Another fine mess?

CLECs face switched access as a changing revenue stream, raising fears in investors

The scenario is this: A competitive local exchange carrier handling calls on its network that belongs to a larger, entrenched carrier charges a high fee for its service. The larger carrier, unhappy with those charges, holds payment in hopes of negotiating lower fees. The situation comes to the attention of investors who, justifiably or not, get nervous that an important revenue stream for the entire CLEC space could be in danger.

Though it may sound like reciprocal compensation, it's not. The issue is switched access, and it could be the latest major headache in what has already been a tough year for CLECs in the stock market.

In the case of switched access, the larger, entrenched service provider is not an incumbent LEC (ILEC) but a long-distance provider.

When a LEC originates or terminates a call for an interexchange carrier (IXC), it has an undisputed right to charge for that transport. Most states set switched access fees for ILECs. CLECs, however, generally have fewer regulatory guidelines and in most cases can set their own switched access rates.

The question is, what should be the basis for these rates - the cost of transport or what the market will bear?

The ILECs serving next door to CLECs in urban settings generally charge about 1cent to 2cent per minute, which is about the actual cost of handling these calls. Some CLECs, however, set their switched access rates at more than 7cent per minute, in line with tariffs filed by the National Exchange Carrier Association, which represents rural service providers.

Not surprisingly, IXCs feel that the NECA tariff is an improper guideline for CLECs that serve customers next door to ILECs' customers. The CLEC charges, the IXCs say, cannot be based on the cost of transport.

Mpower Communications' expenses are higher than those of the large incumbent carriers, thereby justifying higher switched access fees, notes David Clark, senior vice president of investor relations at Mpower, a competitive carrier that traditionally has generated a high percentage of its revenue from switched access fees.

"If the only thing in question were the cost of transport, the [cost-based] argument would be far more valid," Clark said. "The reality is that the cost of hardware to build the network is not going to change value whether in rural or urban areas."

Whether IXCs should be expected to help cover the cost of CLECs' network builds is questionable. In any case, the major long-distance carriers are beginning to take a stand on the issue. And while Mpower and others are willing to work out switched access agreements with long-distance providers, other CLECs are not as eager to negotiate.

"There are... CLECs that are taking a very hard line saying, `It's the rate in my tariff, and that's it,'" said Bill Taggart, division manager for AT&T's CLEC business development and management unit. "We don't have a choice, either take it or leave it. In those situations we prefer to leave it."

When an IXC chooses not to pay the tariff, it doesn't interconnect to the CLEC. That forces some customers to choose between their local and long-distance providers. In addition, the CLEC loses the potential revenue from switched access. Even if CLECs negotiate lower rates with IXCs, the revenue they collect is diminished.

Some argue that CLECs should treat switched access not as a major source of income but as a sideline that could be added to an already strong business."It could be a nice little revenue stream if they're successful. I don't know if it's worth the exposure and bad press to charge [a jacked-up] amount," said Michele Young, principal with Youngideas Consulting.

Indeed, the negative impression that the loss of switched access could give investors might be more damaging to a company than the loss of the revenue itself.

"It's another issue that has caused investor concern and uncertainty given the carnage in the CLEC space," said Trent Spiridellis, senior telecom analyst at Banc of America Securities. "Investors have stayed away from any companies that are perceived to have lower quality and unsustainable revenue streams."

CLECs have taken some steps to mitigate the negative effects of their dependence on switched access. Before working out agreements with the three big long-distance providers, Mpower reported the unpaid switched access fees on its quarterly earnings statement but put a reservation on those earnings to keep investors informed.

Allegiance Telecom, like Mpower, attributes a significant percentage of its revenue to switched access fees. But the Dallas-based CLEC went a step further: It does not count in its earnings the revenue from switched access fees that have been billed but not paid. Only when money is received from an IXC does Allegiance report it, according to the company.

Many CLECs are taking precautions such as these or avoiding the controversy altogether by setting switched access fees in line with ILEC rates. The next step, though, is to keep investors informed of the situation.

"It's one additional item that for many carriers represents nothing other than noise that needs to be explained and understood," Spiridellis said. "And given the given the carnage in the CLEC space, uncertainty commands a greater risk premium."