Bad Connection: Telecom woes;from Forbes
Bad Connection
Scott Woolley, 08.12.02
The giant local phone companies appear to have escaped unscathed in the telecom crackup. Look again: They may well become the final pillar to crumble.
Wall Street has a perverse name for the Baby Bells. They are "cockroaches." An asteroid has destroyed the whole long-distance and fiber-optic sectors, but somehow the local service providers have survived. Verizon, SBC and BellSouth made a combined $20 billion of profit last year and have a collective market value of $240 billion.
1.7 million
The number of cable company lines now used for local phone service.
67%
The average annual growth in the time Americans have spent talking on cell phones over the last five years.
20 million
Bell phone lines now leased by competitors at wholesale prices.
1933
The last year, prior to 2001, that the number of local phone lines in the U.S. shrank-in the depths of the Great Depression.
9 million
The net number of local phone lines cut off in 2001.
So far the Bells' stamina on Wall Street has been remarkable. The stock prices of Verizon, SBC Communications and BellSouth have fallen on average 30% in two years, easily beating the overall market and trouncing Sprint, Qwest, Level 3 and WorldCom, whose shares are off anywhere from 70% to 100%. Investors sought refuge in what had long been one of the most predictable and reliable businesses on the planet. Local phone service has grown, in good years and bad, for seven decades.
Let the shareholder beware: These telecom behemoths are nowhere near as healthy as they appear. While they aren't about to become extinct, neither are they the cash machines they seem to be. Most of those glorious profits are being poured into maintaining equipment or upgrading to meet new competitive threats. In the five years from 1998 through 2002 the Bells will have sunk $140 billion into capital expenses in their local, long-distance, data and international markets. This monstrous outlay will bring them annual revenue growth in those same areas of 2.5%, barely ahead of inflation. Philip Jacobson, an analyst with Network Conceptions in Vienna, Va., puts it succinctly: "The Bells have shown the ability to invest a lot of money with very little result."
Even as the Bells stand triumphant, the 20th-century foundations of their business have begun to fracture. The Baby Bells could one day be exposed as the last great telecom illusion, undone by a combination of an overwhelming wave of new competition--from cable, wireless, resellers and elsewhere--and their own underwhelming success at diversifying into new services such as Internet access. They are on a capital-spending treadmill, and the treadmill is picking up speed.
Competition and price-cutting that first struck the long-distance business and then cell phone service are now spreading to local service. The Bells' phenomenal strength is rooted in their absolute lock on the nation's 180 million local phone lines and the seeming inevitability that, each year, they will continue to lay still more. But last year the total number of local phone lines declined 4.7% from the year before as customers cut off 9 million more lines than they added, according to the Federal Communications Commission. Since AT&T was founded in 1885, government stat-isticians have recorded a drop in phone lines only once before, during the Great Depression.
The line decline in 2001 was a direct result of the ferocious assault on the Bells from all sides. As many as 3 million customers decided to forgo a home phone last year, going wireless instead. Cable operators are beginning to offer local phone calls on their rebuilt lines, and poached 600,000 Bell customers last year. Another 2 million households canceled the second phone lines they were using for poky dial-up access to the Internet; high-speed cable access and DSL don't interfere with regular phone service, making second lines superfluous. BellSouth workers used to go into new suburbs in the Southeast and confidently bury thick bundles of wires containing 1.5 to 2.5 phone lines for every home in the neighborhood; this year its workers began burying just one phone line for every home its wires pass.
The erosion began to show up last month in BellSouth's second-quarter report, as sales fell 3.5% and earnings plunged 67% on one-time charges, sending the stock down 18% in a day. Verizon and SBC were also expected to report further phone line losses.
It gets worse. The Bells now lease 20 million lines to resellers, up 32% last year, and they're forced to rent out these precious tendrils at regulated prices that are often just two-fifths what they get from consumer accounts. Competitors leasing those lines can exploit weaknesses in the Bells' kooky pricing structures, relics of their days as regulated monopolies, to steal the most profitable customers. The Bells count on 95%-plus operating margins on newer features such as caller ID and voice mail to juice their earnings, since basic monthly fees remain regulated. MCI's new Neighborhood Complete plan offers unlimited local and long-distance calling for $50 or $60, depending on the region, with caller ID, call waiting and voice mail--so valuable to the Bells--thrown in free of charge. Since launching the plan in April MCI has landed 600,000 customers and is signing up 200,000 more each month.
The Bells will have a hard time holding off the panoply of new competitors, says David Dorman, recently named chief executive of AT&T and a former chief of Pacific Bell. As newcomers steal the fattest customers, the Bells will get stuck serving the low-spending, high-cost ones. "Inexorably," he says, "cable and wireless are going to eat into their share."
For six years the Bells have been bracing for this onslaught, steeled by the passage of telecom deregulation in 1996 and eager to counterattack by moving into long distance and Internet access. But their foray has been expensive, and the new-growth markets have proven disappointing. The Bells fought hard for the right to sell long-distance service, something they were banned from doing in the 1984 antitrust breakup of AT&T. It has been a Pyrrhic victory. As of April Verizon and SBC (the only Bells to have won the right to sell long distance in their home states) handled long-distance calls for 13.5 million customers, almost double the total of 18 months ago. Yet their long-distance revenue in that same period declined. In the most recent quarter it was $1.5 billion, off 6% in a year and a half (see chart, below).
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