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As the local phone biz fizzles, Sprint
Nextel and Alltel may spin theirs off, while CenturyTel could do
well by expanding its interests
Heading into another earnings season, we at Standard & Poor's
Equity Research will focus on local phone customers, who have been
more fickle than in years past. The local phone business has long
served as the cash generator for integrated telecom service
providers.
Over the past decade, phone companies -- from behemoths like Baby
Bell SBC Communications, with 51 million local access lines, to
smaller players like Telephone & Data Systems, with fewer than a
million lines in its incumbent territory -- used the relative
stability of the business to support the capital and operating
expenses related to launching their own wireless, DSL, and other
value-added services.
EXPECT A SALE. However, this year, the local phone business has
declined in consistency. Competition from cable, wireless, and --
to a lesser extent -- wholesale local services has put pressure on
the voice businesses of the nation's top local phone providers.
In turn, we believe some carriers will spin off or sell their
local phone business.
Third-quarter earnings season for the local telecom providers
begins on Oct. 20 with SBC Communications and extends through
early November. We expect the financial results and the subsequent
conference calls to reveal that the decline in local customer
bases persisted in the third quarter.
BUNDLING UP. In the 12 months ended June 30, the Baby Bells lost
4.5% to 5.5% of their access lines. Even the smaller providers
were not immune to the customer dissipation, as Cincinnati Bell
lost 4.7% of its local customers in its regional market, and
Alltel's wire-line customers declined 3.7%.
To combat customer migration and improve loyalty, the telecom
providers have bundled broadband, long distance, and satellite
services for a discounted price and have begun deploying
higher-speed fiber-based services. Thus, we believe investor
attention has shifted partially away from the local service base
and toward the size of the DSL base and the pace of fiber rollout.
So far, the success of companies' bundling efforts has been mixed.
Even though the penetration rate of these services has increased,
operating margins have been squeezed from the price reductions,
and the rate of access-line losses has continued to rise.
KIDS' INFLUENCE. We think the continuing drop in local lines will
come, in part, from such cable companies as Time Warner that are
further rolling out and marketing their telephony offerings in a
triple-play package with broadband and video services.
In addition, we expect that the recent graduation of hundreds of
thousands of college students -- many of whom have grown
accustomed to using their wireless phones as their primary numbers
-- will lead a decline in the setup of wire-line phones.
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We also expect that the devastation of
hurricanes Katrina and Rita will lead to a decline in local phone
lines. In early September, BellSouth reported that Katrina
affected 1.75 million access lines, or 8.5% of its base.
HEAVY HITTERS? While we believe that BellSouth succeeded in
restoring service to the majority of these Gulf Coast lines, it
remains unclear how many subscribers returned to their homes to
continue their local service from BellSouth.
To a lesser extent, the hurricanes also affected local phone lines
in markets served by CenturyTel and Sprint Nextel. Even though
wireless service was spotty in certain regions for the national
cell-phone providers in September, we expect that wireless
substitution increased in the third quarter, as residents were
displaced.
In addition to focusing on the trend in access-line counts, we
await third-quarter commentary from Sprint Nextel and Alltel, the
two largest independent non-Bell local carriers that appear to
have a stronger interest in wireless market opportunities.
DENSELY POPULATED. Sprint Nextel has begun separating the
operations of Sprint's local telecom business of 7.5 million
lines, and will seek regulatory approval to spin off the local
business to Sprint Nextel shareholders in a tax-free transaction,
which the company expects to complete in 2006.
Meanwhile, in late September, Alltel announced that it would
assess strategic repositioning options related to its wire-line
business. We believe this will result in a decision to spin off or
sell its local phone operations, consisting of 3 million lines, in
the next six months.
We think the Baby Bells are also reviewing options that include
spinning off or selling access lines in less densely populated
regions, as they have begun to roll out their expensive
fiber-based broadband and video services to some existing
customers. (In 2002, Verizon Communications generated $4 billion
by selling 1.3 million primarily rural-based local lines.)
FIVE-STAR PROSPECT. While Alltel and other telecom providers are
strategizing about the merits of offering local phone service now
that wireless and other services are generating cash, CenturyTel
management told analysts at a meeting in September that it would
be interested in bidding for a bundle of local phone lines at the
right price.
The timing and the size of such an offer remain uncertain, in our
view. We think CenturyTel has had success in acquiring rural
access lines and integrating these customers into its business.
As we wait to hear more details about what the carriers will do
with their local services business, we recommend investors
purchase CenturyTel, which has our highest rank of five STARS
(strong buy). We think the rural carrier's wire-line prospects
look more favorable than those of the Baby Bells, based on our
view of CenturyTel's limited competitive pressures from wireless
and cable carriers, and what we see as higher earnings quality. |
