LONG-HAUL CARRIERS PLAY LET'S MAKE A DEAL

Feb 18, 2002 12:00 PM, Glenn Bischoff

With investors hypersensitive about debt, Bell companies may need to take advantage of the depressed long-haul market rather than embark on expensive network buildouts when they receive regulatory approval to provide universal long-distance service.

Qwest Communications' decision last week to draw down its $4 billion credit facility may have been the final wake-up call that Bell companies should consider leasing capacity or merging with existing long-haul providers.

"Investors are screaming, 'No, no, nospend the money elsewhere,'" said Dana Tardelli, senior analyst of communications services for Aberdeen Group. "The focus these days has to be on getting customers."

Conventional wisdom says the Bell companies will win their Section 271 approvals for in-region long distance soon-almost certainly within the next 18 months and perhaps as early as the end of the year-despite a process that at times has seemed as tedious and painful as the Bataan death march.

Once those approvals are in hand, the Bell companies will need network capacity-and lots of it-as they begin to provide long-distance voice and data services throughout their regions. Analysts believe they will almost certainly look to wholesale carriers to meet those needs, as shareholder pressure and a reluctance to add to their debt loads will keep them from embarking on significant builds-at least for now.

"There won't be any building," Tardelli said. Carriers have learned they don't have to be facilities-based to be successful, and the value of owning an end-to-end network diminishes as bandwidth becomes commoditized, Tardelli said.

Indeed, outsourcing-such as the recent long-distance deal Verizon Communications cut with Williams Communication Group-makes sense in a capital-constrained market, said Patti Schmigle, senior vice president of business development for the long-haul backbone provider.

While WCG certainly would welcome additional business from Bell companies, Schmigle dismissed the notion that the perceived bandwidth glut will create a buyers' market for network capacity, limiting the revenue potential for wholesale carriers.

"Bandwidth glut is a misnomer," she said. "There's a big difference between dark fiber and lit capacity. If you look at just the fiber, you might think there's a glut. But what really matters is lit capacity, and when you look at that, you can see there is no glut (see table)."

The market seems to indicate otherwise, said Patrick Comack, telecom analyst for Guzman & Co. "There are plenty of companies out there on the ropes willing to lease at low prices," he said.

Regardless, consensus thinking indicates WCG and its primary competitors in the long-haul space-Level 3 Communications, Broadwing, Qwest and Global Crossing (if it re-emerges from bankruptcy)-will benefit to some degree from new business from the Bells, at least over the short term. But those opportunities eventually may dry up as the capital markets loosen and shareholder skittishness subsides. When that happens, the Bells might decide it's better for their long-term health to control their own destinies.

The fallout of such a decision could be consolidation, with the Bells absorbing a wholesale carrier or interexchange carrier (IXC). Many analysts are calling consolidation inevitable, especially given the depressed stock prices of long-haul carriers. "The value of these companies has gone down," said Lynda Starr, vice president of U.S. carrier research for Probe Research. "Right now they're a bargain."

On the surface, Global Crossing represents the biggest bargain, as bankruptcy proceedings usually result in assets being available for pennies on the dollar. But that's not always the case, said Gregg Theus, vice president of network planning for Verizon. "Sometimes, the expectations are higher than what the equipment is worth," he said.

Perhaps more important to the Bell companies is network compatibility. Theus said facilities owned by other carriers-"while not obsolete"-are often two to three releases behind what Verizon has in its own network.

"That creates additional logistics and expense items," he said, adding that Verizon, given its buying power, can often negotiate a better deal with equipment vendors for new equipment. "This isn't rocket science. It's simple economics. But if the price was right, we would look at another carrier's facilities."

WCG might be the best candidate for plucking, given its current market cap of $334 million, compared with Level 3 ($977 million) and Broadwing ($1.4 billion). But the Bell companies might set their sights instead on established IXCs. Of these, AT&T is considered the most attractive candidate because of its enterprise customer base.

Any Bell company and IXC pairing would come under intense regulatory scrutiny, and some analysts believe that regulators would be reluctant to approve any combination that flies in the face of the 1984 consent decree that broke up AT&T. But Deborah Majoras, deputy assistant attorney general of antitrust for the U.S. Department of Justice, said the department would not immediately take exception to a Bell/IXC merger.

"There's no huge psychological hurdle to overcome," Majoras said. "We take each merger one by one on its merits and have case law to guide us. We look at mergers only from a legal perspective, and I'm sure that's the approach we would take with any Bell long-distance merger. We don't decide how markets develop."

Although Bell companies would acquire considerable network facilities with an IXC merger, there would still be plenty of transport business available for long-haul wholesale carriers because they have newer fiber and better optronics, said Seth Libby, telecom analyst for The Yankee Group.

"Level 3 can produce bandwidth cheaper than AT&T," he said, adding that foreign carriers looking to make a U.S. play would also turn to the wholesalers. "They won't be turning to the incumbents."

AT&T's facilities upgrade will put it in the best position among the long-haul carriers in terms of robustness and scalability, Libby said. "This is real rocket-type stuff," he said. "If you want a network that's going to be rock solid for the next 15 years, it will be AT&T."

This would pressure WCG, Level 3 and the other wholesale carriers to differentiate themselves through service and execution, Libby said. Dan Caruso, group vice president of network business for Level 3, acknowledged this situation.

"We have to understand their needs and realize the RBOCs are in the driver's seat," he said. "We have to make it easy to work with us and make sure their costs don't exceed their revenues. If we're not good partners for them, then we could drive them to get their own networks."

With additional reporting by Toby Weber in Chicago.