Tuesday, April 11, 2006

So AT&T and BellSouth Get Together Does it Really Matter?

Panic on the Press Wire
The AT&T-BellSouth merger news stirred up fears in some quarters of a giant telco monopoly that will reawaken to rule over the Internet with an iron fist. However, right now, telecom is defined by a decline in access line counts, dramatic growth in competitive unlicensed wireless services and growing competition from cable operators in voice and data services. These factors have changed the marketplace substantially and do not support critics' doomsday scenarios.

Why not? When the old Bell System was broken up by the '84 Modified Final Judgment (MFJ) and resulting Antitrust Consent Decree due to concerns over the exercise of monopoly powers in specific market segments it was due to presumed economic power to cross-subsidize local services with long distance services. However, any such economic power has long since disappeared as a matter of technology innovation. That has changed the marketplace substantially, thus mitigating potential consumer harm of AT&T and BellSouth merging.

There is no competitive advantage in internal cross-subsidization between long-distance and local telephony in the current environment and thus no reawakening giant. Interestingly, the Bell's operating structure prior to the MFJ's issuance actually supported competition in long distance (LD) services. For example, MCI's Bill McGowan was fighting to compete with Ma Bell in providing LD services and not doing all that badly. The reason is that AT&T's Long Lines division was providing a massive, and growing, internal cross-subsidy to its local operations, which inflated the cost basis of AT&T's LD service. This in turn allowed MCI to offer cheaper service than AT&T and still make a profit since they had no local operations to subsidize.

The LD subsidy continued after 1984, and was carried out through access charges paid by long haul providers to the local companies originating and terminating calls. In the mid-80s, the average rate for an interLATA (long distance toll) call was 32 cents per minute. This was 60% higher than it cost in 1946, before the transistor was invented, and after which equipment costs to provision LD began to fall dramatically. By 2003, average toll rates had dropped 75% to 8 cents per minute. After two decades of competition, the LD-local subsidy was essentially eliminated, as were any chances of making money in long distance services.

So the AT&T and BellSouth merger really confers no special market advantages from the perspective of the concerns the MFJ was meant to address. Technological innovation is really the key to understanding market directions these days, not internal cross subsidies.

New Services, Old Complaints
So technology innovation as much as judicial and regulatory decisions changed the economics in the LD market and made it increasingly affordable for consumers. The concern about the new AT&T stifling innovation could be valid, but only because BellSouth has long been the most forward thinking of the RBOCs.

In 2001, after battles with state PUCs and the FCC over competitor access to remote terminals, the other three Bells dramatically slowed their deployments of extended DSL, out of fear that the commission would force them to share their investment with capital-starved CLECs. Recognizing that a no-build strategy would cede the market to the MSO's , BellSouth continued to extend DSL deep into neighborhoods, bucking the regulatory-driven strategy of its peers. And in business services, BellSouth was eager to maintain service parity with fast moving startups, and was quick to launch MPLS-based VPNs, Ethernet, and Wavelength services while the other incumbents generally took a much slower approach with new data products.

Actually, the concerns about stifling competition should be less relevant to consumers and regulators than how well the new AT&T will be able to compete. The incumbent phone companies almost let the cable operators run away with broadband, and now they are poised to do the same in the developing market for broadband wireless backhaul. With even more to lose from muni wi-fi than the RBOCs, Cox is signing deals to bring wireless mesh packets onto its newly built metro fiber rings. Just as regulatory swings influenced the RBOCs slower-than-necessary rollout of DSL, their outrage over muni wi-fi is allowing their competitors to walk away with a rapidly growing traffic aggregation opportunity.

AT&T + BellSouth = SBC
Over the last four years, BellSouth has lost one out of every six of its switched access lines, and was barely hovering above 20 million lines in-service as of the end of 2005. SBC/AT&T has lost a similar percentage, falling from over 60 million at the end of 2001 to just over 50 million access lines at the end of last year. So combined, the two companies have lost as many lines over the last four years as BellSouth has currently has in service.

Battle Between Verizon and AT&T
With declining consumer access lines, and slowing growth in broadband and wireless, AT&T will need to increase its revenue from business customers in order to maintain the dividend its broad base of shareholders has come to expect. But the fight for large commercial accounts is increasingly pitting AT&T against Verizon, especially now that both companies own competitive LD business units.

While net neutrality and new video services might excite the trade press and make for good crossfire debates, the success of the AT&T/BellSouth merger will ultimately depend on how many corporate accounts the new company can grab from Verizon.

The new AT&T could include a few more companies by the time Ed Whitacre retires, and every word he utters in public about a cable company, satellite provider, or content partner is sure to appear in multiple trade articles and sell-side research notes. And while he's brought a lot of companies together over the last ten years, his M&A binge has done little to change the way people use networks.

So the bottom line is that in terms of technology innovation, the new AT&T may matter a bit, but only in the likelihood it will allow competitors to outpace it. The consequence will be felt economically in the marketplace, likely to the advantage of consumers who are free to select competitive offers. This is good for competition if not for AT&T.