The ILECs, incumbent local exchange carriers,
have won the war.
The great experiment of local competition, while still
under way, is over. The unbundled element approach -- in which competitive local exchange carriers, or CLECs, leased parts of the local network -- put many, many millions of dollars into the pockets of ILECs, which actually profited from wholesaling parts of their networks. Meanwhile, the CLECs obviously never made the economics work in any large-scale scenario.
Many things caused the system to fail, but the single biggest reason is simply structural: The ILECs still maintain their monopoly ownership of the primary telephone connection into most homes and offices. The ILECs will use these physical assets for many years to continue to dominate the voice world. And they're about to get more dominant.
Operator, Get Me Long Distance
On a state-by-state basis, regulators let ILECs get into the long-distance business when the ILECs' networks are satisfactorily open to allow local competition.
Let me rephrase that: Regulators let ILECs get into the long-distance business when the ILECs
have convinced the regulators
that the networks are satisfactorily opened to allow local competition.
All of which explains why the ILECs have won.
At the top of the ILEC heap are
, which are now going on The Teleconomist's buy list. Each company has nice a yield of about 3%, with little chance of dividend cuts. These ILECs will increasingly leverage DSL/data, wireless and especially long-distance as platforms for future growth. While most analysts have built this into their long-term models, I believe they've underestimated the success ILECs will have as they enter the long-distance business in more and more states.
Can We Talk?
Two things that ILECs always have understood are the voice business and working the government. They are still masters of both.
Over the next few years, as ILECs' long-distance businesses solidify, we'll see high penetration rates for the ILECs' long distance. We'll also see increasing margins and revenues in the long-distance business for the ILECs, at least for the next two or three years. First, rates for long-distance are dropping drastically, but by most measures, the wholesale rate for long-distance voice is dropping faster than retail rates. That works to increase margins.
Second, demand for voice services, such as long distance, typically is elastic. This means as prices drop 10%, demand for those services actually rises, say, 12%, all of which will work into a better bottom line for the ILECs as they sneak in and steal market share from the
of the world.
I've played with many different telecom service-provider models over the years. It's very difficult to work a model to show residential phone service as purely profitable. However, long-developed expertise and nearly fully depreciated assets (which taxpayers helped buy) let the ILECs continue to profitably serve most homes. Only with the added revenue streams of video and Internet/data can most models ever show much positive residential economics. Until cable companies get serious about developing a strategy to provide voice services -- a couple of years away at least -- the ILECs will maintain their monopoly in the home.
Get Me Congress on the Line
The ILECs work the political system as well as anyone. They continue to gain entry into the long-distance business in their home states despite the ongoing competition-squashing they deal out. Whether the Tauzin-Dingell bill is passed (which, for the record, I don't think will be in its current iteration), the system is tilted in favor of the ILECs continuing to thrive. Underscoring its political savvy, SBC created a new position of company president, for well-connected ex-Commerce Secretary and former Gore campaign chairman, William Daley. Let's just say he wasn't hired for his telecom proficiency.
If I were writing a political commentary, I'd likely be railing against the ILECs. However, since we're trying to make money together, I suggest we don't rail, rather let's buy. I will be buying the two best-run ILECs with the clearest long-distance strategies -- Verizon near its current level of about $47.50 and SBC near its current level around $38.30 -- over the next few days.
Cody Willard is president of TelEconomics Consulting, a financial and technology consulting firm. He is also founder of
TelEconomics.com, a Web site devoted to news and analysis of telecommunications stocks. Previously, he was senior analyst for a venture development company, and before that was a partner at the Lanyi Research division of CIBC World Markets. At time of publication, Willard owned no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Willard appreciates your feedback and invites you to send it to