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Yesterday, Bloomberg reported that satellite TV operator DISH Network Corp. (DISH - Analyst Report) recently sent feelers out to its closest rival DIRECTV (DTV - Analyst Report) for a possible merger. In response to the news, yesterday, the stock price of DISH soared $3.67 (6.28%) and that of DIRECTV rose $4.17 (5.7%). However, neither company confirmed the report. Currently, DIRECTV carries a Zacks Rank #2 (Buy) and DISH has a Zacks Rank #3 (Hold).

In 2002, the Federal Communications Commission (FCC) denied a merger proposal between DISH and DIRECTV citing that it will create monopolistic power in the U.S. pay-TV industry. However, the ground reality of the pay-TV industry has witnessed massive changes since then. At that time, cable TV and satellite TV operators were the only video service providers.

However, these traditional players are facing intense competitive pressure from fiber-based video offerings of large telecom operators and the significant growth of low-cost video streaming providers such as, Netflix, Amazon TV, Hulu etc.

According to SNL Kagan, in 2013, the U.S. pay-TV industry lost 251,000 subscribers. At this juncture, attaining economies of scale, deriving significant cost synergies and technological improvement has become critical for the traditional cable and satellite TV operators.

This might have led to the proposed merger U.S.’s two largest cable TV operators, namely, Comcast Corp. (CMCSA - Analyst Report) and Time Warner Cable Inc. (TWC - Analyst Report). The deal is currently awaiting regulatory approval. The combined entity of Comcast and Time Warner cable will have around 33 million video, 32 million high-speed broadband (Internet) and 16 million telephony (voice) subscribers.

On the other side, the DISH-DIRECTV merger will create a pay-TV behemoth with around 34 million video subscribers. However, satellite TV operators, by their technical nature, cannot offer broadband or telephone services.

Meanwhile, DISH has created an extremely powerful portfolio of wireless spectrums, which according to several analysts, can be monetized for approximately $26 billion. However, management is yet to take a decision whether it will build its own wireless network or will team up with any existing operator or simply monetize the asset.

We believe that if the Comcast-Time Warner Cable merger proposal gets regulatory approval then a merger between DISH-DIRECTV will also go through. However, some analysts raised concerns.

While Comcast’s and Time Warner Cable’s operations overlap in very few U.S. markets, the largest two satellite TV operators DIRECTV and DISH are both operating in almost all U.S. markets. Therefore, a merger between these two will effectively reduce an alternative source of pay-TV for consumers.

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