Lehman: Verizon may want to rethink FTTP

In a research note issued this morning, Lehman Brothers analyst Blake Bath suggested that the harsh economics of fiber-to-the-premises deployment may convince Verizon Communications to substantially scale back its FTTP plans this year in favor of fiber-to-the-node. However, Lehman Brothers has received no indications from Verizon that the carrier intends to do so.

Verizon's FTTP initiative, which has now passed more than 3 million homes and businesses in 16 states, cost the company $1 billion in free cash flow in 2005, Bath said in the note. That cost could double this year, he said, draining another $1 billion to $2 billion per year through 2010. AT&T's investment in FTTN, meanwhile, is "smaller and more concentrated," Bath wrote, perhaps totaling $6 billion and ending in 2008, when it could begin to generate free cash flow.

"FiOS-related revenue will be less than $1.5 billion by 2010, less than FiOS-related capex after five years of heavy investment," Bath wrote.

Verizon currently might be spending $500 to $600 per home deploying FTTP, Bath conjectured, which is below Lehman Brothers' initial estimates of $750 per home but still about twice what AT&T is spending on FTTN ($250 to $300 per home).

In addition, although Verizon's stock is currently priced higher than that of any other Bell company, it dropped more than 22% in 2005, while that of AT&T, BellSouth and Qwest Communications rose 0.3%, 1.8% and 27.3%, respectively.

"The market is very skeptical of FiOS spending," Bath wrote, "We believe that if Verizon shares continue to lag its peers and the broader market, it may substantially scale back its fiber build before the end of 2006, due to poor economics and the technical and regulatory delays associated with rolling out video."

A Verizon spokesman acknowledged that FTTP deployment currently is more expensive than FTTN, but argued that FTTP was a superior strategy in the long run. "This is a short- and long-term strategy," the spokesman said. "The strategy is to future-proof the network. We don't want to spend again. We think it's very likely, to be competitive, other companies are going to have to go this route anyway."

Verizon's video strategy is less risky from a technological standpoint than AT&T's IPTV plans, Bath said, as the latter continues to work to iron out its middleware problems with Microsoft and tackle the question of whether IPTV will be able to support the bandwidth necessary for high-definition television.

In addition, the slow process of obtaining video franchises will continue to drag on all Bell video offerings, regardless of technology, Bath said, as changes on that front at the national regulatory level are not likely to affect the Bells until next year or later. As a result, Bath expects the Bells, in aggregate, to extend video service to perhaps no more than 8 million homes by the end of this year, 15 million homes next year and 20 million in 2008. Verizon has launched video service in three small markets so far. AT&T has not launched video service yet.