5/24/98 WashPost. The Telecom Big Top Firms Old and New Jockey for Position on Fiber-Optic High Wire
By Mike Mills
Washington Post Staff Writer
Sunday, May 24, 1998; Page H01
washingtonpost.com
Keeping track of today's confusing telecommunications landscape is like
having a seat in the bleachers at an out-of-control three-ring circus:
Out front are those agile elephants, the Bell operating companies. They've
been linking up, trunk to tail, and trying to keep local telephone
competition at bay, even as they try to nose their way into the
long-distance business.
On the trapeze are the long-distance aerialists -- AT&T Corp., MCI
Communications Corp. and WorldCom Inc. -- trying to stay trim so they
can swing past the Bells into the local telephone market.
From out of the cannon come hot-shot new competitors such as Qwest
Communications International Inc., Level 3 Communications Inc. and
E.spire Communications Inc., each building next-generation data networks
that will undercut the prices and services of their slower, older rivals.
Overseeing it all are federal lawmakers and regulators, the supposed
ringmasters and lion tamers overseeing the big tent. After all, this whole
circus is in town because of the Telecommunications Act of 1996 and its
promise that new competition will force down prices and improve choices.
How is the Federal Communications Commission doing with its head in the
lion's mouth? Smart money is betting on the lion.
Have we missed anyone? Oh, yes: you, the residential telephone customer,
up there in the nosebleed section. Sorry, but this circus has always been
primarily for the business customers down in the expensive seats.
Did you really expect this competitive parade to march past your house so
soon? Well, to paraphrase P.T. Barnum, there's a local phone customer
born every minute.
Metaphors aside, telecommunications is probably the hottest, most
dynamic industry in the world these days. The action is confusing, with so
many companies competing in so many new areas of service. To help
readers understand this fast-moving business story, here's a guide to the
three main acts under the telecommunications big top.
Sorry -- no refunds.
Act 1: The Dancing Elephants
Of Local Phone Service
SBC Communications Inc. stunned even the most jaded observers of the
telecommunications world with its May 11 offer to buy Ameritech Corp.,
another Bell pachyderm that controls the local telephone lines in the
Midwest. SBC, which serves the Southwest from its base in San Antonio,
offered to pay $62 billion in stock for Chicago-based Ameritech. That's a
big deal, even by telecom standards.
Control of local service is certainly SBC's strategy. The deal with
Ameritech would give SBC control over one-third of the nation's local
telephone lines, about 57 million circuits coursing through territory covering
70 percent of the nation's population.
True, SBC would be buying yet more old copper phone networks leading
to more low-spending residential customers. But when your base is thin
ice, the trick is to lie down and spread out: Paradoxically, SBC can better
profit from its low-capacity copper infrastructure by buying more of it and
cutting overhead.
And there's still great money to be made in the local residential business --
particularly if you have it all to yourself. Second phone lines, voice mail,
caller identification, Internet access (including new, faster DSL and ISDN
technologies) and alarm services all are hugely profitable add-ons to basic
dial-tone service.
SBC also is eyeing Ameritech's $9 billion in revenue from toll calls within
state lines -- say, from Chicago to Peoria. That market is becoming
competitive more quickly than the local market, but SBC hopes to
continue dominating toll calling, particularly for regional business
customers.
At a Senate hearing last week, SBC Chairman Edward E. Whitacre Jr.
was asked how many huge phone companies would be left when all the
merger-mania finally settles down. In the end, he said, global competition
will reduce the number to four: AT&T and whomever it acquires, a couple
of foreign giants such as Deutsche Telekom AG and British
Telecommunications PLC, and "a Bell company."
Not seven Bell companies -- the original number when the old AT&T
monopoly was busted up in 1984. Not six -- the number after SBC bought
Pacific Telesis Group Inc. in 1996. Not five -- the remaining number after
Bell Atlantic Corp. bought Nynex Corp. last year. And not four -- the
number that will remain if SBC is allowed by regulators to buy Ameritech.
The others, his answer implied, will be swallowed up -- by an AT&T or a
WorldCom, by a large foreign carrier, by GTE Corp. or by another Bell
company. While few would argue that some consolidation was inevitable in
the industry, the sponsors of the Telecommunications Act clearly were
hoping these companies would fight it out, not get married.
The merger wave is likely to produce a telecom version of the airline "hub
system," with giant carriers dominating regions of the country -- exerting
price control in their home territories while "competing" in a global market,
according to many critics.
Wall Street likes telecom mergers. And it's not just because of those three
"S" words -- scale, scope and synergies -- that CEOs mutter at the
podium during their merger announcements.
It's a fourth "S" phrase: stock value. In a high-flying stock market, where
shareholders play the role junk-bond traders did back in the '80s, the
rewards go to the companies -- and chief executives and investment
bankers -- that can grow through acquisition rather than competition.
SBC's stock value has nearly doubled since it bought Pacific Telesis a year
ago, and Bell Atlantic's has risen almost 50 percent since it bought Nynex.
Brokerage houses and investment banks encourage such deals and reap
billions in fees from them.
"The market hates uncertainty and hates competition. And, generally,
corporations think the biggest boat sinks last," said Scott Cleland, an
analyst for the Legg Mason Precursor Group in the District.
Mergers even have been scuttled because the target company seemed too
eager to compete. Last summer, British Telecom was all ready to buy
MCI for $37.50 a share. But the Brits got skittish about MCI's announced
plans to spend $800 million to attack the U.S. local telephone market.
BT's displeasure caused MCI shares to sink, which led BT to demand a
lower price for MCI. Sensing a loss of billions in stock value, Salomon
Brothers Inc. -- the brokerage firm working the deal -- alerted WorldCom
that MCI would be a spectacular buy. After all, WorldCom already was
spending big on local fiber optics. Now WorldCom is buying MCI for $51
a share, and the local service strategy is focused on business customers.
Act 2: The Long-Distance Trapeze Artists
AT&T has been acting uncharacteristically sure-footed lately. The
company is almost, well, nimble.
Determined to revamp the nation's largest phone company in the way that
Louis V. Gerstner Jr. transformed International Business Machines Corp.,
AT&T Chairman Michael Armstrong has made some daring moves on the
trapeze -- each aimed at putting AT&T back on the offensive after several
years of disarray.
His strategy: Observe the most cutting-edge tactics of his rivals, then
imitate them. His recent marketing arrangements with Yahoo Inc. and
Excite Inc. mimicked MCI's moves to ally with the hottest World Wide
Web companies. Where MCI had struck a deal to market Internet
services on Yahoo's front page, AT&T is now using that same page to sell
long-distance services.
Armstrong also watched closely when regional Bells US West Inc. and
Ameritech recently announced "team marketing" arrangements to sell
long-distance service in their territories under the brand name of Qwest, a
Denver-based company building a new nationwide fiber-optics network.
The Bells aren't supposed to be offering long-distance service -- at least
not until they convince regulators on a state-by-state basis that they've
done enough to make their local phone markets open to competitors. US
West and Ameritech claim this marketing arrangement with Qwest doesn't
violate the ban; MCI and others say it does.
So what did Armstrong do? Instead of simply filing suit to stop the Bells,
he offered them the same deal to market long-distance service under the
AT&T brand name.
His gambit puts AT&T in a win-win situation: It exposes the Bells' strategy
by asking regulators, "If it's okay for the Bells to align with Qwest, why not
AT&T?" And if the Bells ultimately are allowed to engage in such
marketing deals, AT&T will be among the first providers of wholesale
long-distance service to them.
The other long-distance trapeze artists, MCI and WorldCom, have been
quieter lately, as they struggle to overcome regulatory problems with
WorldCom's pending $37 billion acquisition of MCI. Either MCI or
WorldCom may be forced to divest some of their Internet transmission
facilities to appease regulators here and in Europe. That would be a big
price to pay for merging: They, as well as Sprint, have long known that the
future is in the data world -- not in the slower-growing business of
providing voice long-distance service.
The most volatile factor in the long-distance market is the
Telecommunications Act. The Bells and GTE have tied up the telecom act
in the courts, arguing over whether the states or federal regulators should
determine prices for competitors who lease local phone networks.
But the deeper problem, according to some analysts, is that the incentive
approach envisioned by the 1996 act no longer works. Here's why:
The Bells can't get into long-distance service until they make it easy for
competitors to hook into their own local telephone networks. So far no
Bell has done so -- though Bell Atlantic might be coming close in New
York.
But some say the Bells are concluding that the cost of losing local
customers is no longer worth the benefits of offering long-distance service
under their own brands.
During debate on the 1996 law, long-distance rates were a hefty 22 cents
a minute and the industry was growing nearly 20 percent annually. The
Bells estimated they could quickly lock up 30 percent of the $70 billion
market.
Two years later, long-distance service has become a commodity. Calls to
Europe are just 12 cents a minute on most discount calling plans, and a
dime or less domestically. Revenue and traffic growth rates have slowed to
below 10 percent. And new technologies that divide the light waves in
fiber-optic trunk lines are increasing capacity at little cost.
"The Bells recognize the long-distance industry no longer offers enough
allure to make the trade" for opening their local markets to competitors,
said Gerry Salemme, a former AT&T lawyer and lobbyist who now helps
cellular mogul Craig McCaw run a competitive local phone and data
company called Nextlink Communications Inc.
SBC made little mention during its Ameritech announcement of its interest
in entering the long-distance market. Instead, the company essentially
made this deal to regulators: Approve our merger and we will more
aggressively compete against other Bells and GTE in the local market.
Act 3: The Human
Cannonball of
New Data Networks
Rebecca Johnston, an office manager at a downtown law firm, won praise
for cutting the firm's monthly telephone bill by $100 a month, to an average
of $800 for its 10 phone lines. It was simple, she said: One day late last
year, a company she had never heard of -- Winstar Communications Inc.
-- came in and persuaded her to fire Bell Atlantic as her local phone
company.
"They still call me now and then to see if everything's okay," Johnston
marveled.
Winstar, like McCaw's Nextlink and E.spire in Annapolis Junction, Md., is
part of a new breed of "competitive local exchange carriers" that are
trouncing the Bells in downtown business markets.
Their strategy is simple: Pick off the Bells' most lucrative corporate
customers with low-cost packages of local and long-distance phone
service and data and Internet services.
"The new carriers collectively are shaking the very roots of the
telecommunications industry, even though some carriers who are asleep do
not seem to feel the shaking yet," said Denver consultant Frank Spitznogle.
"We're going to see extreme price pressure on a number of the services
that all the Bells offer."
SBC's Whitacre understands his company's core weakness. It's the same
vulnerability faced by every incumbent local phone company: The nation's
circuit-switched telephone network is gradually being replaced by a new
computer network architecture based on Internet protocol, or IP.
Let's put that in English: There are Bell Heads and there are Net Heads.
Bell Heads have prospered for nearly 100 years by building closed circuits
to every home and business, giving people their own private high-quality
voice connections.
Net Heads believe that today's circuit-switched telephone system makes
about as much sense as closing down an entire lane of a road so a single
car can drive to the grocery store. Instead, they want voice and data to
travel in the form of inexpensive packets, which travel at high speed
through the ether of computer networks and optical fibers and reassemble
themselves at the other end.
The change from circuit to packet is happening first for large business
customers that move large volumes of data over networks. But gradually it
will reach down to smaller businesses and, ultimately, consumers.
The rush of IP technology could lead the Bells to cannibalize their business
market, some analysts say. Voice service, which takes up relatively little
"bandwidth" on packet-based computer networks, will essentially become
free to customers with high-speed data networks. That will cost the Bells
billions in lost revenue.
The exploding business of providing "voice over the Internet" illustrates
how this already is happening. Qwest, IDT Communications Inc. and other
companies are offering long-distance service for as little as a nickel a
minute -- though customers must dial extra digits. Free international phone
service, at much lower quality levels, also is available to hobbyists with the
right software.
SBC and other Bells realize this, of course, and are taking steps to join the
revolution. Ameritech has been working closely with IBM on building data
networks. SBC has struck transport deals with Qwest. And Bell Atlantic,
SBC and other Bells are asking federal regulators for permission to
transport data across long-distance calling boundaries.
But how long will it take these futuristic data networks to reach residential
customers?
The best hope, many analysts say, is that local Bell companies will deliver
on their promises to bring high-speed digital technology to homes. But,
given the Bells' slow pace in rolling out ISDN, a decade-old technology for
faster Internet access, they shouldn't hold their breath waiting.
Unless, that is, some new acts come along to make the telecom circus even
wilder. There are several candidates:
Cable television could finally perfect an inexpensive way to handle
two-way data over its coaxial lines, turning cable systems into wide-area
computer networks that offer cheap phone service and lightning-fast
Internet access.
Wireless services, in areas unobstructed by hills and trees, could prove a
viable source of local phone and Internet competition. AT&T Wireless's
recent nationwide cellular pricing plan, 1,400 minutes a month anywhere in
the United States for $149.99, points to a world of flat-rate pricing no
matter where you're calling -- or where you're calling from. That's almost
low enough to start thinking about using your copper phone line only for
Internet access.
At least one unusual company, RCN Corp., claims it wants to immediately
serve residential consumers with low-priced local and long-distance
telephone, Internet and even video. They're the ones marketing under the
Starpower brand name with the Soviet-style billboards proclaiming the end
of the local telephone empire.
RCN has deals with utility companies in the Northeast, including Potomac
Electric Power Co., and plans to string fiber cables along their rights of
way. RCN recently bought Erol's Internet Inc., giving it hundreds of
thousands of Internet customers.
So far, Starpower service is limited to a few apartment buildings in town.
Until then, Bell Atlantic remains the only phone company for local
residential service.
"It would be nice" to have a choice over local phone providers, said office
manager Johnston, who lives in Sterling. "Hopefully prices would come
down. But I get the impression that Bell Atlantic still has quite a mono
poly."
When Change Is Good
As the telecommunications industry goes through a metamorphosis, the
stock prices of many of its most visible players are enjoying a good ride.
Percent change in stock price since February 1996 Telecommunications
Act*
WorldCom -- 139%
MCI -- 90%
BellSouth -- 72%
Ameritech -- 60%
SBC -- 45%
Bell Atlantic -- 49%
AT&T -- 42%
*Includes reinvested dividends
SOURCE: Bloomberg News
c Copyright 1998 The Washington Post Company
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