AT&T’s Predicament Rattles Investors as FCC Vote Looms: Options

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Traders are bracing for losses in AT&T Inc. before an FCC decision that threatens to upend the way the nation’s second-largest wireless carrier does business.

Demand for options that protect against losses in shares of AT&T rose to the highest level in more than three years relative to bullish ones, data compiled by Bloomberg show. The number of AT&T shares sold short has climbed to the most since 2007 amid the company’s pending acquisition of DirecTV.

Proposed rules on how companies deliver data over the Internet, set for a vote next week, would expand Federal Communications Commission oversight allowing it to regulate like utilities not only Internet service providers but also mobile broadband companies from AT&T to Verizon Communications Inc. Investors anticipating that the rules will pass are protecting against the specter of new regulation and the impact it may have on the profitability of the business.

Options trading “is reflecting some cautious sentiment on the part of investors about the what-ifs of FCC regulation,” Max Breier, a senior equity-derivatives trader at BMO Capital Markets Corp. in New York, said by telephone Feb. 13. “The likelihood that the proposal will regulate broadband similar to telephone lines will be a negative for telecom service providers.”

Protecting Consumers

FCC Chairman Tom Wheeler, in an article published Feb. 4 on Wired.com, outlined rules to promote a “fast, fair and open” Internet that will be voted on at the Feb. 26 meeting. The rules, which would end more than a decade of debate over the open Internet, would reclassify broadband Internet as telecom instead of information services, and are designed to protect consumers by barring companies from blocking or slowing Web traffic.

Wireless providers would face a lot more regulation than they’re used to. For the first time, open-Internet protections would apply to the information sent over mobile networks to smartphones.

Phone companies have said they’d protest the regulations in court if they’re approved -- potentially pausing spending on infrastructure while the litigation plays out. AT&T Chief Executive Officer Randall Stephenson told CNBC in an interview earlier this month “there will be litigation” if the rules are implemented.

‘Chill Investment’

“I suspect that all of us in the industry will be asking for a stay, because it’s hard to put in something like this and then undo it,” Stephenson said. “What all this is doing is putting the industry in a moment of uncertainty and lack of clarity.”

Verizon warned in a statement that the regulation would “chill investment” among those touched by the rules “that now will need to consider FCC rules before launching new services.”

Net neutrality rules could also be “a significant issue” in the FCC’s review of a proposed transaction between AT&T and DirecTV, according to Bloomberg Intelligence analysts Paul Sweeney and Sean Ford. The $48.5 billion deal, expected to close in the second quarter pending approval from the FCC and the Justice Department, would contribute to a reordering of the competitive landscape among pay-TV providers.

“While the merger is expected to close by the first half of 2015, there are no guarantees,” Breier said in an e-mailed response to questions Feb. 19. “It’s not surprising that some investors are willing to forgo a piece of the deal spread by buying protection in the event the deal falls apart.”

AT&T Options

The cost of options contracts with an exercise price 10 percent below AT&T shares was 9.8 points more than calls priced 10 percent above on Feb. 12, according to three-month implied-volatility data compiled by Bloomberg. That’s the highest level since November 2011. The relationship known as skew was 9.4 on Feb. 18.

Verizon’s skew reached 6.5 on Jan. 21, the day before it reported fourth-quarter earnings, the highest since February 2013. It was 5.3 on Feb. 18.

“People might be getting out of the way or hedging their risks just based on the specter of new regulation and potential impacts it could have on that business and the profitability of that business,” John Butler, a telecommunications analyst for Bloomberg Intelligence, said by telephone Feb. 13. “AT&T could pause in its investment on upgrading its broadband network if it doesn’t know what the economics are going to look like in the future.”

Intrinsic Value

For some, next week’s vote will do little to affect AT&T’s intrinsic value. The company has jumped 1.5 percent this year, while Verizon has climbed 4.6 percent in 2015.

“It’s sort of rhetoric that is being used,” Paul de Sa, an analyst at Sanford C. Bernstein & Co. who rates AT&T a market perform and Verizon as outperform, said by telephone Feb. 17. “You’ll get a lot of noise about dangers and risks and all these things, so you’ll probably get a bunch of headlines but it has zero effect on any actual fundamentals.”

AT&T spokesman Fletcher Cook declined to comment on the options trading. Bob Varettoni, a Verizon spokesman, also declined to comment.

The number of AT&T shares sold short climbed to about 284 million, or 5.5 percent of shares outstanding, on Feb. 17, according to data compiled by Markit Ltd. That’s around the highest short interest since January 2007, Markit data show.

“Overall it’s a very profitable business for AT&T right now so any regulation of that business could threaten that profitability in unexpected ways,” Butler said. “Every new law has unintended consequences, unforeseen consequences.”