Clear sailing?

Considering the breadth of services they offer and the variety of markets they serve, summing up the whole of Independent telcos is a foolhardy if not impossible task.

However if any trends can be divined by looking at capital spending for the second half of this year, many of the largest telcos don't appear to be slowing their efforts to deploy services, particularly those of the broadband variety, to their customer base despite the general downturn in the financial markets. Moreover, as Independents continue to expand their competitive local exchange carrier (CLEC) efforts in neighboring territories, vendors see an opportunity to make up at least some of the gap left by other carriers' failures.

Making lemonade

“The slowdown in spending is not really happening on their [Independents'] side,” says Rashid Skaf, vice president of marketing and business development with Broadband Gateways, which is trying to reach Independents through partnership channels. “They're still getting the same cash flow. Because their stock is down, their boards are getting much more involved in how they're spending, but from a realistic point of view there is no difference. From a perception standpoint there's a difference.”

Part of that reality stems from the fact that most Independent telcos, like their larger brethren, still get the vast majority of revenue from voice services. Unlike the big boys, though, most face little if any competition from traditional CLECs or IXCs. All of which combines to make for a slightly more stable environment.

“As the Internet bubble reached its crescendo and died with a whimper, most of them are unaffected,” says Steve Grady, vice president of business for Americas at Marconi.

The other part of that reality is the market most Independents operate in, says Kevin McClain, regional vice president of sales for Independents at AFC Telecommunications. “They're unique. They're perpetually in a situation where it's a rural market so you don't have the peaks and valleys of access line growth.”

Demographics and the peculiar economics of Independents also are playing out in their favor, McClain says.

“The [Independents] are really doing well because of sprawl coming into their towns, them going into adjacent RBOC towns and on top of that being able to offer high-speed access. Their approach has been very different from the RBOCs. They're not offering 6 Mb/s. They're saying ‘for $5 extra would you take 64 kb/s and get off my switch,’” he says. “By doing these CLEC ventures, they're able to drag those voice lines into their embedded switch infrastructure. It actually lowers their cost of doing business in their township. Voice is the base line application that lets them make money.”

The fact that they haven't been burdened with the kind of debt that other CLECs have and that they operate away from the media spotlight also benefits Independents in a down market, says Grady. “Most businesses don't like to shout out, ‘Hey, we're growing 2% to 3%,’” he says. “The Street has always been looking for 20% growth. [Independents] never get ahead of their headlights.”

New plans

Still, Independent telcos are changing the way they do business and it's reflected in how they plan to spend in the second half of this year. First and foremost, expect to see a continued increase in deployment of DSL-based services.

In a survey released earlier this year, the National Telephone Cooperative Association said its membership, which consists mostly of rural Independent telcos, has significantly increased the reach of DSL to its customers. According to the survey taken in 2000, about 55% of NTCA members were offering DSL to residential users, while 61% were providing service to business users. However, by the end of this year about 79% of the membership expects to be offering service to either business or residential subscribers (Figure 1).

Figure 1 Estimated upgrade costs for rural access lines

In billions

	Lines	Cost per line	Total cost
Customers within 18,000 feet of central office	1,639,283	$493	$0.81
Customers within 18,000 feet of DLC	1,093,051	$4121	$4.51
Customers in “isolated” areas	600,957	$9328	$5.61
Totals	3,333,291	N/A	$10.92
Source: NTCA

For those that already have begun rolling out DSL, the latter half of this year appears to be a time when the most effort will be concentrated on increasing penetration rates. According to the NTCA survey, average penetration rates among Independents offering DSL is at a mere 0.3% for residential users and 1% for business users.

Hickory Tech, an Independent based in Mankato, Minn., is typical of the trend. The company, which has both incumbent LEC and CLEC properties, likely will spend about the same amount as it did last year on equipment, even though it may appear to be a slowdown, according to a company spokesman.

“We've spent just over $39 million last year and we're looking at spending around the same neighborhood this year,” said the spokesman, noting that in 1999, the company spent around $28 million on capital expenses. “We're going out and wrapping up more of our sales efforts.”

In 1999 and 2000, the company concentrated on expanding its CLEC territory in the past while other CLECs also were expanding. This year, however, with the demise of many CLECs and the general market downturn, there is less pressure to expand footprint and more emphasis on profitability. The result is a spending plan that may include about the same amount of capital outlay, but appears to be a slowdown.

“We're trying to make sure our [CLEC] markets turn profitable a lot sooner,” said the Hickory Tech spokesman.

Better than you thought

And while that certainly is a goal of any telco, some, such as Roseville Communications, see the current market the way any aggressive investor would — as a buying opportunity. The company, which has its ILEC territory just outside of Sacramento, Calif., in Roseville, is typical of ILECs with a CLEC strategy that relies on going into adjacent territory.

“We have a CLEC edge-out build that we're still quite bullish on,” says Brian Strom, president and CEO of Roseville. “With the financing problems of the traditional CLECs, there's a window of opportunity there.”

At of the end of 2000, the company had $14.9 million invested in CLECs and other non-regulated businesses and will continue to invest.

Moreover, with the pressure on traditional CLECs, there may be some opportunity to expand networks without going through the build-out phase, he adds. “There are a lot of assets coming available so we're keeping our eyes open.”

Not all Independents are in the same position, though. And while most appear to be settling into spending about the same or incrementally more than they have in the past, a couple are poised to go on spending sprees.

Iowa Telecom, for instance, is in the unique position of being a new incumbent. Formed a little over a year ago, the company was created specifically to acquire the 300,000 or so access lines that GTE was selling off as part of its acquisition by Verizon. Since then, Iowa Telecom has been assessing the state of the plant in its new territories and planning for some heavy spending on upgrades.

“If you look statewide, GTE in our mind, has really under-invested,” says Alan Wells, president and chief operating officer of Iowa Telecom. “Our biggest challenge now is how to deploy capital. We need significant plant upgrades.”

Just what those upgrades will entail will depend largely on the individual local network's needs. In some cases, it may require new switching while in others it's the outside plant that will get the bulk of the investment. Regardless of where it goes, current market conditions aren't having a major effect on the company's plans, although Wells says it has made borrowing a little more expensive.

“Our deal was funded to acquire the operations,” he says. “In that we had the capital to fund capital improvements. We'd probably rather have cheaper debt but right now, we're looking to increase our debt load.”

The financial straits many vendors are in also has put the squeeze on some financing that previously was easy to come by, he adds.

Regardless of the particular situation any Independent is in, most say they are not as concerned about vendors, noting that they haven't necessarily been more reluctant to buy from start-ups.

“There are some real hard chargers out there that are willing to try new companies and then there's a good contingent out there that won't use a technology until it's completely proven out,” says Bernardin “Berni” Arnason, vice president of business and technology for NTCA. “For the most part they're leery of dealing with start-ups. Not because of what's going on, but because they're start-ups.”

Roseville would fall into the majority on this issue, Strom says. “Most of our vendors are pretty mature, so I don't think we've run into any problems [with start-ups going belly-up].”

For some like Hickory Tech, it's not the size of the company that matters, but the technology it brings to the table.

“You always have to be careful because of the stability of your vendor, but it's always more important for us to decide whether the technology works than whether the organization is going to be there in a few years,” said a spokesman for Hickory.