Analysts Warn Investors to Temper Baby Bell Enthusiasm
Monday January 6, 8:20 pm ET
By Tom Locke
Dow Jones Business News
DENVER -- Shares of Baby Bells were up strongly Monday on word the Federal Communications Commission may no longer require local phone companies to rent their networks to rivals at cheap rates.
But analysts warn that investors may getting ahead of themselves.
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"I think the market's sort of jumping the gun a little bit," said Davenport & Co. analyst F. Drake Johnstone.
Analysts point to many potential pitfalls. It isn't clear what the FCC will decide and what distinctions it will make between the small-business and residential markets. And it is unknown whether the regulatory changes will be made to all elements of the Baby Bells' local networks. Plus, it's possible litigation over such changes that could hold up implementation.
The regulatory changes would make it more expensive for competitors to lease network elements from the Baby Bells in order to compete with the Bells in offering local telephone service. In the last two years, some states have imposed steep discounts on the leasing of those elements, making it more attractive for competitors to provide local phone service.
Mr. Johnstone said that the states "are likely to battle the FCC tooth and nail," he said.
In addition, long distance companies such as AT&T Corp. and WorldCom Inc.'s MCI unit -- who have struggled to make inroads into local phone service -- would battle back legally and through marketing in the proposed two- year phase-in, he said.
Kaufman Brothers analyst Vik Grover thinks the FCC will take a compromise approach and not deregulate all of the network elements.
He thinks the FCC will only deregulate the leasing of the switching element of the networks. And he thinks the deregulation will only affect small business customers, and will occur over a two- or three-year time period.
Because companies like AT&T already have a number of their own switches in place, "this is not a big issue for them." Indeed, it was already in their plans, he said.
But Mr. Grover doesn't foresee switches or other elements of the networks, such as the "local loop" lines that reach residences, being deregulated.
Mr. Grover thinks the Bells could be hurt by regulation changes that would cost them wholesale revenue. The Baby Bells "are making plenty of money" in leasing network elements, he said.
Guzman & Co. analyst Patrick Comack said that the market prior to Monday had already anticipated the possible deregulation of the switch elements of the Baby Bells' networks for small businesses. But an article in Monday's edition of The Wall Street Journal appeared to imply that all the network elements, including the local lines out to homes, would eventually be deregulated, he said.
That would be damaging to long-distance companies such as AT&T and WorldCom's MCI because they are now able to compete with the Bells by getting the network elements below cost, he said.
Jefferies & Co. analyst Richard Klugman said that if competitors like AT&T have to use their own switches, it could still be tough for them to compete in offering local service. That may depend on the amount of cooperation provided by the Baby Bells in switching lines to competitive switches, he said.
Another question is how quickly the FCC would be able to implement any changes, particularly if states and long distance companies filed legal challenges. With the support of states, Mr. Klugman said, AT&T "would have a very good case for getting a stay" that would stop implementation of the new regulations.
All the Baby Bells rose Monday. Verizon Communications was up 8.9%, BellSouth Corp. (NYSE:BLS - News) was up 7.9%, Qwest Communications International Inc. (NYSE:Q - News) was up 10.2% and SBC Communications Inc. (NYSE:SBC - News) was up 8%.
AT&T Corp. was down 0.7%. Sprint Corp. was up 7.7%. It doesn't have the same exposure to the FCC regulatory issue as AT&T, said Mr. Johnstone.
None of the analysts cited own shares in the companies they cover. Guzman has had investment banking ties to some of the companies. The other firms don't currently have such ties to those companies.
AT&T spokeswoman Timi Aguilar declined to comment directly on the report in The Wall Street Journal or to speculate on the FCC's actions, but she did say that the leasing of unbundled network elements is necessary for local competition.
Competitors now provide 11 million local lines to residential and small- business customers through leasing network elements, and about 2 million of those are provided by AT&T, Ms. Aguilar said. The regulations regarding unbundled network elements apply to residences and small businesses, but not big businesses with a large number of lines.
The leasing of the network elements has been the most effective way for competitors to gain local customers, she said.
"We'd hope that they'd vote in favor of competition," Ms. Aguilar said of the FCC, and "not take away the most effective means of competition."
It would be too expensive and take too long for AT&T to build its own network, with lines extending out to residential neighborhoods and individual houses, Ms. Aguilar said.
It's "not a viable option," she added.
The Baby Bells are not being forced to lease network elements below cost, she said. "They're well above cost," she said. Indeed, in many states AT&T can't compete in offering local service because the wholesale rates for the network elements are too high, she added.
WorldCom spokesman Peter Lucht also stressed that the Baby Bells are not losing money on the leasing of network elements, and that such leasing is " vital" for competition.
He also stressed that the state commissions are closest to the consumers and they should continue to have power in setting rates on network elements.
WorldCom provides customers 2.5 million local lines, either standalone or in conjunction with long-distance service, and competition is really starting to take hold in the local-service arena, Mr. Lucht said.
"Just when it's starting to work, there's the threat of it being eliminated, " he said.
Deregulation of the switch element is not favored by WorldCom for at least two reasons, according to Mr. Lucht. Of the 8,000 Baby Bell central offices that house their switches nationwide, WorldCom has its own switches connecting to only 431, he said. Plus, there are technical and other difficulties in connecting the switches of the Baby Bells with those of their competitors, he said.
The FCC is required under the Telecommunications Act of 1996 to review its rules under the act every three years, said Mr. Lucht, and the attention to its policy regarding network elements is part of that review process.
He declined to speculate on how the FCC might rule. "We continue to be engaged with the FCC," he said.
Analysts generally agreed that, if network elements become deregulated, it is unlikely that competitors would compensate by building their own networks with lines that would reach out to residential customers.
Mr. Johnstone said it's important for the long-distance companies to be able to bundle local and long-distance services in order to compete with the Baby Bells, which have been entering the long-distance market in their local-service areas.
While Mr. Johnstone thinks that the discounting of rates for network elements has been too steep in some instances, he doesn't favor an elimination of regulation of the amount charged because of the loss of competition it would entail. "There's got to be a happy medium," he said.
-Tom Locke, Dow Jones Newswires; 303-293-9294; tom.locke@dowjones.com |
