Telecom's Topsy-Turvy World

S&P sees the competitive arena between local and long-distance services shrinking, as the battle between telecom and cable outfits heats up

By Todd Rosenbluth

By any measure, the wireline telecommunications industry has become increasingly difficult to define over the past few years, given the erosion of previous boundaries. Through competitive initiatives and regulatory changes, distinctions between the regional Bell operating companies, also known as the Baby Bells, and the national long-distance carriers such as AT&T (T ; S&P investment rank 3 STARS, hold; recent price, $19), MCI (MCIP ; 3 STARS; $23), and Sprint (FON ; 4 STARS, buy; $23) have been evaporating for more than five years.

We at Standard & Poor's Equity Research believe the industry was first turned upside down when Verizon Communications (VZ ; 4 STARS; $35) was granted regulatory approval to provide long-distance service in New York in December, 1999 -- three years after the 1996 Telecom Act granted Baby Bells the right to apply to offer such service on a state-by-state basis.


  By January, 2005, the four Baby Bells were offering consumer long-distance in all of their local markets for at least 12 months. And they captured as much as a 40% share of their respective markets by bundling local and long-distance services in one package, often with a broadband or dial-up Internet offering. Meanwhile, the traditional long-distance providers were pulling back on their consumer marketing efforts due to recent regulatory rulings.

In late 2004, competition in long-distance was showing few signs of slowing down, and we at S&P believed the industry's services were turning into a commodity. Just three months later, the three top traditional long-distance carriers made strategic decisions likely to make stand-alone long-distance service a quaint memory.

In December, 2004, Sprint, which also offers local service to about 8 million customers in 18 states and owns the third-largest wireless carrier, Sprint PCS, agreed to acquire Nextel Communications (NXTL ; 4 STARS; $29), the fifth-largest wireless carrier. The transaction is expected to close in the second half of 2005, subject to necessary approvals. Following that, Sprint Nextel plans to separate Sprint's local telecom business in a tax-free transaction. With the planned spin-out, we believe Sprint's revenues will be derived primarily from wireless services.


  Shortly after the Sprint deal was announced, in late January, AT&T agreed to sell itself to SBC Communications (SBC ; 3 STARS; $24) in a mostly stock-based $16 billion deal set to close by the middle of 2006, pending shareholder and regulatory approvals. SBC's focus appears to us to be on finding synergies in AT&T's large-business customer base and extensive network capabilities. The AT&T consumer long-distance brand, once among the country's most recognized, is likely to be diluted by SBC, as were other corporate monikers such as Pacific Bell and Ameritech.

Similar to AT&T, MCI's is an attractive acquisiton target for the regional telecom carriers because of, in our view, its business customer base and national network capabilities. Earlier in February, MCI, which has operated as a publicly traded company for less than a year after emerging from bankruptcy proceedings, accepted an offer to be acquired by Verizon for $20.75 a share. But on Feb. 25, Qwest Communications (Q ; 2 STARS, sell; $4), which had made an earlier run at buying MCI, attempted to derail Verizon's planned purchase by resubmitting its $24.60 per share bid to acquire MCI. The new offer contains a larger cash component and protection against a decline in Qwest shares.

With the combination of their dominant local services and the assets the Baby Bells plan to acquire from AT&T and MCI, it's easy to assume the regional telecom carriers will dominate the communications landscape for years to come. However, while the competitive arena between local and long-distance services is set to shrink, the battle between telecom and cable-service providers is emerging.


  According to Leichtman Research Group, a broadband research firm, as of the third quarter of 2004, the top cable-broadband providers had a 6.6 million-subscriber advantage over DSL providers and held a 61% share of the total market vs. DSL. In addition to broadband competition, the cable companies are competing with the Baby Bells via cable-telephony offerings.

We expect the cable companies to offer a discounted bundle of telephony and traditional TV service. With a large marketing budget and established customer loyalty, we believe cable companies such as Time Warner (TWX ; 4 STARS; $18) and Cablevision (CVC ; 3 STARS; $28) have the ability to put pressure on traditional voice carriers.

At the same time, Verizon, SBC, and BellSouth (BLS ; 2 STARS; $25) are testing their own "triple-play" offerings in selected markets in 2005, using a variety of fiber-based technologies to offer high-speed video services. Regardless of their specific fiber strategy, the common theme for the telecoms is to defend their core wireline customer base from cable carriers' offerings of voice, video, and data services.

We believe widespread fiber services are still years away, and any potential rollout will likely focus on new high-end residential community buildouts. We also expect SBC to take advantage of the network capabilities it's likely to acquire from AT&T to help with its fiber initiatives, keeping the Baby Bell on a collision course with the cable carriers in its backyard.

Note: Todd Rosenbluth has no stock ownership or financial interest in any of the companies in his coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at

Required Disclosures

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

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Other Disclosures

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This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

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Analyst Rosenbluth follows shares of telecom service providers for Standard & Poor's Equity Research Services

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