DBRS Releases US Telco Study “A New Competitive Equilibrium”
Dominion Bond Rating Service (“DBRS”) believes the U.S. telco industry faces some significant challenges going forward as advances in technology have allowed competitors to replicate the telcos’ last-mile advantage, breaking the control over one of the last areas in the communications industry in the U.S. that remained largely dominated by the incumbent carriers.
In its study on the U.S. telco industry titled “A New Competitive Equilibrium”, DBRS says that it currently believes the threat the cable industry poses with its local voice service, facilitated through VoIP technology, to the telcos is more sustainable as it is built on a foundation of the cable operator’s network facilities, unlike previous threats that were largely predicated on artificial terms through regulatory measures, such as the mandated unbundling of the telcos’ networks.
“As such, the much-anticipated clash between the telcos and the cable industry is expected to further unfold in 2006,” says report author and DBRS Vice President, Chris Diceman. “This is expected to create a new competitive equilibrium for the U.S. telcos.”
DBRS believes that this form of competition will be more sustainable than the regulatory-driven initiatives that occurred in the past, including the structural separation of the long-distance industry and the ambiguities created through the interpretation of the Telecommunications Act of 1996. While these regulatory initiatives have created uncertainty and stifled innovation, it appears that the recent levelling of some of the regulatory burdens that have been placed on the telcos in the past will continue going forward and should benefit the U.S. telcos. DBRS expects these deregulation initiatives to place the telcos more in-line with the cable industry’s light regulatory touch and will attempt to simplify the regulatory complexities that exist today in further favour of free-market forces.
DBRS notes these regulatory developments, in conjunction with the anticipation of cable’s entry into the consumer telephony market, have facilitated and led the U.S. telcos to undertake a series of mergers and acquisitions that have fundamentally altered the shape of the industry going forward. This activity has been predicated by three principal reasons. Firstly, the transactions were an attempt to expand the telco’s position into other markets such as the enterprise segment. Secondly, these transactions served to increase a telco’s gearing toward growth businesses such as wireless. Finally, these transactions were undertaken to reduce their stake or exposure to wireline businesses.
“DBRS believes that these new strategic focuses will continue to be drivers behind further merger and acquisition activity and asset repositioning in the U.S. telco industry going forward,” says Mr. Diceman. “A strong balance sheet and financial flexibility are significant competitive advantages for the U.S. telcos that will be further competing with cable companies that generally have weaker balance sheets.”
Mr. Diceman adds that despite some of the benefits from regulatory and asset repositioning, DBRS expects some of the threats the telcos face will, if unchecked, place further pressure on the telcos’ cash flow from operations in the future. This pressure, in conjunction with higher capex levels expected with network upgrade plans, will likely pressure their free cash flow generation over the next couple of years. However, DBRS does not expect the telcos to go into free cash flow deficits over this timeframe.
DBRS believes the outcome of this competitive clash with the cable industry will not have the binary outcome that was once predicted. As such, a new equilibrium will likely be found for the U.S. telcos in addition to the cable industry where their services overlap. This belief is further supported by the regulatory and asset repositioning initiatives that will allow the telcos to better respond and to focus on diversified businesses and not just residential services. As such, DBRS expects that the cable operators will take share in the telephony market over the medium term while the telcos enter the video market to take their share of video subscribers.
“While DBRS notes that the majority of the telcos will benefit from the continued growth of wireless over the medium term, the one area where the telcos are currently lacking is broadband market share,” says Mr. Diceman. “While the U.S. telcos were second-to-market for broadband services, DBRS believes that the telcos will have the opportunity to close this gap over the medium term with converged services, video offers, and targeting the dial-up customer base.”
In the residential market DBRS expects that securing broadband market share will be critical as it will likely be a more critical part of the bundle going forward, giving the telcos the opportunity to sell new services over this broadband connection.
Finally, DBRS expects the telcos will look to undertake some of the sizeable opportunities that are available to them to help mitigate some of the competitive threat that will be increasingly placed on their incumbent businesses. However, the anticipated clash will not likely be as direct as initially anticipated as the telcos will likely gain further regulatory benefits and will likely further attempt to reposition themselves by gearing their businesses, where possible, away from the residential voice business which will likely be subject to the greatest competitive risk going forward.
Companies covered in this study:
Verizon Communications Inc.
BellSouth Corporation
AT&T Inc.
ALLTEL Corporation
Sprint Nextel Corporation
AT&T Corporation
MCI, Inc.
Qwest Communications International Inc.
-- Qwest Corporation
-- Qwest Services Corporation
-- Qwest Communications International Inc.
-- Qwest Capital Funding, Inc.
-- Qwest Communications Corporation
If you are interested in receiving a copy of this study, please email info@dbrs.com.