Cashing in on convergence

To large ILECs, losing hundreds of thousands of residential consumer access lines every quarter for the last few years has been like getting stabbed in the heart — not just a loss of customers and revenue, but a dramatic weakening of their traditional cash flow center. It wasn't a blow dealt only by competition, either. In fact, the more overwhelming reason for access line loss was wireless substitution. Wireline customers have been cutting the cord in increasing numbers, and even if some of them were just moving over to the wireless subsidiaries of these ILECs, the writing on the wall suggested that access lines were losing their value — both literally and as a financial metric for measuring ILEC success.

Access line loss always has been a difficult trend to measure accurately, and it remains so. Wireless substitution and competition are not the only reason for access line numbers to decline. In the residential market, some traditional voice access lines are being switched to broadband, and in business market segments, business users are migrating to different kinds of available data circuits. Yet overall, the decline in access lines has been very bad news for companies that always have touted their millions of access lines as perhaps their most fundamental indicator of financial strength and in turn have seen investors use access line count as a key indicator of public market value.

The industry is now entering its fourth year of consistently large access line loss. By the beginning of 2004, access line losses were numbering in the hundreds of thousands at each of the former Bell companies. At Verizon Communications, 784,000 retail residential access lines were lost in the second quarter of 2004 alone.

However, more recently, as the largest telephone companies reported fourth-quarter and year-end earnings, there was some good news, or perhaps more accurately, less bad news about access line decline. Verizon, SBC Communications and BellSouth all reported that they lost fewer residential access lines during the fourth quarter of 2004 than in the previous quarter.

Moreover, these companies also reported that they are beginning to see enough revenue from new services that it is causing the ongoing losses to be offset by increasing revenue per customer.

In reporting Verizon's fourth-quarter earnings two weeks ago, Doreen Toben, executive vice president and chief financial officer at Verizon, told analysts, “We continue to see line erosion for all of the reasons we have cited for some time,” she said. “But we've seen improvement in the trend of retail access line loss, and our losses there also are being more than offset by DSL revenues.”

For Verizon, it was the second consecutive quarter of improvement. The company saw residential lines decline by 518,000 in the third quarter and by 466,000 in the fourth quarter. Meanwhile, revenue from access lines grew from $9.65 billion to $9.67 billion, and data revenue increased from $1.98 billion to $2.04 billion. Verizon also is seeing revenue performance improve in its business access line segments.

Though that represents minimal growth, Toben saw a trend. “The best way to understand our business is really to think of it in terms of revenue per customer,” she said.

Larry Vanston, president of Technology Futures Inc., said producing DSL-related revenue growth is an important step for the large telcos.

“It is a good sign because it means they are now establishing themselves in the broadband business,” Vanston said. “The question is can they continue to add value to access lines.”

Verizon's Toben indicated the value of access lines, despite the losses, is being reinforced.

“Despite the access line losses to technology substitution and competition, 2004 was the year we saw revenue stabilization, with the emergence of new sources of revenue and strong growth,” Toben said. “We're showing that despite all the challenges, we can still grow our wireline business.”

She said the company got $12 million in cash flow during 2004. “Wireline is still generating the cash we need to grow.”

BellSouth had a similar story in the fourth quarter. Residential access lines declined by 87,000, and the company experienced a net loss overall of 220,000 lines. However, a more positive face gets put on the residential line loss when you consider that it was BellSouth's smallest quarterly decline in the last three years.

“The ongoing loss in access lines reflects the effects of wireless substitution, and to a lesser extent, competition from other facilities-based providers in the marketplace,” said Ron Dykes, chief financial officer of BellSouth.

“But, access line losses were offset by revenue growth in data and long-distance services,” he said. “About 65% of our revenues are coming from the fastest-growing, most desirable sectors of telecom. Long-distance and DSL services will continue to be the drivers of wireline revenue.”

SBC also said ongoing growth in data and long-distance revenue mitigated access line losses. That company saw DSL-related increases from $578 million in the third quarter to $594 million in the fourth quarter.

For both BellSouth and SBC, partnerships with satellite TV providers — considered an interim video strategy before they roll out telco TV services — also produced new revenue through voice and video bundles.

Wireline and wireless bundling also is starting to pay off.

“The RBOCs are doing more wireline and wireless bundling, and that is helping,” Technology Futures' Vanston said.

Some large telcos also might be losing wireline customers directly to their own wireless subsidiaries, though Vanston said it's not likely to be a measurable trade-off.

Aside from these revenue improvements, the phasing out of UNE-P rules undoubtedly is also is helping the large ILECs, according to Frank Louthan, wireline industry analyst at Raymond James & Associates.

Louthan wrote in a recent research note that though access line losses are likely to continue, he expects the RBOCs' increased revenue per user still will mitigate the effect.

While access line declines seem to be stabilizing — or at least slowing industrywide — and the largest telcos are gaining revenue from new sources, it's unclear how things will shape up even in the short-term future.

“Access line decline is something that's going to continue,” said Vanston. “If you've got voice over IP and wireless both growing, that equals a long-term migration of traditional voice access lines.”

Also, in Louthan's research note, he stated that cable-based VoIP has yet to have much effect on telco line loss, but with Comcast and other cable companies launching VoIP this year, the situation could change.

Dykes admitted during the BellSouth call, “You can't read too much into the fluctuation of access line trends. We don't have great visibility into the future where that's concerned.”

In addition to these competitive trends, the shape of the industry continues to change in ways that make the future seem uncertain. The recently announced and pending acquisition of AT&T by SBC seems capable of boosting SBC's access line base, its ability to hold onto its existing access line customers and the competitiveness with which it can win access lines away from other service providers.

As telcos face the prospect of ongoing access line loss, despite improving revenue, they also have the option to deal with the situation by selling off the groups of access lines that are not producing revenue above a certain threshold, or that are not carrying service bundles.

Last year, Verizon Chairman and CEO Ivan Seidenberg said the company was interested in shedding about 10 million to 15 million access lines by selling them to other companies. However, during the company's fourth-quarter earnings call, Seidenberg admitted the company is re-evaluating, in light of market and industry changes, exactly how it will proceed.

“We'll explore our options as the year unfolds,” he said, but acknowledged that access line value has been affected by a glut of lines from various carriers being put up for sale.

“[Divesting access line] is something we're still thinking about,” he said. “But, in the last couple of months, things have changed, and we want to take a more careful look at the market before we jump into the pool. Nobody knows right now what will happen to the access lines of the various companies that are merging.”

Indeed, while SBC officials have insisted that the company shouldn't have to divest any properties before acquiring AT&T, it is quite likely that the company will be forced to do so in order to gain approval for the acquisition from the FCC. (During 2004, both SBC and BellSouth were forced to put access lines in several markets on the auction block before their wireless joint venture, Cingular Wireless, was able to complete its acquisition of AT&T Wireless.)

If there's anything to be gleaned from the way service providers have begun to handle ongoing access line loss, it's that they will no longer allow access line counts to be the measure of their pulse as public companies. Their overall strategy across the industry is to increase the value of access lines by putting new and better services over them, but they also will not deny the whims of a social trend. They're moving to better position their firms to take advantage of these trends, and working to make their investors believe that they are as much sellers of services as they are operators of networks.