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IP: Briefing.com Stock Brief: The Unintended Outcome of the Telecom Act of 1996
From: David Farber <dave () farber net>
Date: Thu, 02 Aug 2001 12:28:25 -0400
Date: Thu, 02 Aug 2001 09:26:12 -0700 From: "Robert J. Berger" <rberger () ultradevices com> Organization: UltraDevices Inc. [received explicit permission to have this reprinted in Interesting People, please respect the copyright and contact the author rvgreen () briefing com, for other public reprinting] Briefing.com Stock Brief: The Unintended Outcome of the Telecom Act of 1996 30-Jul-01 08:37 ET [BRIEFING.COM - Robert V. Green] Two events happened last week that illustrate a great irony in how the telecom market has unfolded. Already in bankruptcy, 360 Networks (TSIXQ) was delisted on Friday. Also, Verizon issued a positive press release that seems to indicate pending approval of the FCC of Verizon's intent to offer long distance in Pennsylvania, even as the FCC complained that Verizon makes it hard for CLECs to buy service from them. In the five years since the passage of the Telecom Act of 1996, things haven't turned out the way they were intended. Brief History The modern telecom environment starts with the breakup of AT&T (T) in 1983. By separating long distance from local service, Congress intended to create opportunities primarily for other long distance services. MCI (WCOM) was the first really large company to show that the breakup was working, but others followed. The breakup of AT&T, if viewed as a means to provide long distance competition and lower prices for consumers, was a success. But at the time of the AT&T breakup, the telecom system was viewed as primarily for voice. The growth of data transfer and the birth of the internet as a public infrastructure changed public policy on the telecommunications infrastructure. The Telecommunications Act of 1996 was designed to create competition for all types of telecommunications services: local, long distance, internet access, broadband services. A prime element of the act was the required access to the existing infrastructure. The Regional Bell Operating Companies (RBOCS) were required to sell access to their system to Competitive Local Exchange Carriers (CLECs), the new companies that would be created by the Telecommunications Act of 1996. It is a separate argument as to whether the government should be able to force private companies to engage in businesses against their own interests. The RBOCs were forced to sell, at regulated rates, access to their own central offices and systems, to companies whose goal was to take business from them. It could be that the roots of the Act's failure lie in this forced market situation. The Great Capital Rush Wall Street saw the Telecommunications Act as the Great Land Rush. Dozens and dozens of companies with business plans to start new telecom services got funded. Billions were raised in anticipation of the huge size of the telecom market that would be built. Companies like Global Crossing raised more than $7 billion in debt, $3 billion in convertible preferred, and $13 billion in common stock, more than $23 billion, and they did it easily. Stock was sold at high valuations, convertibles were sold at low interest rates because of visible conversion prices, and the debt was secured only by rapidly depreciating assets. Tabulating the entire capital allocated to the telecom space, as a result of the Telecom Act of 1996, over the past years, would be revealing, although more work than was possible for this Stock Brief. But it is certainly in the upper hundreds of billions, and may approach $1 trillion. Nearly all of that capital, allocated to new businesses created to capture the space opened up by the Telecommunications Act of 1996, has gone to build companies unable to build profitable models. But, it seemed, just three years ago, that the entire space would be made available because of the Act. After all, AT&T and the RBOCs would be held back by the courts until the new companies could be established. AT&T would be held back from offering local service, and the RBOCs held back from offering long distance, until each had significant competition to face. How could they fail with the government on the side of the new companies? Competition But while many of the CLEC's never made it to profitability, they did get some customers. For example, New Jersey CLEC, KMC Telecom never made it to the public markets, but raised more than $2 billion in debt. It has yet to report even an EBITDA profitable quarter. But what KMC Telecom has accomplished is a "competitive lines" number. At 570,000 lines, KMC Telecom is going a long way towards establishing that Verizon has opened up the NJ market to local competition. In Massachusetts, Verizon (VZ) now offers long distance. Essentials.com, which simply resold Verizon lines, was one of the firms that "established" that Verizon was allowing competition in local calling. But essentials.com is now filing for Chapter 7 bankruptcy, dissolution. And now, in Pennsylvania, the FCC has decided that "CLECs have made significant inroads into the local markets in Pennsylvania." The FCC did complain about Verizon's difficult billing process, for charging CLECs for their service, but indicating a willingness to approve the long distance application, if progress was shown. One of the competitors listed is Z-Tel, (ZTEL) which operates in Pennsylvania. Z-Tel can hardly be held up as an example of successful competition, as it struggles for its own existence. The stock is just above $1, the company is flooded with shareholder lawsuits, and they are still unprofitable. But the FCC was clear on Thursday: if Verizon can make billing of its own competitors a little easier, they can have the long distance market. The absurdity of this situation seems to be lost on the FCC. The Great Collapse It seems like all of the new companies created by the Act are now floundering. Not just CLECs, but nearly every sector of the revolution opened up by the Telecommunications Act has collapsed: - DSL vendors: DSL.net, RythymNet Connections, etc. - Fiber Optic Networks and Interchange carriers (ICX): Metromedia Fiber, Level3, etc. - Network Equipment vendors: JDS Uniphase, etc. - Internet Service Providers: PSI Net, etc. - DSL Equipment Vendors: Covad, Copper Mountain, etc. - Web hosting: Exodus, Genuity It would take a whole page to list all of the failed and severely hampered companies inspired by the Telecommunications Act of 1996. What Went Wrong? What went wrong? The list of possibilities include: - Too many companies: Things would have been fine if three large CLECs had been funded with the same amount of money. - No real market: not enough businesses or consumers switched away from the RBOCs fast enough. The proposition wasn't strong enough. - RBOCs didn't cooperate: they really made it easy for competitors to hook up in the Central Offices. - No killer application: The infrastructure was built, but nothing came along to populate it with revenue. - Misleading demand indications: The dot-com explosion in 1998 and 1999 gave the wrong signal about future levels of sustainable demand. - Foolish Market: The public market's willingness to fund anything caused a huge misallocation of capital. - Companies were given money simply to IPO, rather than build lasting models. - The Great Irony - The Unintended Consequence The coming twelve months or more will be the year of bankruptcy for telecommunications companies inspired by the Telecommunications Act of 1996. It seems inevitable that Teligent will be followed by dozens and dozens more. What happens when a company goes bankrupt? If the company can keep operating, the debt is restructured and common stockholders usually get nothing. Chapter 11 is a "restart." But sometimes the company is dissolved (Chapter 7). When that happens everything gets put up for sale. At bargain prices. Huge amounts of "barely used" telecom equipment, from DSL rack systems already installed in central offices to web hosting server farms to miles and miles of fiber are going to be "on-sale cheap" in the coming months. And the only ones with cash to buy them will be the RBOCs, and possibly AT&T. Certainly the RBOCS will get their lost customers back. In Massachusetts, it is likely that every one of the essentials.com customers will automatically revert back to Verizon when essentials.com finally folds. After having helped Verizon prove "competitiveness," essentials.com will now likely give back the competitive business. The outcome of the Telecommunications Act of 1996 now looks like this: - "Competitive" local markets were proven with public capital (not RBOCs capital). - The RBOCs will get their coveted long distance permission as a result. - Many competitive local exchanges will be folding just as the RBOCs start up their one-stop service offerings. - DSL will finally "work" and be available, when the RBOCs will be the only ones left offering it. - And when all the excess fiber network and web hosting equipment goes up for sale, the RBOCs will be able to pick and choose what they want. Probably at one-tenth what they would have had to pay, if they had invested in the equipment themselves. Investors What does this mean for telecom investors? The best bets, long term, are now the RBOCs themselves. Verizon and SBC Communications (SBC) are probably the best selections in that space. Second bets are companies like Qwest (Q) and Broadwing (BRW) which could be considered "children" of the RBOCs. However, neither of these bets are the types of stocks that telecom growth investors really wanted: five times the money in three years. But slow growth, as they capture the inevitable rollout of new telecom services, is likely to accrue to these players. Of course, the scene might change completely, if and when Congress decides to rewrite a whole new set of rules, with equally good intentions as the Telecommunications Act of 1996. Comments may be emailed to the author, Robert V. Green, at rvgreen () briefing com ---------------------------------------------------------------------------- ---- Copyright © 2001 Briefing.com, Inc. All rights reserved. Reprinted by permission for onetime use on DewayneNet and Interesting People of Briefing.com -- Robert J. Berger UltraDevices, Inc. 257 Castro Street, Suite 223 Mt. View CA. 94041 Email: rberger () ultradevices com http://www.ultradevices.com Voice: 408-882-4755 Fax: 408-490-2868
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- IP: Briefing.com Stock Brief: The Unintended Outcome of the Telecom Act of 1996 David Farber (Aug 02)