It was a bizarre outcome, even by the telecom industry's twisted standards. When the Federal Communications Commission began to debate a revamp of deregulation policy, industry experts clearly expected the Republican-controlled agency to scale back Clinton-era rules that favored upstarts in the $45 billion residential local phone market. But that was before Kevin J. Martin, one of the three Republicans on the five-member panel, joined forces with two Democrats. When the FCC finally voted on Feb. 20, it dealt a crushing defeat to Chairman Michael K. Powell and his vision for the industry.
In direct contradiction to Powell's push for reform, the FCC ruled that local phone companies must continue to lease their networks to long distance rivals, such as AT&T (T
) and WorldCom Inc., at steeply discounted rates. For local carriers, the decision is a huge setback: They complain they will have to continue selling capacity for less than their costs. "I think the local phone ruling is economically unsustainable," BellSouth Corp. (BLS
) CEO Duane Ackerman says, fuming. So are the long-distance carriers dancing in the streets? Hardly. They're almost as miffed as the Bells because the FCC won't force the Bells to share new broadband networks at cheap rates. The new move, complains WorldCom lobbyist Donna Sorgi, "relegates competitors to the slow lane."
The Bells and their long-distance rivals aren't the only ones with a beef. In the days following the FCC vote, shell-shocked telecom investors watched their already beaten-down shares tumble even lower. The market cap of U.S. telecom-services and equipment companies has fallen 6.8%, to $265 billion, since word of the ruling began to leak on Feb. 14, according to UBS Warburg. One big reason: The vote increases the uncertainty surrounding telecom's future. Although the FCC has issued a two-page press release on its ruling, the full details won't be known until a hefty document is issued a month or two from now.
Compounding the confusion, the FCC has opened the door for states to weigh in with their own rules on local competition, a process that could take four or more years to complete. All that will presumably lead to ever more complex rounds of lobbying--and a host of inevitable court challenges. Says Alex Peters, manager of the $185 million Franklin Global Communications Fund, which owns SBC Communications Inc. (SBC
) and AT&T: "I view the [FCC vote] as a negative for the entire industry."
Still, not everyone will feel the pain. Increased competition in the local market will benefit consumers. And some telecom players stand to gain as the dust settles from the FCC vote. Here's what to expect from the most important regulatory ruling since the Telecommunications Act of 1996:
-- Consumers win. Consumers should do well, since the price of local phone service will likely continue to fall. As carriers battle for their loyalty, customers may also benefit from new services, such as the combination of wireless and traditional phone service under one phone number. And competition from cable and wireless rivals will also force the Bells to continue to invest in their networks, resulting in faster home Internet connections.
-- Competition will flourish. The FCC's ruling may finally turn the residential local phone market into a competitive battleground like long distance. With new players just gaining momentum in the past couple of years, the Bells still control 92% of the market. But with local competition preserved, rivals could increase their share to 25% within two years, says telecom analyst Phil Jacobson of Network Conceptions LLC. That will be a boon for companies such as struggling AT&T, which has lost 30% of its long-distance market in many states to the Bells. WorldCom and Sprint Corp. (FON
) are vying in local markets, too, along with upstarts such as Z-Tel and Talk America (TALK
).
-- The Bells will get squeezed. Just as no-holds-barred competition led to a debilitating price war in long distance, local carriers could now be destabilized. The economics of the local and long-distance markets are very different. The capital investment required to build a local phone system is five or six times higher than the capital costs of long-distance phone service, because local carriers must extend their networks all the way into the homes and offices of their customers. The Bells are stuck with these high fixed capital costs regardless of how many customers they lose in a competitive market. And rivals leasing Bell lines at low government-mandated rates avoid the need to make such huge investments. It wouldn't take much to wipe out all their profits. In fact, a 6% revenue decrease could swallow all the Bells' earnings, warns analyst Francis McInerney of investment company North River Ventures LLC. To avoid a meltdown, the Bells will probably have to undertake massive job reductions, just as long-distance providers did.
-- But they'll gain in broadband. Rival broadband providers and consumer advocates are furious because the FCC ruled that the Bells don't have to lease their DSL lines. That could compound the problems of smaller, struggling broadband companies, such as Covad Communications Group Inc. (COVD
), which said it might leave the consumer market as a result of the decision.
Still, the Bells say their victory in broadband isn't as clear as it seems. In markets where they build next-generation fiber networks, state regulators may deny the Bells permission to rip out old slow-speed copper connections to homes and offices because those wires may still serve competitors. That could force the Bells to operate two networks. The bottom line: The Bells will probably make some additional investments in broadband. But the upgrades will be gradual.
-- Equipment makers won't see much relief. The FCC ruling doesn't help telecom-equipment makers Lucent Technologies Inc. (LU
) and Nortel Networks Ltd. (NT
), which are struggling to return to profitability. It does nothing to encourage new entrants in the local phone market to buy their own telephone switches, which direct traffic across the network. And to the extent that the Bells lose revenue, they will have less to invest in the upgrade of their own networks. The only glimmer of hope on the horizon: spending to upgrade broadband technology. Tara Hedlund, co-manager of the $12.5 million Turner Technology Fund, says that equipment makers such as Ciena (CIEN
), Corning (GLW
), Juniper (JNPR
), and Cisco Systems (CSCO
) could benefit from any additional investment that Bells such as Verizon (VZ
) make in broadband.
-- Consolidation could stall out. The ruling will not help revive the telecom merger machine, even though considerable overcapacity still exists in the industry. "It will delay consolidation, which might have been healthy for the industry. The buyers--the Bells--will be weaker," says Peters of the Franklin Global Communications Fund. And as long-distance companies emerge as full-fledged local rivals, antitrust issues will make local and long-distance mergers more problematic. Still, the new environment could encourage the Bells to make more investments in unregulated businesses. For example, SBC is already contemplating an acquisition of satellite TV service DirecTV Inc. (GMH
) Although investors remain lukewarm on such a deal, Nicholas D. Gerber, manager of the $1.3 billion Ameristock Funds, believes it is now more likely.
Clearly, the impact of the FCC vote--the latest in a long series of compromise measures imposed on the industry by Washington--will be felt for years. "Regulators are under enormous pressure to produce competition at any cost," says Alfred Kahn, an expert in deregulation who has advised everyone from President Carter to the Bells. The goal is surely worthy. But getting there has been one messy process--and it's not over yet.
By Steve Rosenbush in New York, with Roger O. Crockett in Chicago and Charles Haddad in Atlanta
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