Copyright 1999 Federal News Service, Inc.
Federal News Service
JUNE 30, 1999, WEDNESDAY
SECTION: IN THE NEWS
LENGTH:
3091 words
HEADLINE: PREPARED STATEMENT BY
TOD A.
JACOBS
SENIOR TELECOMMUNICATIONS ANALYST
SANFORD C. BERNSTEIN &
COMPANY
BEFORE THE HOUSE COMMITTEE ON THE JUDICIARY
SUBJECT - RE: H.R. 1685 & H.R. 1686
BODY:
Mr. Chairman and Members of the Committee. Thank you for inviting me
here today to address the "Internet Freedom Act" and "Internet Growth and
Development Act of 1999." My name is Tod Jacobs, and I'm senior
telecommunications analyst at Sanford C. Bernstein & Company. Bernstein is
an investment management and research firm; one part of the firm manages about
$90 billion in equity and fixed income funds. The other side, where I work,
advises money managers globally on a number of key industries. My job is to
forecast the growth and earnings and stock performance of the telecom industry
as well as its largest companies, including the Baby Bells (RBOCs, or regional
Bell holding companies), the large long distance carriers and several wireless
carriers. Our firm is somewhat unique among brokerage firms in that we do not
engage in investment banking; that is, we don't work for any of the companies we
cover as analysts. We therefore avoid conflicts of interest, and have the
ability to speak our minds without fear of repercussion. My only clients are the
analysts and portfolio managers charged with investing in telecom stocks. I am
neither a lawyer nor regulatory expert nor engineer, but rather deal with all
issues relevant to telecom investing. My only mandate is to be right. And for
the record, I'm currently favoring long distance companies such as WorldCom,
Sprint and AT&T, and have neutral ratings on the RBOCs. And indeed, I was
quite bullish on the RBOCs from early 1997 through June of 1998, when AT&T
announced its acquisition of TCI - a transaction that brought with it for the
first time the specter of facilities-based local residential competition to the
RBOCs. Also for the record, my colleague Tom Wolzien, who covers video media and
online, currently has buy ratings on AOL and MediaOne, and neutral ratings on
Time Warner and Cox.
The bills before you have, in my opinion, been defined
through three primary goals:
First, to unfetter the RBOCs relative to
certain obligations they bear to provide discounted resale and unbundled access
to their networks to competitors. Second, to fetter the cable companies with
obligations that are quite similar to those that would be at the same time
lifted from the shoulders of the RBOCs. Third, to loosen certain business- line
restrictions shouldered by the RBOCs in relation to the transport of data
services across LATA boundaries.
It's my intention to focus on the issue of
open access to cable high- speed transport services, and then to touch on the
issue of allowing the RBOCs into inter-LATA data services prior to letting them
into inter-LATA, or long-distance, voice.
In many ways the problem with
discussing these issues is that it's easy to lose sight of the big picture. We
get lost in endless legal and technical discussions about the propriety of one
set of rules versus another; and special interests tend to create one-sided
distortions of the underlying reality. In my opinion, all these issues revolve
around one basic question: what is the path toward competition - both with
respect to telecom services and broadband services? And why and how are the two
related?
Fortunately, we have something of a blueprint of the competitive
goal - a fuzzy and at times contradictory one - but a blueprint nonetheless:
namely, the Telecom Act of 1996. Despite endless wrangling around its details
and implementation, if you had your 9- year old read it, once he woke up he'd
tell you that there's a simple goal: the RBOCs need to open up the local
exchange to competition. And in return, they'll be let into long distance. The
truth is that any of us could this afternoon go and start a long-distance
business from scratch in our garage that could easily serve residential and
small business customers. It's local that's hard. And that's why the Act of 1996
was about opening local markets. And it appears that Congress believed that the
RBOCs would not be properly incented to open up local if they first received
approval to offer long distance.
Where are we in pursuing that goal? Not
very far - it seems. In Exhibit 1, we present the RBOC lines lost to resale and
unbundling as of the most recent quarter. Three years and one month after
passage of the act, the highest market share losers so far are BellSouth and US
West, with about 2.7% each lost to resale and unbundling, followed by SBC with
2.6%, Ameritech with 2.4% and Bell Atlantic with 1.9%. Not very impressive.
What's more, if you cut more finely, you'll find that business line losses are
in the 3-4% range, but that residential share loss is holding at about 1%. And
while these numbers don't include loss to carriers serving customers on their
own facilities, since the RBOCs can't or won't break out the data, we strongly
believe that at best you're talking about an incremental 2-4 points of share
loss. And at least 95% of that relates to business customers, again leaving
residential to about 1%.
Why? First, because while business lines represent
only about 35% of total access lines, they nonetheless drive about three
quarters of RBOC profit due to the industry's strange and artificial pricing
structure. Residential lines are nearly profitless, and are geographically
dispersed, while subsidy-laden business lines are extremely rich, and are
geographically clustered in small areas. So no one approaching the industry
fresh as a competitor would ever try to attack the residential market,
especially if it required the deployment of expensive facilities. Second, as
we'll see, with the exception of AT&T, no single long distance company has
sufficient consumer exposure, and therefore sufficient fear, to make the
expensive investments necessary to enter residential on a large scale.
Now,
the reality is that the initial market-opening strategy pushed by the FCC in
1996 and 1997- a highly discounted form of resale known as rebundling, or the
unbundled network element platform (UNE-P) -- would have drawn all of the LD
companies into residential since it offered about a 35% average discount, which
most could have at least broken even on. That's worth doing if the bundling in
of a local service product serves to hang onto profitable long distance
customers longer. But the RBOCs believed that even long distance entry wasn't
worth the price of UNE-P. So they decided not to pursue it - and indeed had it
overturned by the Eighth Circuit in mid-1997. And even though it would cost them
long-distance entry, the RBOCs were content to grow earnings in double digits
based upon the strength of the local markets. At the same time, numerous
strategies were employed to skirt the 271 entry process: the Qwest
joint-marketing deals with US West and Ameritech, and the famous "Bill of
Attainder" arguments put forth in two circuits that attempted to have the
inter-LATA restrictions declared unconstitutional.
For their parts, bereft
of UNE-P, each of the major long-distance companies attempted to offer plain
vanilla resale of local residential service - at about a third the effective
discount of UNE-P - but quickly found that you couldn't lose a bit on the margin
and make it up in the volume. So they stopped trying, and the industry entered a
two-year truce, particularly with respect to residential.
The one with the
problem, though, was AT&T. That is, the company knew well that eventually
the RBOCs would enter long distance. When they did, they would easily add a long
distance component to the existing local service. And AT&T, with its $23
billion consumer long distance business - unable to offer a bundle that included
local service - would simply get crushed.
That simple and sad reality
led the company to purchase TCI - a strategy that caused the company to invest
$40 billion and to dilute its earnings severely - in the process crushing the
stock for several months - all in pursuit of a path into the home for local
service.
Make no mistake about it. AT&T didn't buy TCI because it liked
the cable business. It bought TCI for defensive reasons, for fear of getting
crushed in consumer long distance by the RBOCs if it couldn't offer a bundle
that included local service. Second, because AT&T is a national company and
TCI is regional, AT&T couldn't stop with TCI. Thus, the company went about
pursuing joint ventures with other cable companies in order to get access to
enough homes to make a difference. But those deals were hard to come by, with
only Time Warner coming close among large cable companies. And that's despite
AT&T's willingness to pay upfront fees for access, and to foot nearly all of
the capital expenditures - about $500 per subscribing home on average over the
next 5 years, or somewhere between $9 billion and $12 billion, not including the
cost of upgrading TCI's lines to support two-way digital services (another $2-3
billion) to roll out on a nationwide basis.
Moreover, it was the difficulty
in clinching cable resale deals that forced the company to again dilute its
earnings, this time spending $60 billion, to acquire MediaOne, which despite its
relatively small footprint, nonetheless holds the key to cementing the national
footprint, since it will ultimately lead to resale deals with Comcast and a
finalization of the Time Warner deal. Taken in sum, the creation of this
strategy is plainly and simply the first fruit of the Act of 1996 - the only
large-scale strategy being pursued by any telecom company that will bring
residential competition to the local exchange.
What has this to do with open
access to broadband cable? Everything. Because when you spend an average of
$3,300-3,400 a subscriber to acquire cable companies, then add $150 a home
passed to enable two-way services, then spend $500 a subscriber for those that
take local telephone service, you've got to get a return on your capital. And
the combination of basic cable and local telephone won't come close to driving
that return. Only the inclusion of incremental growth services like high-speed
data give you a prayer. And according to several leading analysts, even that
won't be enough. So the fate of broadband services is critical. And to the
extent that AT&T's ability to drive an adequate return on broadband services
is threatened by the unknown economics that regulators and legislators could
mandate in open cable access, Wall Street will deny AT&T and all other cable
companies the capital to build the broadband pipe. I would be the first to
downgrade my buy recommendation on AT&T through the creation of that
uncertainty.
How do we respond to the concerns of the major players?
Argument: AOL could be denied access at will to the cable plant.
Let's
note a few facts:
The company currently has 16 million online customers
versus under 800,000 at the cable companies in total; so clearly it will be some
time before the company is marginalized by the activities of cable.
AOL has
already struck resale deals for broadband xDSL access on a commercial basis,
including volume discounts, with Bell Atlantic and SBC. We believe that more
RBOC deals are in the works. So the company will have broadband access to tens
of millions of homes over the next 12 months. That's not to mention commercial
deals struck with satellite.
AOL's service is a proprietary one. Customers
of other Internet Service Providers (ISPs) are denied access to AOL's content;
in addition the company appears to be opposed to any attempt to regulate the
internet - except as regards open access to cable plant. So there is an issue of
consistency.
We believe that AOL can and should pursue commercial deals with
cable, and that such deals could be extremely beneficial to both sides.
Finally, any one of the ISPs, including AOL, could elect to invest capital
and gain local franchise approval to overbuild the existing cable plants, just
as Ameritech has done in parts of Chicago and Detroit and a number of
municipalities have done elsewhere in the country.
Argument: the RBOCs are
being treated unfairly since they have to unbundle and resell their plant while
cable is not yet subject to similar obligations.
There is an inequity in the
regulation of the two industries. But we would argue that the long-term solution
to the problem is the eventual deregulation of the RBOCs in the high-speed data
area, not regulation of the fledgling cable high-speed industry.
Several
other key points:
DSL Deployment Depends on Cable Modem Deployment: It is
precisely the AT&T national cable-telephony strategy, along with the general
aggressive investment posture of the other cable companies with respect to
high-speed data deployment that has driven the RBOCs to begin to aggressively
deploy xDSL. Indeed that technology has been around for several years and the
RBOCs have been very slow to deploy it until recently, especially since it
represents the threat of cannibalization of the RBOC's $5 billion private line
business, which offers similar speed services for a fraction of the price.
RBOC Push Toward Ubiquity Depends on Cable Modem Deployment: Only 40- 50% of
RBOC access lines are currently addressable with xDSL given line lengths and the
presence of certain splicing and multiplexing technologies on many access lines
that preclude xDSL deployment. To address this problem, the RBOCs will have to
spend $8-12 billion over the next several years to push fiber further down into
the neighborhood to enable ubiquitous xDSL deployment. Such investments are only
now being announced, and are clearly driven by the desire not to lose the market
to cable modems. In the absence of a cable modem threat, these incremental
investments are unlikely to be made, certainly not on the accelerated basis now
being contemplated. Moreover, more aggressive RBOC spending will be met with
further cable investment. Few things will prove better for the consumer than a
battle to bring broadband to the home.
AT&T & Cable Open to
Negotiations: AT&T and other cable companies have made clear that they are
open to commercial relationships with ISPs such as AOL. Indeed they'd be crazy
not to strike deals, and Wall Street is pushing them to do so quickly, if only
to end the reign of that killer of stocks called "regulatory risk" - but more so
because it's good business to have as many people selling your services as
possible if the terms are reasonable. A vibrant commercial resale market would
obviate the need for regulated unbundling.
Why Regulate a Fledgling Industry
Now When You Can Do it Later? The real fear is that cable behaves with respect
to broadband services the way it did in programming (where anti-competitive
behavior led to regulation in the early 1990s). The FCC policy has been to say:
"We'll leave you alone for now ut we're watching." This shot across the bow has,
in our view, been noted by cable managements. We recognize, however, the need of
the FCC to be assured that the technical systems being established today will
not practically preclude regulation to counter any actual anti-competitive
abuses should they occur years from now. It is in the province of the FCC to be
certain that the design of the billions of dollars of hardware and systems being
installed by cable now allow for the consideration of regulation of high speed
data at the system level in the future if anti-competitive abuses occur. I know
my colleague Tom Wolzien will be discussing this issue in his comments at the
FCC on July 8th.
At the end of the day, the question comes down to one of a
policy choice. In our opinion, the first goal of the Telecom Act is local - and
especially residential local - competition. Without an ability to buttress with
incremental broadband services the huge expenditures required (mostly of
AT&T) to roll out competitive local telephone service, local telecom
competition won't ever come. In turn, the presence of a vibrant cable investment
posture in broadband services depends upon the perceived ability to generate
returns on capital. To the extent that those returns could be curtailed by
regulation, cable won't build. To the extent that the cable build is slowed or
stopped, the RBOCs will slow their finally-accelerating broadband
deployment - that's the rational thing to do. No one wants to deploy
capital for the sake of being popular, especially when it dilutes earnings or
risks cannibalization of other services. So in many ways, the choice is between
two major broadband buildouts in competition (in addition to several niche
competing access technologies like MMDS, LMDS and DBS and standard wireless) or
no major broadband buildout. And with it, no local telephone competition.
Finally, on the subject of RBOC inter-LATA relief with respect to data
services:
Again, the question is one of policy goals. For the past 2-1/2
years the RBOCs were mostly content to sit out long distance entry as long as
local wasn't threatened. All that changed with the new AT&T cable- telephony
strategy, which holds the possibility that AT&T could reach the consumer
with a bundled offering (local, long distance, data and video) before the RBOC
does. Now, numerous RBOCs have decided that UNE-P might be worth the price of
admission to long distance after all.
What's the risk of allowing for an
easing of the restriction on data? It depends on what you think is driving the
RBOCs toward market opening. In our opinion, over the next 5 years, 60% of the
growth in telecom services revenue will be driven by local and long distance
data and Internet products. Local and long distance voice products, on the other
hand, will drive only about 15% of growth, despite making up two-thirds of the
total telecom pie (Exhibit 2).
More to the point, focusing on inter-LATA
services only (including long-distance voice, long-distance data and internet
services - which RBOCs are precluded from offering), about 85% of all inter-LATA
growth over the next five years is expected to come from data and internet
products. Only 15% is expected to come from long-distance voice (Exhibit 3).
Thus it should be rather clear that data is the key to inter-LATA growth in the
future.
So the question is rather simple: if the RBOCs are allowed into
inter- LATA data, thus gaining access to 85% of all inter-LATA growth even
without access to traditional long distance voice - are they likely to be
proactive in opening up the $90 billion local market in order to gain access to
the other 15% of the growth? The answer to this question should help you
determine the proper course of action toward achieving your policy goals.
END
LOAD-DATE: July 1, 1999
