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The Giants Aren't Sleeping


Cover Story: TELECOM'S NEW AGE

THE GIANTS AREN'T SLEEPING

Long distance's titans intend to stay on top

At first blush, deregulation might look like a big negative for the long-distance companies. After all, the status quo in their market is pretty cozy: The triopoly of AT&T, MCI, and Sprint controls almost 90% of this $76 billion market. The fourth-largest competitor, WorldCom Inc., has just 4.8%. Despite spirited ad battles, prices move in a nice orderly way--lately they've been inching up. And profits are the best in telecommunications.

Deregulation will spoil that party by admitting eight well-heeled and hungry competitors--the seven regional Bell operating companies and GTE Corp. Wall Street is already nervous. Shares of AT&T, which has the most to lose, have dropped by 9.4%, to around $61, since the Telecom Act took effect in February.

Wall Street may be missing the big picture, though. "The Bells have a clear advantage short-term, but there is a big difference over the short run and the long term," says T. Mark Maybell, managing director of Merrill Lynch & Co.'s telecom investment banking group. The long-distance carriers have the marketing skills, the brand awareness, and the technological knowhow to put together packages of local, long-distance, data, and video services. Long-term, that puts them in better shape to become 21st century "supercarriers"--single sources for all communications services. "It's no longer a question of how large a share of the $76 billion long-distance market you can get," says UBS Securities Inc. analyst Linda Meltzer. "It's a question of how big a share of the $500 billion converged or integrated market they will get."

NOTHIN' BUT NET. AT&T has been out front in pursuing that prize. It started in 1994 with the $12.6 billion acquisition of McCaw Cellular, vaulting instantly from zero to first place in cellular. In March, AT&T rewrote the economics of the online market with its dramatic offer of unlimited Internet access for only $19.95 a month--and a free one-year trial offer for its 80 million long-distance customers. On Mar. 25, it announced plans to market DirecTV's satellite-TV service. It had already bought a 2.5% stake in the Hughes Electronics Corp. venture. AT&T will offer special discounts on DirecTV to its long-distance and Universal Card customers. "We intend to be the premier deliverer of a whole range of services: local, long distance, wireless, entertainment," pledges AT&T Chairman Robert E. Allen.

MCI and Sprint are determined to match AT&T service for service. MCI sold 20% of its shares to British Telecommunications Ltd. in 1994 to finance its own diversification plans. Its first move: spending $2 billion for 13.5% of Rupert Murdoch's News Corp. MCI then went out and bid $682 million in January for a license to launch its own DBS service, which it will build in partnership with News Corp. The company recently spent a total of $1.2 billion on a cellular phone reseller and a computer systems integrator and teamed with Microsoft Corp. to develop new Internet services.

Sprint, meanwhile, is building one of the nation's largest wireless calling networks using the new personal communications services (PCS) technology. PCS works much the same as cellular, delivering calls over radio waves, but is all-digital and cheaper to run. Sprint's partners in the venture: three of the largest U.S. cable operators, reach a total of 39 million households.

All these supercarrier visions will come to naught, though, if the long-distance companies don't grab local customers before the local companies grab theirs. This is where the long-distance companies face the biggest risks. It will take two or three years and huge investments to make the local connections, while local phone companies--once they get the nod from the Federal Communications Commission--can move into long distance without having to spend much at all. The reason: Those long-distance networks crisscrossing the nation have lots of excess capacity available to resellers. This has already forged a lucrative business for hundreds of long-distance small fry that buy service from the Big Three at discounts of 40% or more and resell it to consumers at a profit.

Reselling is how the Bells will get into long distance--and how the long-distance companies will get their start in local service, too. But there's a critical difference. Because there is only one network per region, there is less excess capacity. As a result, the Bells are arguing for a resale discount--which will be set by the FCC--of around 5%. "The law couldn't be more lopsided," says analyst Scott Cleland of the Washington Research Group. "The telephone companies get to resell long distance at a 30% to 60% discount, while the long-distance carriers can expect no more than a 5% to 20% discount."

The alternatives are costly. Building wires to every home is out of the question: Industry experts estimate that it would cost AT&T $5 billion and take the rest of the decade to connect every home in just the top 50 markets. Wireless phoning is another option and, indeed, McCaw Cellular (now AT&T Wireless) along with a planned PCS network, will cover 80% of the nation's population. But it will be at least three years before this setup can compete with wired service. "Wireless technology over some period of time will provide a way to directly reach homes," says Joseph P. Nacchio, head of AT&T's consumer calling business. "But I take a relatively modest view of when that will happen."

There are other ways to circumvent the Bells. AT&T has signed agreements with at least 20 competitive access providers (CAPs), companies such as MFS Communications Co. and Intelcom Group. CAPs have high-speed lines in major cities that connect corporate customers directly to long-distance nets. These corporations are the best Bell customers. They generate lots of traffic and are prospects for high-speed data lines, videoconferencing, and consulting services. They are also the most likely to switch local carriers, say numerous surveys.

CABLE CHAOS. Then there's cable. As cable-TV systems gain voice-calling capabilities, they can provide the links to millions of homes. Sprint is putting its heaviest bets on cable. It wants to combine the nationwide PCS network it's building with cable-TV systems that will have voice and video. The grand scheme: offer consumers a discount on wireless calling, say, if they also sign up for local phone service, long distance, and cable TV, all under the Sprint brand name.

The venture was set up last year, but it has run into a big glitch. The cable partners--Tele-Communications, Comcast, and Cox Communications--couldn't come to an agreement on a formula for dividing up revenues from the different parts of the package, so each is now negotiating its own deal with Sprint. "There's no guarantee, but there's a very high probability that the deals will be completed," says Sprint Chairman William T. Esrey.

That could leave Sprint scrambling to make the local connection. And in the short term, at least, it may be far easier to buy rather than build. That's MCI's approach to cellular, for instance: "We're not going to build local wireless services," says President Gerald H. Taylor. "We can lease those facilities cheaper."

But will reselling be a viable long-term strategy? Not according to Merrill Lynch's Maybell: "If you don't own the asset, you're too vulnerable and too dependent on the competition." And that does not sound like the model of a 21st century digital supercarrier.By Catherine Arnst in New York, with bureau reportsReturn to top


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