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Make the phone mergers pay off for you
Individuals have two ways to weigh in on the SBC-AT&T and Verizon-MCI mergers: as investors and as consumers. Here's what you need to know on both counts.
By Jim Jubak
Let's be clear: These huge telephone deals aren't about you, me or the other 35 million individual long-distance customers at the soon-to-be-late, but not-especially-lamented, AT&T (T, news, msgs) and MCI (MCIP, news, msgs).
No, it's the corporate customer base that made SBC Communications (SBC, news, msgs) and Verizon Communications (VZ, news, msgs) so willing to pay $16 billion and $6.7 billion, respectively, for the long-distance operations. Both SBC and Verizon will acquire huge pools of established corporate customers and increase their ability to add new customers by offering businesses the kind of one-stop shopping that they prefer for everything from local phone service to data services.
That doesn't mean the individual isn't important. We're still the golden goose that has to be gently massaged and firmly squeezed for these deals to work.
We all have a couple of ways to vote on these deals. As investors, we can decide which, if any, of these stocks are worth owning. As consumers, we can choose which, if any, of these phone services are worth buying. Here's my solution for navigating the newest Brave New World of Telecommunications.
The new telecom landscape
Let's start by looking at why local phone companies SBC and Verizon are acquiring AT&T and MCI, and not the other way around.
When AT&T agreed to settle its long antitrust battle with the U.S. Department of Justice in 1984, the company thought it had struck a good deal. In exchange for giving up its highly regulated and slow-growing local phone business, it gained a chance to invest its massive cash flow from its then-thriving long-distance business in new technologies such as computers, wireless phones and cable television. That deal turned out to be a terrible bargain -- but it didn't have to work out that way.
Besides making what turned out to be smarter investments in these new technologies than AT&T, the regional Bell phone companies fought a hard and ultimately successful lobbying war to keep control of the last "mile" of copper wire that connected homes and businesses to the national communications network. The local phone companies had to make that wire available to competitors. But the Baby Bells also continued to control the local distribution-and-switching system and collect a fee from any competitor that wanted to use the wire.
In that competition, the regional Bells turned out to be the big winners. That really shouldn't have been a surprise. The companies had monthly contact with their customers, they controlled how and when a competitor would gain access to the local phone system, and they collected that fee. Think about it this way: every time AT&T or MCI signed up a customer, they had to fork over a part of the revenue to the regional Bell that controlled the local access point. A Verizon or an SBC, on the other hand, got to keep all of its customer revenue.
According to the Yankee Group, in the most lucrative part of the telecommunications market -- the corporate or enterprise side -- about 25% to 40% of the telecommunications bill goes to pay for the last stretch of copper wire.
Locking in the corporate customer
If you keep that in mind, then the logic of the corporate part of these acquisitions is pretty straightforward. By buying an AT&T or an MCI, a regional Bell adds huge scale. Verizon/MCI will have 18.5 million business-access lines; SBC/AT&T will control 22.3 million. In their regions for corporate customers, Verizon and SBC will be just about unchallenged. They are acquiring their largest competitors. If AT&T and MCI couldn't find a way to compete against the regional Bells and their control of the last piece of copper wire, I don't expect that companies like Sprint (FON, news, msgs), with its 2.1 million business-access lines, or Qwest Communications International (Q, news, msgs), with its 6.2 million business-access lines, will be successful.
Related news and commentary on MSN Money
Even the corporate end of the companies they're acquiring, however, aren't exactly growth businesses. In the fourth quarter of 2004, for example, revenue from the business side of AT&T fell 7.4% from the fourth quarter of 2003. Standard & Poor's estimated before the acquisition that in 2005, business revenue -- which made up nearly 75% of revenue at AT&T -- would fall 11%.
For this part of the deal to work, the acquiring companies have to achieve massive cost-savings by consolidating long-haul backbone and local high-speed fiber networks. They also need to eliminate overlap in billing and sales and cut the work force.
They will also need to steal market share from competitors. This aspect of the deal isn't good news for companies like Level 3 Communications (LVLT, news, msgs) that are in the business of leasing long-haul fiber networks to the regional Bell phone companies. But it might be good news for software companies such as Amdocs (DOX, news, msgs) that sell billing and account management software to telecommunications companies.
Individual customers count, too
Oddly enough, it's the individual retail side of these businesses which have the most potential to turn these acquisitions into successes. The problems at AT&T and MCI are well known: Thanks to competition from "free" wireless long distance and falling long-distance prices, these companies' consumer businesses have wilted. Before the deal, Standard & Poor's estimated that revenue from the consumer side of AT&T's business would fall 26% in 2005.
Doing better than that shouldn't be too hard. SBC, the company acquiring AT&T, saw revenue in its core local-phone business fall 3% in the fourth quarter of 2004 as the number of land lines served fell by 266,000. That continues a trend that has seen a decline from 55.8 million lines in the second quarter of 2003 to 52.4 million at the end of 2004.
But notice the speed of the decline -- just 3% in revenue for the quarter and a drop of 6% in land lines in 18 months.
Why have SBC and Verizon been able to show so much less of a decline in their plain-vanilla phone businesses?
Give the credit to "bundling." By selling a consumer a bundle of services -- local and long-distance phone service, a high-speed broadband Internet connection, and wireless phone service -- Verizon and SBC have discovered that they can slow the erosion in their land-line base and cut customer churn. Since it costs so much to identify and sell a new customer, reducing the churn can vastly improve profit margin and earnings.
How bundling can work for you
That's where you and I come in. Because these companies know that bundling works, individual retail telecommunications customers can expect to see more and more enticing bundled offers. The pressure on SBC and Verizon to bundle will get an added boost from cable companies, the phone companies' toughest remaining competitors, who have discovered bundling works for them as well.
Will bundling be good or bad for you as a consumer? Well, it depends. If the way you already use your phone, cell, computer, etc., exactly fits the terms of the bundle, you could actually wind up saving some money. But bundling isn't just a way for phone and cable companies to attract and keep customers. It's also a way to push consumers into buying more minutes of service than they use now and signing up for services that they don't use at all now. With the margin cost to the phone and cable companies of a minute of long distance so low, it pays for them to offer you an extra 100 minutes for just an extra $5 a month. Of course, if your old service fit your needs adequately, the new bundle isn't a bargain but a de facto price increase. (If you're looking for ways to do an end run around the phone companies, you'll want to read Liz Pulliam Weston's forthcoming column on making the switch to Internet-based phone service. It's scheduled for March 17.)
The losers in all this are likely to be consumers who are perfectly satisfied with their current, relatively plain-vanilla telecommunications services, especially if they don't have or want a broadband Internet connection. These customers aren't likely to see price cuts -- indeed, with the subtraction of MCI and AT&T, which used to sell plain-vanilla services, competition in this part of the market will fall and prices are likely to rise.
Phone vs. cable
If you'd like to get some of your telecom bill back -- or if you're just looking for a good stock -- you should definitely consider shares of SBC or Verizon. Both stocks pay hefty dividends -- 4.2% for Verizon, 5.3% for SBC -- and I think that they're set to take a run at recreating the kind of competitive advantage they enjoyed versus AT&T and MCI with their new competitors, the cable companies.
It's clear that the telephone and cable industries are headed to convergence. Cable companies already offer high-speed Internet connections and Internet telephony. The regional Bells are also in the high-speed Internet business, and this year they will start rolling out tests that offer TV, movies and other digital media over their systems.
It's way too early to pick a winner in this fight. But it is clear that the game between cable and telephone companies isn't currently being played on a level field. Cable companies have to apply to local governments for franchises to offer services in a community; telephone companies don't. Cable companies have to pay a franchise fee in most locales to offer service; telephone companies don't. (Last year, franchise fees cost cable companies $2 billion nationally.) Telephone companies, on the other hand, pay federal taxes and fees to offer phone service; cable companies don't.
Right now, I'd say, the playing field favors the phone companies. That could change as regulators and legislators work out new rules for the next stage in the competition. And while I don't know how the regulators and legislators will eventually rule, I do know that lobbying is a game that the regional Bells play extremely well. Just ask AT&T and MCI.
New developments on past columns
3 ways to capture the September effect
News this week that an Indonesian scientist has recanted won't put an end to the battle over charges of massive pollution problems at Newmont Mining (NEM, news, msgs)'s gold operations in Indonesia. The scene is merely shifting from Indonesia to the United States, where several Newmont investors are fighting to put the company's environmental practices -- or lack thereof -- on the ballot at the company's upcoming shareholder meeting.
Recently, the Indonesian doctor, Jane Pangemanan, who had claimed that the company's dumping of mine wastes near its Minahasa gold mine had caused health problems among local villages, withdrew her allegations, calling them "premature." Newmont had denied the charges and filed a defamation suit against Pangemanan. (Outside tests have been inconclusive. The World Health Organization and an initial Indonesia Environment Ministry report found the water unpolluted. But a subsequent ministry study found arsenic levels 100 times higher at the waste-dumping site.) But for investors that's not the end of the issue.
Boston Common Asset Management, which holds $2.8 million in Newmont Mining stock, has asked the company to put together a tougher environmental policy. The comptroller of New York City and the trustee of the New York State Common Retirement Fund have both asked the company to improve its waste disposal policies and asked that the company put its Indonesian waste disposal policy to a shareholder vote at the company's annual meeting this spring. (The state retirement fund owns nearly 1.7 million Newmont shares.) Newmont Mining has asked the Securities & Exchange Commission to quash the shareholder vote. What troubles these investors is what they see as a pattern that forces Newmont to walk away from rich gold deposits. In Peru, for example, massive community protests over drinking water supplies led Newmont to abandon plans to tap a potentially rich field there. What troubles me is Newmont's decision to adopt a confrontational stance, stonewalling not only local activists and U.S. environmentalists, but also its own concerned shareholders.
The company is due to report fourth-quarter earnings on Feb. 24. But for me, it's increasingly looking like the spring annual meeting will be critical in my decision to hold or sell. (Full disclosure: I own shares of Newmont Mining.)
10 best stocks for the rest of 2004
On Feb. 15, Smithfield Foods (SFD, news, msgs) told Wall Street analysts and investors that, thanks to a 49% increase in the price of live hogs, the company expects to report earnings of 85 to 87 cents a share for the recently concluded fiscal third quarter. The consensus Wall Street analyst projection now stands at 74 cents a share. The company will report earnings on March 1.
Editor's Note: A new Jubak's Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Newmont Mining and Smithfield Foods. He does not own short positions in any stock mentioned in this column.
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