The resulting market volatility the last few days, however, has blinded many to what could prove ultimately to be a far more transformative development than Washington’s current squabbles. In fact, that’s likely to be true even if the country does go over the fiscal cliff.
That’s AT&T’s (NYSE: T) announcement this week that it will retire its legacy copper wire network, pending the approval of the Federal Communications Commission (FCC).
The copper wire network originated in an era in which the US phone system was a monopoly. The old AT&T–from which the current AT&T and Verizon Communications (NYSE: VZ) descended–was under obligation to provide “universal” phone service to all who asked for it. In return, it was guaranteed a return on investment that funded construction of a truly national network, as well as the breakthrough technological innovations of Bell Labs.
That model, however, began to break down in the 1970s with the advent of competition in the long distance phone business. And by 1984, when Judge Harold Green administered the breakup of Ma Bell into AT&T and seven regional “Baby Bells,” the Bell system was already losing business to competitors not shackled to the obligation of providing service to all.
When the Telecom Act of 1996 broke up the local phone monopolies, many assumed the Baby Bells would fold under the weight of bloated bureaucracy and stodgy management. Instead, we’ve seen an uninterrupted rise to dominance of Ma Bell’s descendants AT&T and arch-rival Verizon.
Competition has never ceased to eat away at their traditional phone business. But reliable revenue from what they’ve held has enabled capital spending to build the wireless and broadband networks the nation now depends upon. No other rival has come close to matching them, and the gap has widened every year.
With the re-election of President Obama, telecom’s Big Two are set to receive increasing scrutiny from the FCC over the next four years. Yet as the failure of LightSquared this year again proved, regulators can’t block their rise, even if it effectively subsidizes a new competitor and technology using federal rules and funds.
In fact, all the FCC can do at this point is cut off their access to purchasing new spectrum, mandating it be distributed to rivals such as Sprint (NYSE: S). And given the shaky financial state of the nation’s No. 3 telecom–even with an investment from Japan’s No. 3–it’s understandable the FCC has not done that. In fact, it’s approved major spectrum purchases by both AT&T and Verizon in the past year.
Both AT&T and Verizon continue to serve large numbers of people over copper wires. These bases continue to generate cash flow and have been paid for several times over. But the numbers are dropping rapidly, as customers go all wireless, opt for cable or some alternative phone service provider or choose the pair’s own broadband service, which includes voice. Consequently, these operations are a drag on other metrics that attract investors and keep capital costs low, such as revenue growth.
By essentially converting its remaining copper customers to broadband ready, AT&T will raise its capital spending to an annual rate estimated at $22 billion a year, little more than a 10 percent increase from its current pace of $19 billion to $20 billion. That’s already caused a stir in the marketplace, with some investors fretting about the impact on future stock buybacks and others worrying about a potential credit rating downgrade.
But for AT&T, essentially wiping out a declining business and converting it to a high-growth one means faster revenue and earnings growth. And ultimately that means dividend and share price growth.
At this point, the main hurdle to the company’s plan is winning FCC approval to scrap its universal service obligations. That may be a tough nut to crack, even with demonstrated competition in the wireline phone service market. The company does have more than a little experience dealing with the Commission, however, having both succeeded and failed in trying to get mergers done over the last 12 months. If anyone can make it happen, it will be AT&T.
In the end, the FCC may use this opportunity to set the rules for the final phase-out of copper wire and universal service in the US–which it’s often stated as a goal in recent years. In fact, it’s vital the industry have national rules, as questions arise about broadband network interconnections that have heretofore been mostly out of the legal purview.
FCC approval could usher in a wholesale dumping of traditional wireline networks around the country. But we could also quite possibly see the rise of a new breed of company that provides very cut-rate service over copper networks that it’s purchased for fractions of pennies on the dollar. In fact, such companies could eventually prove just as profitable as prepaid wireless companies are now, serving the lower end of what’s still a rapidly growing market for constant global connectivity.
One thing is certain. AT&T has just speeded up a game that America has been building up to for more than two decades. Whether it succeeds, what conditions it has to adopt and who the winners and losers will be are a subject for many future Utility & Income columns, long after the US fiscal cliff is resolved–or isn’t.
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