6
Month Market Review
Telecom
and 1997
Telecommunications Act
of 1996 Meets 1997
by Dale Wettlaufer
(TMF [email protected])
Pricing the New Market
Lamenting the headlines about increased rates for cable TV services and his
perception that rates for phone service were going up, Senate Commerce Committee
Chair John McCain (R-Ariz.) told The Washington Post earlier this year, "What
the
[Telecommunications
Act of 1996] tried to do is ensure there were no losers." So far, consumer
groups and many in the media have tried to portray consumers as the losers
and big business as the winners. To this point, though, it's not so cut-and-dry.
While it can be extremely difficult to legislate fairness for all groups
across industries representing hundreds of billions of dollars of annual
revenues, it is awfully early to tell whether the telecom bill has hit its
intended goals. Although the capitalist system adapts very quickly to
opportunities, the long-term consequences of major legislative sea changes
are not always clear within two years of those changes.
According to the same Washington Post article, rates for long-distance
phone calls increased at twice the rate of CPI inflation last year, and much
more for those consumers not using discount calling plans. So why did
AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> have such a horrible year in 1996 and why isn't
1997 turning out any better? According to the Post, the AT&T's share
of the long-distance market fell one percentage point in 1996. That's $700
million dollars considering that U.S. long distance service is a $70 billion
market.
AT&T is also spending significant amounts of money haggling with its
former Babies (the Regional Bell Operating Companies, or RBOCs) about how
much it will pay to reach the local customer and how much it will charge
for its former Babies to reach out and touch someone through AT&T's network.
In the short term, prices may blip up or down, but price deflation in long
distance is a firmly established trend, which was only accelerated by the
full opening of the telecom market after the 1982 Consent Decree that broke
up Ma Bell.
The Local Loop
Moving forward to 1997, the nexus of competition is still the local loop
and the pricing of access to the customers in the local access and transport
area (LATA). Pricing hasn't really been hashed out in local loops, given
that that the FCC didn't release an order on pricing and interconnection
standards until August 1996. Between the beginning of 1995 and the passage
of the Act, performance of the shares of BELL ATLANTIC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BEL)") else Response.Write("(NYSE: BEL)") end if %>,
NYNEX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NYN)") else Response.Write("(NYSE: NYN)") end if %>, SBC COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SBC)") else Response.Write("(NYSE: SBC)") end if %> and other RBOCs
was excellent. From the open to the close of 1995, these companies returned
on average 40% to their shareholders, before dividends. 1996 wasn't so kind;
these stocks on average have returned 7.1% (before dividends) since the beginning
of 1996. Annualizing those gains, these stocks have returned 4.8% per year
before dividends and perhaps a shade over 9% per year, pre-tax, adding in
dividends. These are not exactly monopoly-type returns.
The conclusion one can draw from the performance in the shares of these companies
is that the Telecom Act hasn't unleashed a great new torrent of profits from
the massive physical plants of the RBOCs. There is still a disincentive to
maximize profits as long as state public utility commissions can dictate
the pricing and return on equity for basic telephone services. That leaves
the RBOCs to compete in the arena of business dial tone and data services,
which is more lucrative -- and more competitive -- than local access for
residential customers.
This is an area where MCI <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %>, whose pending merger with BRITISH
TELECOMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BTY)") else Response.Write("(NYSE: BTY)") end if %> was made possible by the Telecom Act,
has excelled in the last few years. With competition in the commodity
long-distance field so intense, MCI knew that it would have to concentrate
on hooking up businesses into its worldwide fiber optic, satellite, and microwave
network, allowing customers to do all their telecommunications shopping with
a single provider. Faxes, teleconferences, and voice all go out onto corporate
telecommunications backbones provided through the fiber of the unregulated
MCI and companies like WORLDCOM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCOM)") else Response.Write("(Nasdaq: WCOM)") end if %>.
While AT&T was busy with consumer services and wooing customers back
to AT&T long distance with cash rewards, MCI was gaining more corporate
profits from business services. Most observers aren't worried that Ma Bell
will somehow return to the days of being the long-distance overlord, even
if there is a merger with SBC. There are simply too many resellers of long
distance and too many wholesalers competing on the consumer side, such as
LCI <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LCI)") else Response.Write("(NYSE: LCI)") end if %> and FRONTIER COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FRO)") else Response.Write("(NYSE: FRO)") end if %>. On
the business side, AT&T has been, and will continue to be, occupied by
competition from the likes of MCI, Worldcom, SPRINT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FON)") else Response.Write("(NYSE: FON)") end if %>, and
within the next ten years, MOTOROLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MOT)") else Response.Write("(NYSE: MOT)") end if %>, which is planning
multiple high-bandwidth satellites that will act as another part of the network
backbone as well as a link directly to the customer in the not-so-local loop.
Data Moves Onto the WAN
The proliferation of data services would have happened with or without telecom
reform, and many have participated in the megatrend of data moving off the
local area network (LAN) and onto the wide area network (WAN) by owning stock
in the equipment providers that facilitate the trend. One of the greatest
successes of the decade has been CISCO SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %>, which
is now worth more than any of the Big Three auto companies. The company's
biggest-ever acquisition came in 1996 when it acquired Stratacom in a deal
worth more than $4 billion. That company makes frame relay switches and ATM
switches, both of which are installed on the WAN and are used for corporate
access to the network and to control the flow of data across those networks.
The leader in frame relay, CASCADE COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCC)") else Response.Write("(Nasdaq: CSCC)") end if %>,
this year agreed to merge with ASCEND COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ASND)") else Response.Write("(Nasdaq: ASND)") end if %>
in a bid to match Cascade's proficiency at building equipment for the core
of the telecom networks with Ascend's leadership in putting together equipment
that allows users to access the network. Neither of these companies have
had a strong year so far, as managements at companies like NYNEX, Bell Atlantic,
Pacific Bell and SBC were focused on mergers and not capital expenditures
in the first half of the year.
Cable Hot Again, Chased By xDSL
Cable companies are hot properties once again, not because they've taken
advantage of the pricing and service freedom given by the Telecom Act, but
possibly because they have not taken advantage -- and thus became, for a
short time, quite inexpensive (possibly to the point where it's cheaper for
them to buy networks than build new ones). A major catalyst in making investors
sit up and notice the value of the high bandwidth cable pipe into consumers'
homes was a $1 billion investment in cable operator COMCAST <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CMCSA)") else Response.Write("(Nasdaq: CMCSA)") end if %> by Microsoft. With that cash, Comcast will be able to upgrade its
systems, which are not ready for the two-way transmissions needed in a
deregulated world if they're anything like that of the country's overall
cable plant. Only about 10% of cable systems are ready for two-way data
communications and telephony.
Since the day before the Microsoft investment in Comcast,
TELE-COMMUNICATIONS INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TCOMA)") else Response.Write("(Nasdaq: TCOMA)") end if %> has appreciated 12%, Comcast
17%, and CABLEVISION <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: CVC)") else Response.Write("(AMEX: CVC)") end if %> 53%. Despite the cries that deregulation
has only resulted in laissez-faire pricing for these companies, they have
created zero shareholder return since the Telecom Act went into effect. No
major cable company has made telephony and data services available on a
widespread basis despite the provisions of the Act that allow them to do
so. At the same time that cable companies have stalled with advanced equipment
deployments like their cousins at the Baby Bells, new entrants like direct
broadcast satellite operators DirectTV and USSB <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USSB)") else Response.Write("(Nasdaq: USSB)") end if %> have ushered
in the era of untethered digital competition.
New Service Providers and Capabilities
Competitive local exchange carrier (CLECs) and Internet Service Providers
(ISPs) who have filed for CLEC status to offer expanded services will have
an advantage in the current highly regulated world of deregulation. Those
companies will be taking advantage of an arbitrage possibility, or a market
inefficiency (a favorite topic of DMG Technology Group analyst Bill Gurley),
that has arisen from the push-pull regulations that have come forth from
various federal and state agencies.
While the state public utility commissions still have pricing control over
the RBOCs (justified by the mandate for universal service for the disadvantaged
and rural customers), Reed Hundt of the FCC has championed the non-tariff
status of "advanced telecommunications providers" such as UUNet (a division
of Worldcom) and PSINET <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PSIX)") else Response.Write("(Nasdaq: PSIX)") end if %>. Either as an ISP or as a CLEC,
these companies (or other utilities) will be able to offer packet-switched
telephony that will allow them to avoid the local access fees charged to
traditional circuit-switched telephony providers. Originally, the FCC made
this rule to promote new technologies and avoid smothering in the cradle
the infant data communications industry.
Now, though, digital signal processors, equipment, and software made available
by companies such as NATURAL MICROSYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NMSS)") else Response.Write("(Nasdaq: NMSS)") end if %>, VOXWARE
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VOXW)") else Response.Write("(Nasdaq: VOXW)") end if %>, and VOCALTEC <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VOCLF)") else Response.Write("(Nasdaq: VOCLF)") end if %>, will allow consumers
to make full two-way phone calls and send faxes over the Internet without
paying "tolls" to the Baby Bells. Of course, the consumer with the
INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> equipped PC will be the first to take advantage
of these services. Whether or not the RBOCs will rise to the challenge remains
to be seen, but the so-called Data Coalition made up of companies such as
AMERICA ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> and NETSCAPE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NSCP)") else Response.Write("(Nasdaq: NSCP)") end if %> will
be hip deep in the competition.
Why AT&T Wants to Grow
This is one of the major reasons for the combination of Nynex and Bell Atlantic
(still in process) and the already consummated merger between SBC (formerly
Southwestern Bell) and Pacific Telesis (formerly Pacific Bell). To compete
with specialized competitors such as AOL, the heavily regulated RBOCs will
need all of the capital strength they can get. Without telecom deregulation,
these mergers would not have been allowed to happen under the provisions
of the Consent Decree that separated the Baby Bells from Ma Bell.
Such mergers will allow local phone companies sufficient critical mass to
provide the backbone and the connection to the local loop, and to match up
with the inevitable competition that will be required if these companies
want to get into the long-distance business. Regulators have called a
widely-rumored AT&T - SBC merger unthinkable, but this is another example
of companies needing the size to generate economies of scale large enough
to provide the lowest-cost service while having the latitude to invest in
highly intelligent but capital-intensive new technologies.
As the reader can plainly see, the effects of telecom deregulation are only
now being felt in many corners of the industries included in the legislation's
purview. Far from being an immediate boon to these industries as investors
were hoping in 1995, 1996 and early 1997 were times of confusion and, in
some corners, slight paralysis. With the developments in the cable industry
in the last few weeks and with enabling technologies that will position the
more entrepreneurial competitors in offering local access services, the present
telecom giants face more of a fight than impatient consumer groups and the
media would have us believe |