Scott Moritz

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FCC Could Revive Telcos' Urge to Merge

Scott Moritz

The Federal Communications Commission, in its triennial review of local competition laws, is expected to decide Thursday whether to free the regional Bells from some of the wholesale pricing laws that force them to rent their networks to rivals. The agency is set to review the so-called unbundled network elements platform, or UNE-P, mandate.

But the ramifications of any FCC action could spread well beyond wholesale pricing. In fact, some investors believe that the agency, noting the poor health of many telecom players and the evolution of wireless service, is ready to pursue policies that would shift its focus away from competition and toward enhancing industry stability. This could mean liberalizing the market to a degree that was unthinkable before the bubble burst three years ago, observers say -- and paving the way for big mergers.

"No matter how much or little the FCC review dismantles UNE-P, it will be a reset of the rules of the road, and eliminate the uncertainty that has precluded mergers and network investment," says independent industry consultant Marty Hyman, who has worked with the Bells on these issues.

Consequences

The potential shift at the FCC stems in part from vast changes in the markets over recent years. The rule the agency is set to review stems from the Telecommunications Act of 1996, which was written to foster competition in local phone markets.

But now, with the advent of wireless anytime all-distance minutes plus the growing voice-over-the-Net movement, the distinction between local markets and long-distance markets looks arbitrary at best.

"Historically, local has been a separate market, but today we are moving to an all-distance market. That obliterates the local-market distinction," says Steve Axinn, a New York antitrust lawyer who worked with the Justice Department to kill the WorldCom-Sprint(FON Quote) merger in 2000.

So should the FCC agree to phase out the wholesale pricing discounts, resellers such as AT&T(T Quote) and WorldCom could find the business unprofitable and decide to pull out of local competition.

Meanwhile, with their core local phone businesses declining, the Bells face an unsavory prospect of watching their livelihood slowly fade away, unless they attempt to break into new markets. SBC (SBC Quote), for example, is reported to be discussing the purchase of GM's(GM Quote) DirecTV satellite business.

Control

Previously, regulators have objected to large telecom mergers on the grounds that too much of a given market would be controlled by too few companies, thereby muting competition. The thinking has been that the more choices consumers have, the more market incentive there is for pricing and service innovation.

But now, to some antitrust experts, any backpedaling on the discounts would signal that top regulators are satisfied with the health of local competition. If that's true, combinations between large local Bells such as Verizon (VZ Quote), SBC, BellSouth (BLS Quote) and Qwest (Q Quote), on the one hand, and long-distance outfits such as AT&T and WorldCom, on the other, would suddenly be fair game.

"If the FCC does what people assume it will do, it will profoundly affect the government's thinking on mergers and what constitutes antitrust violations," says Axinn.

"Assuming the review takes away [discounts], the dominoes will start to fall," says Axinn. "Those doing UNE-P will withdraw and AT&T, WorldCom and Sprint could be the subject of takeovers by the regional Bells."

NutraSweet

While critics charge that the FCC is simply bailing out the Bells just as competition heats up, supporters say that competition was artificially supported by below-cost network rental prices.

If it comes down to a legal battle, which history suggests is inevitable, Axinn says it's unlikely that the courts will ultimately say that the Telecom Act requires companies to fund their competition.

"You have major issues coming together here that will trigger consolidation," says Hyman. New UNE-P rules and long-distance approval for the Bells will force the telcos to address their strategies for the future, he says.

While nearly all observers who have ventured an opinion on the matter see the need for consolidation ahead, not everyone sees AT&T as the immediate prize.

"AT&T will probably get bought three years from now," says Lehman Brothers analyst Blake Bath. "But the first priority for the Bells will be to focus on their wireless businesses. Once we've had some wireless consolidation, the Bells may consider AT&T."

Fog Rolls In

One of the hurdles to mergers is the uncertainty of the market. Declining sales warrant continued cost cuts, and there's no sense that trend is ending. But one of the reasons that would compel a Bell to buy AT&T is the opportunity to seize the crown jewel of phone services -- namely big corporations.

The Bells are expected to be granted approval for entry into the long-distance market this year. The barrier to that market has prevented the Bells from selling big-ticket contracts to national and multinational companies. Since there are three reasonably healthy Bells and three less-healthy long-distance companies, the crude math suggests some sort of pairing, say analysts.

Now, amid the widespread financial collapse of the industry, federal regulators may have a much different opinion about blockbuster mergers, say some experts.

"That whole triopoly thing is probably sounding good to the antitrust people these days," says Hyman. "There's something to be said for the prospect of three financially stable companies doing business in the market."