The Price Wars Wounding Telecom

The industry can't escape the forces pushing for lower charges. Soon it'll be MCI, out from bankruptcy, looking to grab customers

By Todd Rosenbluth

The thorns in the side of the long-distance phone business -- fierce competition and lower prices -- may soon dig deeper as the industry braces for the return of MCI (MCIAV ; not ranked by S&P; recent price: $23.45). It's likely to emerge from bankruptcy in the next couple of months with a slimmed-down balance sheet. On Feb. 11, MCI filed for a 60-day extension with the U.S. Bankruptcy Court regarding the date that it will formally come out of Chapter 11.

We at Standard & Poor's expect that when MCI does return, the much-maligned carrier will aggressively try to win back customers. MCI's outlook for 2004 is for revenues to decline 10% to 12% from levels the company expected in 2003, reflecting overall industry conditions and continued declining trends in the consumer market. (The latest revenues published for November were roughly $1.8 billion.) We expect MCI to use price as the principal competitive approach in its "Neighborhood" bundling strategy that offers unlimited local, long-distance, and high-speed Internet access.

With MCI close to coming back to the market, and given the competitive threat from wireless -- and now from cable as well in the voice over Internet protocol (VoIP) services area -- we at S&P continue to have a negative investment outlook for integrated telecom stocks. The S&P Integrated Telecommunications index has risen 3.2% so far this year through Feb. 6, after declining 4.2% last year. That compares to a 2.8% rise in the broader S&P 1500 index this year.


  During the last few years, the three major long-distance providers –- AT&T (T ; ranked 3 STARS, hold; $20.06), Sprint (FON ; 2 STARS, avoid; $18.41), and MCI -- have lost market share to the Baby Bells, thanks to the Telecommunications Act of 1996. This rule outlined procedures for BellSouth (BLS ; 2 STARS; $30.09), Qwest Communications (Q ; 3 STARS; $4.71), SBC Communications (SBC ; 2 STARS; $25.64), and Verizon Communications (VZ ; 3 STARS; $37.84) to offer in-region long-distance service on a state-by-state basis after getting approval from each state's regulators and the Federal Communications Commission (FCC).

With the December, 2003, approval of Qwest's application to offer long-distance service in Arizona, the Bells have now rolled out long-distance in all of their local backyards. Primarily bundled at a discount with traditional local service in an all-together package and advertised aggressively, SBC and Verizon had catapulted ahead of MCI and Sprint in long-distance household nationwide market share with 14% each (as of the third quarter), according to market researcher TNS Telecoms. BellSouth and Qwest, which provide services to fewer access lines that their Bell brethren, remain further behind, at 4% and 3%, respectively.

Meanwhile, AT&T's share of the long-distance market (excluding wireless) declined from about 90% of all households in 1984 to 27% as of the third quarter of 2003. The market shares of MCI and Sprint have also fallen. MCI's declined to 12% in the third quarter of 2003, from 22% at the end of 2000. And Sprint's share dropped to 7%, from 9% in the same period.


  The Bells' success has primarily been in offering long-distance to existing local consumer and small-business customers in their respective territories. S&P expects the Bells to now move the contest to the potentially more lucrative large-business market, where MCI and AT&T are now among the top players.

According to SBC, the market for providing local, long-distance, data, wireless, and managed services to large businesses is about $99 billion, of which SBC has about a 5% share.

Based on the Fortune 500 companies headquartered in SBC's primarily Midwest and Western footprint, the carrier believes it has the opportunity to capture nearly 34% of the market. SBC plans to grab some of these large accounts by improving communications with partners, suppliers, and customers, and providing business continuity for disaster recovery and security.


  Big businesses have traditionally worked with carriers that can service the bulk of their communications needs. With approval granted early in the fourth quarter of 2003 to offer long-distance throughout its territory, SBC, like the other Bells, has only recently stepped into the ring and pursued major corporations.

Another trend worth watching: Prices may go even lower. AT&T, which once dominated long-distance, says revenues declined 9%, to $34.5 billion, in 2003. But as expected, it isn't conceding its market leadership. Through wholesale access obtained from the Baby Bells, AT&T says by the end of February, it will offer a flat rate for its own bundle of local and long-distance service, plus features such as call-waiting and -forwarding in 30 states.

AT&T believes its bundle is about 5% lower in price than competing Bell plans. Furthermore, AT&T announced in January that with its scale advantages, there's no reason it should lose on price, leading us to believe that Ma Bell may make greater use of pricing discounts and other customer-retention techniques.


  In addition, we at S&P are encouraged by AT&T's plans to have an increased consumer VoIP presence by the first half of 2004. S&P expects that with AT&T's strong brand name and network quality nationwide, it will remain a fierce competitor.

However, we see AT&T's operating margins and earnings per share declining in 2004, due in part to the increasingly competitive environment. We recommend that investors hold the shares, as we believe AT&T already trades at an appropriate discount to its telecom peers on a price-earnings and cash-flow basis.

Overall, we believe that as the pricing bar gets lowered, it'll be challenging for all of the long-distance players to bring what they charge for the commodity-like service back to the point where revenues can grow. In the end, we believe the long-term winners of this hard-fought battle will be consumers, rather than the companies that provide long-distance.

Note: Todd Rosenbluth has no stock ownership or financial interest in any of the companies in his coverage area. He's a registered representative of Standard & Poor's Securities, Inc. Other S&P affiliates may provide services to the companies under discussion.

Analyst Rosenbluth follows telecommunications services stocks for Standard & Poor's Equity Research

Edited by Karyn McCormack

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