New Telergee Study: Rural telco operating margins declined again

A new financial survey of small rural telcos offers good and bad news about the rural telecom industry today. On the plus side, small telcos’ Internet business continued to be strong. On the downside, the telcos once again saw operating margins decline.

The survey also found that small telcos with video and wireless businesses continue to struggle to earn a profit with those business lines, while telcos with CLEC operations saw margins improve.

The Telergee Alliance, a group of accounting firms that specialize in the rural telco market, has conducted the survey, called the Telergee Benchmarking Study, for several years. Once again, as in previous years, the alliance has shared the survey results, normally available only to client companies, with Connected Planet.
This year’s survey drew 221 responses, which should be a representative sample of the 800-odd incumbent rural telcos nationwide. It is based on data for calendar year 2010.

First the bad news
I normally prefer to end columns on a positive note, so I’ll start with the bad news:
-- Operating margins were down 5% from the previous year, continuing a trend we have seen for at least three years now. Once again, non-regulated margins were up (4.9% compared to the previous year), but those gains were insufficient to make up for a 15.4% year-on-year margin decrease on the wireline side of the business, which is comprised largely of regulated revenues.


-- Just over half (51.4%) of respondents offer cable services and 35.5% offer IPTV. But telcos’ video businesses once again operated at a loss. As we’ve seen in previous Telergee studies, small telcos have struggled to make money on video.

Clay Sturgis, telecom group leader at Telergee member firm Moss Adams, pointed to the high cost of content as a key factor underlying that profit struggle. Rural carriers don’t have the volume or scale to negotiate the best rates for content, Sturgis said. Nevertheless Sturgis doesn’t expect to see rural telcos give up on the video market. “For a lot of ILECs, keeping a customer is so valuable”--and to keep customers, small telcos feel the need to have video as a piece of a broader service bundle, despite its low margins, he said.


-- For the 19.3% of respondents who offer wireless services, average revenue per user (ARPU) was just $35.51, down from $37.12 in 2009 and $40.93 in 2008—and a far cry from what larger national carriers are experiencing.

-- Despite 3.8% customer growth, rural telcos’ wireless businesses operated at a slight loss for the year. This likely reflects increased competitive pressures, as rural wireless companies face increasingly concentrated national players that have better access to the latest devices.


Now the good news
On the plus side:

-- The Internet continues to be the bright spot for small rural telcos. Internet service revenues were up 5.6% for the year—a continuation of a growth trend we have seen for several years.


-- Interest expenses declined 4.6%. Moss Adams Office Managing Partner Rick Betts attributes this phenomenon to unprecedented low interest rates and to the fact that companies have postponed borrowing—in part because of regulatory uncertainty. He cautioned, however, that “It’s getting to the point where the industry needs to start borrowing.”


-- Among the 24.3% of rural telcos with CLEC operations, margins were up 29.3%. “What we’ve seen in our client base is that revenue per line is jumping because of a focus on getting customers with higher ARPU,” comments Cliff Abbott, a principal with Telergee Alliance firm BerryDunn.

Abbott cited the example of one client that previously focused on both residential and business CLEC services but now focuses only on the business market. A substantial component of the cost of serving CLEC customers is fixed due to available excess capacity, Abbott noted, which means “if you can bring up ARPU by ten dollars, it’s likely that a vast majority of that will fall to the bottom line.”

Something perplexing
Betts noted an interesting anomaly in the Telergee data. Even though 26.8% of last year’s respondents said they planned to be providing VoIP service by the end of 2010, only 10.4% of this year’s respondents said they have done so.

Betts attributes the reluctance to deploy VoIP, in part, to the current access charge system, which offers a disincentive for small rural telcos that are highly reliant on access charge revenues, to interconnect calls using VoIP. Betts believes rural telco VoIP deployments could increase dramatically, depending how the access charge system is reformed.
As the Universal Service transitions from being a voice-centric to a data-centric system, telcos also may have an incentive to convert to VoIP because traditional voice infrastructure would no longer receive Universal Service support.

But for rural telcos that have deployed broadband, that may not be a big concern, said Rhonda Bethe, controller for Kansas-based Tri-County Telephone, a client of Telergee Alliance firm Kiesling and Associates. Bethe noted that her company is currently deploying fiber-to-the-home and as it does so, it is moving customers off of their traditional copper infrastructure, even if they do not plan to subscribe to video or data services.

“As long as we can provide broadband service at levels that enable us to retain funding, we think VoIP will be a natural progression,” said Bethe.

TCT is among the roughly one-quarter of rural telcos that have a CLEC business—and Bethe also shed some additional light on why the profit picture in that area has improved. “The per-megabit backbone cost has come down,” said Bethe. TCT is now able to use Ethernet where it previously would have used slower and more costly DS-3 circuits, Bethe said.