open pdf version​We live in a world that is constantly evolving, especially when it comes to business. Companies are routinely looking for ways to maximize the value of their operations by purchasing industry peers or divesting themselves of divisions that would be worth more in the hands of other owners. As investors that focus on a shortlist of stocks in deep detail, we have found select companies that are going through an acquisition or divesture and therefore can provide attractive opportunities for your portfolio. We are excited to have this as part of our process because this corporate practice is as old as the telephone.

“Ma Bell”, the beloved monopoly

Ma Bell

Over 140 years ago, Alexander Graham Bell founded the first telephone company, American Telephone and Telegraph (AT&T), that would later be known colloquially as “Ma Bell” or Mother Bell. What would follow is one of the longest string of corporate acquisitions and dispositions in modern history. It is through that long journey we can see the repeated and unsuccessful attempts at changing the face of the economy. There is also a rich history around Bell Labs and the technologies that have come to define our modern world today (transistors, the graphical user interface – G.U.I. – a precursor to Windows 1.0) but let’s save that for a future blog.

Just after the turn of the century, it became clear that AT&T was becoming a monopoly by having the best technology which was, at the time, being able to offer long distance calling. In addition, the U.S. government was getting concerned about AT&T’s unwillingness to allow competitors to connect to their network. This was Ma Bell’s first big run-in with the federal government, and they just barely avoided nationalization with the Kingsbury Commitment, the first attempt at defying economic reality. At the time it was clear that this was a business where scale wins and large scale allows for the ability to invest in cutting edge technology such as long-distance calling.

It took almost 70 years, but the government finally succeeded and ushered in the era of the Baby Bells.

Baby Bell era

In 1984, on the cusp of losing another anti-trust monopoly lawsuit, AT&T voluntarily decided to break itself into seven Regional Bell Operating Companies (RBOC), better known as the Baby Bells. Each of the new companies were limited to their existing regions, thus limiting the ability to rebuild the national network.

Southwestern BellIt took the introduction of the Telecommunications Act in 1996 to encourage more competition and that mergers were allowed between the Baby Bells. Southwestern Bell which had at the time been the smallest of the Baby Bells pounced on the opportunity and initiated a string of acquisitions to combine operations, improve service and lower total costs. The journey came full circle when, in 2005, Southwestern Bell completed a $16 billion acquisition of the old assets of AT&T. By 2006 the last of the Baby Bells had been merged into either AT&T or its competitor Verizon Communications (the former Bell Atlantic).

AT&TIn the 30 years after this historic break-up, the U.S. telecommunications industry returned to a consolidated market with two large players – AT&T and Verizon – with a challenger in the new T-Mobile/Sprint. During this entire period of divestures and mergers, it became clear that economies of scale were very powerful in this industry and bigger was in many ways better. For over 100 years, customers have demanded the best network and the lowest prices. Serving those customer demands having a large footprint and the scale to invest in the future. The only thing that changed was what customers wanted. A cutting-edge network in 1910 might have been a good signal from Chicago to New York. Today we are ushering in the 5G era with high-end smartphones and the Internet at our fingertips.

Understanding economic reality

Our portfolio is not invested in AT&T, so why the history lesson, Dan? In our minds the history of AT&T is a perfect example of economic reality prevailing time after time. Telecommunications is a naturally consolidating market to a few large players.

During our deep dive research on businesses, the question we always ask is what is the long-term structure of the industry and will this create value for shareholders over time? For some industries that are still going through this consolidation process, there is significant potential opportunity. A well thought out acquisition of a competitor or supplier can be attractive financially in the upcoming few years and re-enforce the competitive advantage in the long-term. There are many different forms, and some can be high profile, such as Facebook buying Instagram, but others may fall under the radar. Our objective always remains the same, making sure we’re aligned with economic reality.

Closing thoughts

Analyzing businesses that are actively allocating capital is one of the more technically challenging parts of our research, but we believe the effort is worth the reward. It comes as no surprise to us that passive, smart beta and other rules-based strategies have decided that this part of the stock market is not for them. After all, these strategies are built on having clean and standardized data fed to a machine. A merger cannot easily be processed; it simply does not compute. We are committed to rolling up our sleeves and getting to the bottom of the economic reality so you may benefit with better risk-adjusted returns.

 

Dan Rohinton, Portfolio Manager

P.S. If you’re a business history nerd like I am, you will surely find the life and dealings of Jay Gould fascinating. One of the notorious robber barons at the time he built Union Pacific, he dominated the New York press and the telegraph industry while also manipulating stock prices of competitors. He was instrumental in unintentionally paving the way for AT&T to be born.

 

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Published July 13, 2020