A Big Break For Small Operators?Catherine Arnst
In the debate over telecommunications reform that has been going on in Washington all year, it's easy to assume that the argument is one between a handful of corporate behemoths fighting for the right to add billions of dollars to their already bulging coffers. On one side of the fight to open up telephone calling to greater competition are the seven huge regional Bell operating companies (rbocs), which control some 98% of local phone markets in this country. On the other side are the three long-distance giants--at&t, mci Communications, and Sprint, which together carry 90% of all toll calls.
Not so. Some of the biggest opportunities in any overhaul of the telecommunications landscape will fall to the 500 or so long-distance companies that scramble for the 10% of the market that the Big Three don't reach directly. These so-called second- and third-tier carriers--many of which simply resell calls for at&t, Sprint, and mci--range in size from WorldCom, the No.4 long-distance company, with $2.2 billion in annual revenues and a 4.9% market share, to obscure regional or niche players with names such as midcom Communications and Working Assets Long Distance, whose market shares can barely be measured.
For any outfit that's seeking a quick entree into the long-distance business, these small fry have big potential. "There's one school of thought that the Baby Bells may be looking to acquire some of these second-tier players as a kind of a quick bootstrap up into the long-distance industry," says Merrill Lynch & Co. analyst Mark Kasten. "An acquisition is a great way for them to get customers and an easy way to enter the business."
Wall Street is betting on just such a scenario. WorldCom, Frontier, and lci International, the fourth-, fifth-, and sixth-largest long-distance carriers, respectively, all saw their stocks hit record highs at the end of July, as the House version of the telecom-reform bill, H.R. 1555, neared a vote. The latest version --the most Bell-friendly version of the bill yet--would let the regional phone companies apply to offer long-distance service without waiting for significant competition to emerge in their local markets. That means the Bells could start offering long-haul service as early as two years from now. Buying, not building, might be the easiest way for them to start.
ON A SPREE. Second-tier players may also prove a lure to foreign carriers looking for a U.S. foothold, since the proposed bill loosens foreign ownership restrictions of telephone companies. "Everyone in Europe except [France Telecom and Deutsche Telekom] has come to us," says Ronald L. Bittner, chairman of Frontier Corp. (formerly Rochester Telephone Corp.). "We really have no plans now, but it's not beyond the realm of possibility."
And if the Bells and foreigners don't come knocking, chances are another second-tier player will. WorldCom, Frontier, and lci have been on a buying spree for more than a year (table) and don't plan to stop now. Even after spending $3 billion in cash and stock on WilTel and idb Communications seven months ago, WorldCom Inc. says it is still looking for takeover targets. lci International Inc. is also eager to acquire, and it has a $450 million credit line to help it do so (box).
Telecom deregulation could also provide WorldCom, Frontier, and lci with seven huge new customers. Because the three have their own nationwide networks, the Baby Bells may look to them to buy long-distance capacity rather than at&t, mci, and Sprint, which are planning to spend big bucks going after the local calling market. Says WorldCom ceo Bernard J. Ebbers: "We intend to be in relationships with the Bells, cellular carriers, and cable companies to load traffic on our network."
BULK BUYING. That opportunity, though, is not available to the other 500 or so long-distance carriers. Rather than possessing their own networks, most of them make a living by purchasing long-distance service at bulk rates from the Big Three and then reselling it to customers under their own brand. The 30%-40% difference between wholesale and retail prices allows for a very healthy business: Revenues from resold long-distance services grew at a compound annual rate of 31% between 1993 and 1995, to $8.8 billion, according to the Boston consulting firm Atlantic-acm.
Resellers primarily target small and midsize businesses that, they say, the Big Three serve halfheartedly. They gain loyal subscribers by providing such personal services as custom bills--itemized in any way the customer wants. "We're mom-and-pop shops," says Robert T. Hale Jr. of Network Plus Inc., an $80 million-a-year reseller in Quincy, Mass.
But these small shops may find it tough going once telecom reform lets in a slew of new competitors. The Bells in particular could be formidable in the small-business market, with their ability to bundle services and offer customers one bill for local and long distance. Not to mention brand names that are a little more familiar than, say, Total-Tel usa Communications Inc., of Clifton, N.J.
Then again, Total-Tel demonstrates why resellers may continue to thrive. Total-Tel may have had only $19 million in sales last year, but that figure represents more than 100% growth for three consecutive years. "In the second tier, if your growth rate goes from 40% to 30% because the Bells get in, that's still very respectable," says Bruce J. Roberts, telecom analyst at Ladenburg, Thalmann & Co. Might be a good time to bone up on some of those lesser names.
Who's On Second
The leading members of the second tier of long-distance carriers
(Formerly LDDS Communications)
1994 Revenues: $2.2 billion
Long-Distance Market Share: 4.9%
As the fourth-largest long-distance carrier with its own nationwide network, WorldCom is an obvious partner for companies looking to enter the business. It has led the second-tier consolidation with its acquisitions of IDB Communications and WilTel.
(Formerly Rochester Telephone Corp.)
1994 Revenues*: $1.9 billion
Market Share: 1.8%
Frontier has also been on a buying spree and will vault from seventh- to fifth-largest carrier when its acquisition of ALC Communications Corp. is completed. With its local, long-distance, and wireless operations, Frontier is an attractive target as a "one-stop" provider.
*Adjusted for pending ALC acquisition
1994 Revenues: $464 million
Market Share: 0.8%
LCI is the fastest-growing of these three long-distance carriers. Started in 1983 as a regional carrier in Ohio and Michigan, LCI now operates a nationwide network and is known for its savvy marketing and simple pricing plans.
DATA: COMPANY REPORTS, MERRILL LYNCH & Co.