Remember all that talk of deregulating the U.S. telecom industry? The Telecommunications Act of 1996 was supposed to tear control of the industry from the regulators and let freewheeling rivals go after each other with abandon. AT&T and a host of new competitors would burst into the local telephone markets, Baby Bells would finally get a chance to sell long-distance service, and cable companies would offer phone service. Consumers would end up with more choice, lower prices, and better service.

Forget about it. This will be the year of the regulator. The Federal Communications Commission and state regulators will play the central role in how telecom companies fare in 1999, as the competition envisioned by the Telecom Act remains more promise than reality. "Basically, nothing has happened for three years," says Robert Fox, vice-president at Mercer Management Consulting.

Regulators will have a hand in most of the key decisions to be made in the telecom industry over the next year. Take Ameritech Corp. The Chicago-based Bell wants to merge with SBC Communications Inc., but the deal is subject to approval by the FCC. Ameritech would like to offer long-distance service to its customers; again, the FCC will decide if that happens in 1999 or later. The company is hoping to build a national data network--and even considered buying IBM's Global Network, for which AT&T just ponied up $5 billion--but it's barred from doing so by current regulations. Even Ameritech's plans to expand its security monitoring business may be limited by the FCC. "I think [regulators] are trying to pick winners and losers," says Richard C. Notebaert, Ameritech's chairman and CEO.

LOCAL NEWS. And they will, make no mistake about it. Phone companies now are jostling for position before a long race. Each carrier is trying to gain a slight edge by insisting on certain conditions that it finds favorable before the competition begins. The companies that prevail in this year's regulatory debates will have a strong shot at becoming the telecom titans of the 21st century.

Probably the most significant regulatory decisions of 1999 will be on the two proposed mergers between local phone companies. SBC Communications and Ameritech want to combine, they contend, because only together will they have the financial muscle to take on other giants such as AT&T and MCI WorldCom. When the two local companies announced their $62 billion merger proposal last May, they promised to start offering local service in 30 markets outside their own territory. In July, Bell Atlantic Corp. and GTE Corp. announced plans to merge, also arguing that they needed to bulk up--although they made no specific promises about invading the turf of other local phone companies.

Much has been made of the fact that the FCC's staff is reluctant to approve the two megamergers--but don't bet that the deals will be blocked. The FCC has much to gain if it uses approval of the deals to pry open local markets around the country. For example, the commission could insist that the wholesale discounts at which competitors buy access to the local phone companies' networks be increased from the current 18% or so to 40% or 50%. That would allow AT&T, MCI WorldCom, and others to offer local residential service at competitive prices without losing their shirts. "I think the FCC is going to push very hard to use [the proposed mergers] to open up the local markets," says Fox.

"DEAL-BREAKER." Of course, the local phone companies may push back. It was state regulators who determined the current wholesale discounts--and courts have repeatedly ruled that state, not federal, regulators are entitled to set these rates. Rather than agree to the FCC's demands, some analysts speculate that Bell Atlantic, GTE, SBC, and Ameritech may simply call their deals off.

AT&T's fate is also inextricably linked to the FCC. The reason it proposed the $48 billion merger with Tele-Communications Inc. in June is to use the cable company's network to offer local phone service and high-speed Internet access to residential customers. But now there's a catch. America Online Inc. wants regulators to require that AT&T-TCI carry AOL's content. AT&T Chairman and CEO C. Michael Armstrong has said that condition would be "a deal-breaker." The FCC has generally supported the AT&T-TCI merger because it thinks the deal will bring competition to the local phone markets, so the early betting is that AOL will lose out.

Even telecom's technological developments will be snarled in red tape in 1999. One of the most promising applications in the industry is making voice calls over the Internet using a technology called Internet Protocol, or IP. The companies that sell IP-based long-distance service avoid paying 3 cents to 4 cents a minute to the Bells because data calls aren't subject to the access fees levied on voice calls. That allows Qwest Communications International Inc., for example, to offer IP long distance at a rock-bottom 9 cents a minute.

This loophole has the local phone companies up in arms. They think IP voice calls should be treated like any other phone traffic. BellSouth Corp. and U S West Inc. have started charging access fees for IP calls even though regulators have yet to set any. "We can identify a lot of these companies, and we plan to bill them," says BellSouth CEO F. Duane Ackerman. The FCC is leaning toward imposing some kind of access fee on IP voice, but Congress is strongly against any kind of tax on the Internet.

GOING TO COURT. The telecom players that do best in the year ahead will be the companies that can stay out of the regulatory quagmire and start the race to offer a full suite of integrated services to their customers. MCI WorldCom Inc. is a prime example. With its merger complete, the company is starting to market voice and data services over a network that's entirely its own. Besides its long-distance network, it has local facilities in 81 markets. That means it can avoid tangling with the Bells and offer big discounts to its customers. "The cost savings are enormous," says Timothy F. Price, president of MCI WorldCom's U.S. communications subsidiary.

Look for wireless, another unregulated service, to continue to explode this year. With four, five, and even six carriers in many markets, prices are falling 20% yearly--more, for high-end users. Carriers are kicking in a host of snazzy new services, like voice dialing and E-mail. And AT&T, Sprint Corp., and others are offering free roaming and long distance with their wireless minutes. All those goodies should help drive the number of U.S. subscribers up 18%, to 79 million, in 1999.

Satellite services should become more popular in 1999 as well. Iridium is marketing its service aggressively, and other players are expected to follow this year. The service is expensive: Iridium's handsets go for $3,000, and talk time costs $3 a minute or more. Still, the phones can be used anyplace in the world, and their makers are betting that globe-trotters will find them indispensable. Iridium's performance is likely to determine whether other satellite operators get up and running. "The whole [satellite] industry is absolutely subject to the outcome at Iridium," says Lawrence Kenny, a partner at the consulting firm PriceWaterhouseCoopers.

And the telecom industry will be absolutely subject to the regulators in 1999--or the courts. Virtually every facet of the Telecom Reform Act has faced legal challenges from local or long-distance carriers. "Every decision can be challenged in every state and with every regulator," says Sir Peter Bonfield, CEO of British Telecommunications PLC, which has gone through a more successful deregulation in Britain. So when it comes to local and long-distance service, look for a little more competition and a lot more litigation in 1999.

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