Sky has been given a huge advantage in the UK TV market – should you buy?

The market for phone services in the UK has become pretty competitive in recent years.

The stranglehold that BT once had on the domestic telecoms market has been well and truly broken.

Rivals such as Sky (BSY) and TalkTalk can now go into BT's local telephone exchanges, put in their own equipment, and supply broadband and phone services to customers. (This is known as 'local loop unbundling', or LLU).

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They still have to pay a monthly fee to BT, but they can then go and build a profitable business on top of that.

So it's rather ironic that the competition authorities now seem to have handed Sky a massive advantage in its battle to prevent BT from encroaching on its turf in the pay-TV market.

It's a decision that could have major implications for investors in both companies. Here's why...

Why telecoms companies need to worry about TV schedules

Everyone pays a monthly fee to watch TV, of course, unless you are 75 or over. You might not subscribe to any television service, but it'll still cost you £12.13 a month for a TV licence.

But if you decide that you want something more the latest Hollywood films or live football, say is there a level playing field? That depends on who you talk to.

Communications regulator Ofcom thinks that Sky is too powerful. But the competition authorities seem to think otherwise.

Last week, the Competition Commission ruled that the market for blockbuster films was fair. And on Wednesday the Competition Appeal Tribunal overruled another significant decision by Ofcom.

In early 2010, Ofcom forced Sky to sell its premium sports channels to the likes of Virgin and BT for a fixed price. This cut the price that Sky was previously charging by 23.4% for standalone channels, and by just over 10% for both channels as a bundle.

This was a good deal for football fans, and it kept Sky in check - after all, BT had been forced to cut its prices for years.

But this decision has now been overturned. It's a move that could have major implications for both customers and investors.

Why? Because pay-TV has become a key part of the triple-play' packages of phone, broadband and TV offered by telecoms companies. Having a single monthly bill makes life easier for households. It's also more profitable for companies, as they can spread more income over a lot of fixed costs.

So increasingly, your TV provider will end up being your internet provider too. That means a telecoms company needs to be able to offer attractive television packages to be able to win more broadband customers.

You only need to look at the recent football rights auctions to see this. BT sees live football as a vital part of its efforts to sell its BT Vision television service, and so sign up more profitable broadband customers too.

So it tried to take most of the live Premier League football rights off Sky.It failed to do so, and both ended up paying eye-watering amounts of money for the packages that they did win.

Does Sky now have an unstoppable advantage?

Unsurprisingly, BT is upset with the competition authorities' decision. BT currently sells Sky Sports to its customers at a small loss. It has one year remaining on its existing contract with Sky. Now that Sky no longer has to sell its channels to BT or charge a regulated price, BT's TV strategy could be left in tatters.

From next year, BT has 38 live football matches, while Sky has 116. BT needs Sky's subscriber base to buy its bundle of matches, in order to make its investment pay. But it's by no means certain that Sky needs the small number of BT customers who currently buy its sports channels.

Sky will probably continue to supply BT and Virgin Media's bigger customer base. But at what price? Will both have to sell at bigger losses, or face losing customers? It looks as though there's little standing in the way of customers having to pay higher prices to watch football.

As if this wasn't bad enough for BT, it looks like it will also have to cut the prices it charges its competitors for LLU and for renting capacity on its telephone lines. This means it's getting cheaper for Sky to take customers off BT.

Sky has 10.6 million household customers in the UK; four million of these take its broadband service. With Sky looking to make its TV packages more flexible, more customers could follow. And BT would probably be the biggest loser.

What does this mean for the shares?

It's hard not to feel a little sorry for BT. It was prevented from entering the TV market for years. Ofcom's ruling on sports channels gave it an opportunity and also meant more choice for customers.

Now, without a strong sports line-up at a fair price, it's hard to see how the £738m it has paid for football is going to stack up. Sky now seems to have the power to stifle BT's competition in TV. We've been big fans of BT shares, because we saw its TV business as a source of growth, but clearly we're less upbeat on this score now.

It's not all doom and gloom though. Fibre-optic broadband gives BT a very valuable asset, while it has plenty of surplus cash flow to keep growing its dividends. At 216p, the shares trade on 8.7 times this year's expected profit, and pay a 4.3% yield. At that level we'd be happy to hold on to the shares, but we're not rushing to buy more.

As for Sky, its competitive position looks stronger than it has for some time. That means that profits should keep going up. However, there's a limit to how much the company can keep raising prices in a weak UK economy. City analysts expect profits to grow by about 4-5% per year. With the shares trading on 13.7 times forecast earnings, and yielding 3.7%, they also look like a fairly-priced hold'.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here.

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