IP: Briefing.com Stock Brief: The Unintended Outcome of the Telecom Act of 1996

[David Farber <dave () farber net>]

> 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
> ----------------------------------------------------------------------------
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> Copyright © 2001 Briefing.com, Inc. All rights reserved.
> Reprinted by permission for onetime use on DewayneNet and Interesting 
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>
>
> --
> 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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