead as a complementary offering in both markets.

In broadband, we estimate Starlink has captured about 3 million customers in the US. While impressive, we believe the vast majority of these customers live in rural areas and that most have migrated from inferior satellite offerings, like Hughesnet, or very slow-speed DSL service. Looking forward, we expect Starlink’s capacity limitations, while improving, will restrict the number of customers it can serve well, as terrestrial networks continue to deliver very high-quality service.

Starlink’s plans to offer wireless service directly to customers have sparked fears that it will soon go head-to-head with the major US carriers. We think that proposition is highly unlikely. Satellite coverage is best suited to low-density outdoor areas, but customers demand service wherever they go. So, Starlink will need a terrestrial network to fill in coverage gaps.

Building a network from scratch would be extremely difficult, as the firm would need to spend billions acquiring spectrum licenses and building infrastructure. The wireless business is already highly mature and competitive, so the prospects of earning an attractive return on investment are weak. In addition, AT&T, Verizon, and T-Mobile have all said they are not interested in providing wholesale network access to SpaceX. The three firms have also formed a venture to jointly manage their relationships with all satellite companies, including SpaceX, likely ensuring none of them breaks ranks.

Top Communication Services Sector Picks

Comcast CMCSA

• Fair Value Estimate: $41.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

We expect Comcast’s decision to spin off its media assets will allow it to pursue strategic options far more efficiently. The firm has struggled to retain broadband customers as competition has increased, but demand for internet connectivity isn’t going anywhere. We expect Comcast to gradually stabilize its customer base over the coming years while enjoying some pricing power. In this state of the world, consolidation makes sense, and we would not be surprised if Comcast merged with Charter in the future. The new media business holds key content franchises and sports rights that could benefit a number of other firms. Netflix has already expressed interest in acquisitions with its failed bid for Warner Bros.

Walt Disney DIS

• Fair Value Estimate: $125.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

We see Disney as the most attractive among its video media peers, based on quality, risk, and valuation. We see a runway for accelerating top and bottom-line growth over the next several years and a likelihood that the firm exceeds our near-term projections, which build in macroeconomic risk. With linear TV revenue becoming much less material to overall results and added experiences capacity coming online, sales growth should accelerate. Ongoing profit improvements in the maturing streaming business and the commencement of new experiences revenue to catch up with the investment of the past few years should bring margin expansion at the same time.

Omnicom OMC

• Fair Value Estimate: $115.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

Traditional ad agencies like Omnicom have been sapped by AI fears. AI-powered tools may hurt pricing power for creative and production services, but the core of the agency’s business now revolves around omnichannel marketing planning and managing data assets, which we believe will play an increasingly important role in a complex and fragmented ad ecosystem. With the IPG merger closed, we expect Omnicom to join Publicis in outperforming other agencies thanks to its trainable data assets that can improve targeting and conversion efficiency.