Wall Street and Washington differ on the at&t-tci merger
Despite conflicting opinions and a stock market tumble, at&t has made the right move to get around the local phone companies` barriers to market entry.
By Stephen N. Brown
When at&t announced its merger with Tele-Communications Inc. (tci), America`s financial capital reacted differently than America`s political capital. at&t`s market value dropped $16 billion in 10 days because Wall Street disapproved of the merger, driving down at&t`s per-share stock price from $65 to $55, while the stock`s turnover jumped to five times its normal rate.
Few people believed the merger`s justification: One cable delivering all telecommunications services to businesses and homes. Michael Noll, a professor at the University of Southern California, said in the Los Angeles Times, "The only problem with this [merger`s] dream of a single broadband telecommunication medium to the home is that it is decades old and the technology to do it cost-effectively is not available...and thus the mighty at&t has entered its last chapter--a chapter that might end in a few years with its acquisition at a rock bottom price."
Ordinarily this news would be bad for any company. Yet at&t is not an ordinary company, and the telecommunications industry today is not an ordinary industry. It is steeped deeply in politics, so Wall Street`s reaction is not the last word--Washington`s reaction counts, too.
The Senate Judiciary Subcommittee on Antitrust, Business Rights and Competition held hearings in July and indicated its approval of the merger. The subcommittee`s chairman, Senator Mike DeWine (Republican--OH), issued a statement saying that at&t and tci have "announced a merger that I believe will increase competition and will realize a central objective of the [Telecom] Act of 1996, promoting competition in local residential and business and telephone markets." Federal Communications Commission (fcc) chairman William Kennard also took a positive view of the merger. "If at&t and tci make a strong commitment to bring residential consumers more choice in local telephone and high-speed Internet access services, then this proposed merger is eminently thinkable," he said.
Of course, this is exactly what the merged company will do, according to the testimony of at&t`s chairman, C. Michael Armstrong. He told the subcommittee, " I am here with three messages. at&t`s merger...will benefit consumers...[it] will enhance competition ...the Bell companies [must] open their markets to competition."
At first glance Armstrong`s remark about the Bell companies is incongruous, because the whole point of the merger is to bypass the Bells` facilities whenever possible. One disadvantage of the merger is that tci`s system is segmented over many states, but the solution to this problem is to interconnect the segments with long-lines, either at&t`s or someone else`s. However, a major problem remains: When at&t`s local networks are in their vulnerable infant stage, they will need to complete local and long-distance calls by interconnecting with the Bells. This is the point where the merger`s commercial viability will be challenged by the Bells` operating practices, which have been finely honed in their battles with competitive local exchange carriers (clecs) and Internet service providers (isps).
The Bells defend the central office
In the past two years, the local phone companies have fought several battles to control central offices, the switching equipment that connects local customers to regional and national networks. The Telecom Act requires the Bells to allow clecs to "collocate" in the central office so the clecs have access to the so- called unbundled elements of the local company`s network. Collocation, however, does not necessarily allow a clec to place its own switch inside a Bell company`s switch. If that were to occur, then the Bells would be very vulnerable to competitors, but over two years ago the fcc deferred the matter to state utility commissions. They have generally sided with the local companies that are forcing clecs to gather their traffic at the Bells` switch and then haul the traffic to the clec`s switch some distance away. For example, if a clec picks up two customers within the same telephone exchange and one customer wants to call the other, the calls goes to the local company`s switch, then to the clec switch, then back to the local company`s switch, and then to the destination. The natural effect is to raise the clec`s costs and hamper its ability to compete with the local company.
isps are also suffering from the Bells` victories. isps are barred from placing any equipment whatsoever in the central office--and in the meantime the Bells are devising ways to encroach on the isps` turf. Earlier this summer, US West announced that it is removing isp traffic from the switched network by intercepting isp traffic at the central office and routing it to data networks. US West justified its activities by claiming that isp traffic causes congestion at the central office. To reroute, the phone company diverts isp traffic away from the isp modem banks to the company`s modem banks and relies on packet concentrators to deliver Internet services, which lowers system performance. In effect, US West is removing isps from the business of owning and operating modems.
The local companies could easily solve the supposed congestion problem by purchasing large nonblocking switches such as a DMS200, but it is not in their interest to do so. Larger switches would prevent the locals from making the arguments that they are running out of room to collocate clecs` equipment in the central offices. isps also are afraid that if they make too much trouble, the local phone company might take retribution in the form of slow response time to outages, unfilled orders, and delayed service. Apparently, the isps can do little to protect themselves from the locals, which are offering their own Internet services through digital subscriber line (dsl) technology, the single most important weapon in the Bells` arsenal.
dsl wrapped in politics
dsl technology is extremely important to the Bells because it helps them achieve a political goal: entering the long-distance data-services market. Earlier this summer, the companies issued several press releases saying that dsl broadband services would be offered to millions of local customers. BellSouth, for example, said it would offer asynchronous dsl in 30 markets in the next two years. This move came about five months after Ameritech, Bell Atlantic, and US West petitioned the fcc to give them regulatory relief from the Telecom Act`s section 706, which specifically bars them from offering long-distance data services. By rolling out dsl at the local level, the Bells are making the case that people want access to high-speed data transfer and that the companies are in the position to offer the services immediately if the fcc would let them. But there are several things wrong with this scenario.
Broadband services are normally associated with fiber optics, which have a capacity several hundred times larger than dsl. Calling dsl a lightning-fast broadband service is akin to saying you see farther on a foggy day than a clear day. It makes sense only if you are blind to the potential of true broadband services. The Bells have already said that dsl cannot serve more than 30% of its customers without adding significant amounts of fiber to their networks.
In January 1997, the fcc held its first broadband forum, where fcc staff member Robert Pepper asked Bell Atlantic`s vice president of research and development, Pat White, "What percentage of lines or households could be provisioned with adsl or xdsl without having to significantly upgrade the network?" White replied, "Twenty to thirty percent could probably be satisfied that way. The rest would require some fiber."
In Docket 97-01262 before the Tennessee Regulatory Authority, BellSouth gave a typical timetable for such upgrades. "Concerning the replacement of copper by fiber in the distribution network, BellSouth`s depreciation studies estimate this will not be complete until 2015," testified the company`s director of finance, David Cunningham. Therefore, dsl technology will be deployed over a 15-year period instead of the near-term timetable suggested by the phone companies. This is certainly one reason for the fcc to be skeptical of the Bells` petitions for relief from the restrictions of section 706.
The Bells` dogged protection of their networks, combined with their marketing practices for dsl technology, means that at&t is correct in bypassing such networks and that a single fiber-like broadband connection to the business and home is the only way around the Bells` barriers. Washington understands this and Wall Street will too, eventually. q