TC2's David Rohde on Telecom - Mergers and Acquisitions

A fine book of business: AT&T and Verizon's service mix pays dividends

Wed, 28 Jul 2010 16:14:00 -0400

Is telecom the worst business in the world, or the best? For every intractable problem the big carriers have developed over the past decade, you can now name an opposite phenomenon where the same carriers are golden. I mean, consider that consumers are dropping their primary telephone landlines from incumbent carriers in droves. Oh, but wait a minute, the carriers still have a near-monopoly on dedicated local access lines to businesses to nicely offset that revenue loss (and with higher returns). Or did you say that wireline long distance is losing popularity at an accelerating pace? Whoops, consumers are more than making up for that with mobile minutes (and at higher prices). Huge deflation in wholesale intercity bandwidth? Big deal, when the big carriers are also enjoying big increases in hosting revenues from enterprises (and on a much "stickier" service). Traditional voice under threat of extinction as everything goes across data networks? So what, when the big carriers are supplying smartphones that are practically becoming the personal data device of choice (and to which people are becoming addicted). This yin-and-yang characteristic of the telecom industry is nicely illustrated in the recent strong earnings reports from AT&T and Verizon. A bullet point near the top of AT&T's announcement spoke volumes: "Consolidated operating margin expansion to 19.8%, up from 18.0% in the year-earlier quarter." This statistic is a reference to the entire AT&T in all its glory: the legacy long distance and local businesses, the wireline and wireless sides, the domestic and international revenues, and the old circuit-switched and new IP-based services -- all mashed together. The complete mix of services at AT&T is now generating a combined profit margin that's moving up smartly. For an industry with a reputation for suffering ruinous deflation, and for a brand once associated almost entirely with legacy products, this is a notable occurrence. It's especially worth keeping in mind as AT&T makes statements to the effect that the need to maintain the Public Switched Telephone Network is dragging it down financially. If it is, it's more than made up for by the rest of AT&T's business. It's also worth keeping in mind as AT&T and Verizon cite their huge expenditures for wireless network upgrades, wireline broadband buildouts, and the like. Now, profit margins are a notoriously tricky statistic with which to make comparisons across industries. If you're in an industry that's at all politically sensitive, you may already know that. One type of company's profit margin may not be comparable to another, and this has proven to be an issue in economic and political debates. To make an easy comparison, a grocery store's profit margin is of course going to be lower than a furniture store's profit margin, because the grocery store gets to sell the same item over and over in the same spot on the floor, and the furniture store's turnover is much less. Which business actually has the greater return on the owners' investment is unknown until you factor in other inputs besides raw margins. But the comparison here is between a big carrier's margins today vs. the same company's margins yesterday. The major suppliers' decisive move into growth services is no longer a matter of playing catch-up. It's the outstanding feature of their businesses from a financial standpoint. We've discussed why another carrier like Qwest may have had so many operational problems that it couldn't make it on its own. But an argument can made that Qwest had to sell out simply because it never got into the wireless business beyond resale. Qwest today remains a valuable national competitor for individual services and circuits, but for those who remember what Qwest was originally supposed to be -- the giant-killer that would bring down the legacy players with its more-advanced networks -- it's notable how enterprises actually tend to use Qwest for the simplest, not the most complex, voice and data services. Those comprehensive, mission-critical deals still go overwhelmingly to AT&T, Verizon and -- still very occasionally -- Sprint, and you bet these carriers are going to be looking to enlarge their relationships with you even further. When they make that attempt, remember that their "big tents" -- legacy services and all -- are providing an excellent mix of businesses for them, with an improving financial yield. That financial reward for them should very much be on the table for you when they seek your business.

Lower USF surcharge brings illusory benefits in the heat of midyear changes

Fri, 18 Jun 2010 09:03:00 -0400

Do you want to hear some good news about surcharges? I could pretend to have some, if that'll make your day! The federal universal service surcharge for the quarter beginning July 1 will be 13.6%. And while that's really high, it's down from the amazing 15.3% of the current quarter. So why couldn't an optimistic, glass-half-full person treat that as a positive development? Because the quarterly USF contribution factor -- you know, the bit owed by carriers on their interstate revenues that they don't have to pass along, but always do -- is never the end of the story. The very idea that the landline surcharges with the biggest bite are "revenue-based" is an open invitation for carriers to play with their entire line-up of surcharges so that you never really get a break. And looky here: Verizon at the same time is increasing its "Property Tax Recovery Charge" from 3% to 3.65% of applicable revenues. That's an extra chunk of money out of the same or similar revenue base, instituted through a quiet change that Verizon has just made in its Service Guide. That move alone cuts in half the benefit of the USF reduction for Verizon's national enterprise customers. I've had some fun in the past with Verizon's particular love of collecting extra dough out of the property tax allotment, given that the "revenues" in question have nothing to do with Verizon's real estate for its POPs and central offices but rather your revenues to Verizon for voice and data services. But by no means am I meaning to just pick on Verizon today. Turns out that midyear of 2010 seems to be a red-letter day for AT&T on two other fronts: -- June 30 happens to be the expiration date for some multiyear regulatory conditions of the AT&T-BellSouth merger -- remember that one? Under the conditions, AT&T had to file tariffs over three years ago that dropped its unregulated rates down to regulated levels in order to get its merger approved. But AT&T's filing will also kick the special access rates back up again automatically when the merger condition expires. That's pretty clever -- where else can you announce price increases three years in advance? -- The folks at LB3 have noticed that AT&T has started making an interesting, and potentially nefarious, change to proposed Master Agreement wording for enterprise customers. It's technically a replacement for the "Regulatory Charges" clause but it allows AT&T to raise the rates or impose new charges for goods and services, period. Unlike older form contracts, this right is not limited to increases prompted by changes in AT&T's regulatory obligations. Now, if you have a well-designed current deal with AT&T, neither of those two developments necessarily change your operating and procurement results ... yet. Free-flowing T1/T3 access price negotiations continue to be a crucial part of competitive bids for national data networks. The AT&T special access price move directly affects only those who buy access directly from "AT&T the ILEC" (the legacy RBOCs that it rolled up) or those whose current contracts with the national legacy AT&T fail to stabilize prices. And of course, the idea that AT&T wants to extend a sense of user helplessness against price increases beyond surcharges to the price of actual services is something you'll want to fight if it's proposed to you! But all of these things certainly change the procurement environment going forward, and it's a predictable by-product of the looming duopolization of the U.S. market. The leverage you'll want to bring to the table to fight these fights on multiple fronts will have to grow as the big carriers' market positions appear to strengthen. What you don't want to be is surprised, and TC2 and LB3 stand ready to anticipate and deal with these issues for you. Look for follow-ups on these individual issues soon.

Qwest falls into the hands of a player far from the enterprise

Thu, 22 Apr 2010 15:11:00 -0400

There's always been an element of luck in the "local telephone business." All local exchange carriers with an incumbent territory are in the enviable position of extracting rents for the great majority of business dedicated access lines in their markets. But beyond that, the sense of whether more urbanized or more rural LECs have a financial advantage has varied depending on broad trends in pricing, telecom regulation, universal service, and consumer adoption of new technology. Recently the financial advantage in the local telecom business has swung to a distinct set of carriers that have been rolling up small-town and mid-market LECs. That's because they're losing landline consumer telephony customers to exclusively mobile connectivity at a slower rate than the big telcos. And so it is that one of the three remaining major Bell LECs, Qwest, is being bought out today by CenturyTel, a nearly invisible brand outside its diverse but widely scattered local territories. Not too long ago, Qwest was viewed as immune from the consumer line-loss issue because analysts thought consumers in its western territories wouldn't flee to cell phones as fast as they would in AT&T and Verizon territories. But that turned out not to be the case in the last couple of years, as Qwest's line losses turned into the same 10%-a-year-or-more rout as the other two carriers who rolled up the rest of the Bell system. Meanwhile, Qwest had built up a debt overhang owing to a long-ago buildout of intercity broadband transport that was then sold into a hugely deflationary wholesale bandwidth market. AT&T and Verizon had lots of debt, too, but their debt bought them wireless spectrum and network buildouts for what are today very profitable cell phone contracts -- exactly where those missing customers have gone. Qwest's search for a buyer thus meant finding someone who would actually take over the dead-weight debt in order to get further into a business they feel they know -- local telecommunications. CenturyTel has the revenue stream to pull that off, but Century is a far cry from a full enterprise player, not least because the brand is so unfamiliar and would be difficult to sell to top management in most customer organizations. Ironically, Qwest was technically a forerunner of what we today call AT&T and Verizon on the wireline side -- a combination local and long distance carrier. Qwest had a 14-state local incumbent network, a long distance voice and data network, and full regulatory approval to sell all services years before the defining SBC/AT&T and Verizon/MCI mergers. So why didn't Qwest get a leg up that it could bring to Century now? At first, Qwest had scaling issues with large national rollouts. But over time Qwest had periods where its contracting practices were some of the most troubling in the industry, even while making nominally eye-popping financial offers. Serious enterprises often could not get past the way Qwest would try to tack on very onerous circuit-by-circuit commitments to nominally low-commitment deals, or come up with some of the worst "we're not responsible for anything/you're responsible for everything" language. Going forward, I expect Qwest to continue to make good one-off financial offers for data circuits and certain other services. But the newly merged Century/Qwest would have a huge uphill climb to make a renewed play to be the primary alternative to AT&T and Verizon, especially as Level 3 and others have been showing significantly renewed energy to move up in the ever-churning world second and third tier of carriers. Of course, CenturyTel is in fact a "long distance" carrier itself as anyone can be these days for their local customers, and Century and Qwest cited "enterprise" prominently in their announcement today. No doubt Century expects Qwest's national enterprise business to bring it dividends -- as the original wholesale-only Qwest expected when it bought a niche enterprise carrier called LCI in the 1990s, as Level 3 did when it bought a niche enterprise carrier called Broadwing a few years ago, and as certain foreign carriers have expected over time in "allying" with U.S. carriers. But we have often found that carriers looking from the outside in on the U.S. business marketplace are naive about the distance between "long distance" and "enterprise," misreading the huge requirements for feature functionality, customer support, and, yes, addressing of the legacy ties of Fortune 500 businesses to Verizon and, especially, AT&T. One thing's for sure: Today's Century/Qwest deal is not the last in what we expect to be a series of deals changing up the competition behind the looming duopoly. Will this deal be the one that puts forth the eventual main competitor to AT&T and Verizon? Only time will tell for sure, but the odds are against it. Stay tuned as other, key industry deals are likely to make news sooner or later.

Avaya's plans for Nortel could force serious SIP proposals from carriers

Fri, 22 Jan 2010 08:06:00 -0400

Avaya came out with its product roadmap for the acquired Nortel base this week, and you could summarize it like this: We'll give you lots of space at the beginning of the year, provided you're playing ball with us by the end of the year. Avaya is cutting off nobody in the Nortel PBX base -- at least, nobody whose Nortel product hadn't already begun down the end-of-sale, end-of-support trail. And it's declaring its own end-of-sale only on some supplementary products like the Nortel MCS 5100, a multimedia communications server providing audio and videoconferencing, collaboration tools and the like. On the core question of what to do with Nortel's IP PBX flagship, the Communication Server 1000, Avaya's immediate plan is to follow on Nortel's post-bankruptcy Release 6 with more upgrades of its own over the next 12-18 months. But this looks like a time-delimited strategy. Some experts think there will be two more CS 1000 full releases over the 12-18 month period. Others, such as Stephen Leaden, who gave an excellent webinar yesterday on the Avaya-Nortel roadmap for our friends at The Voice Report, thinks there will be only one. After this initial year or year and a half, Avaya has made it clear that CS 1000 users will have to begin "layering on" Avaya's own Aura platform to stay current. Aura is Avaya's new unified communications architecture that incorporates a SIP Session Manager to handle supported applications, including SIP trunking carrier services. As we've discussed, those services can eliminate many traditional voice trunks in favor centralizing voice streams over a corporate MPLS network with an expedited-forwarding, or real-time, class of service, and then out to the public as necessary (or the reverse in the case of calls into contact centers, including those taken by remote agents logged onto the network). But as you can imagine, the common challenge in all of the Nortel users' roadmap options is enterprise capital availability. Leaden explained that during 2010, Nortel users theoretically have three choices -- wait and consider, begin investigating an investment in Aura (which was designed for interoperability with other vendors even before Nortel's downfall), or begin due diligence on a move to another vendor (such as Cisco, Siemens, etc.). But by 2011 that's really squeezed down to the last two options due to the timeline Avaya laid out. There's a lot more to the Avaya-Nortel roadmap, and I encourage you to check out the replay of the Voice Report webinar especially to learn about the other products in play. What I personally found fascinating were repeated references to exactly how Avaya will be presenting investments in the Aura platform to Nortel users. It's clear that Nortel users will be hit with ROI and payback analyses, and that Avaya will load in benefits that are dependent on other parts of an enterprise's telecom "ecosystem." Leaden listed not only items such as centralized voicemail and unified messaging but also the trunk consolidation benefits from SIP trunking as likely inputs into Avaya ROI models. No doubt Avaya will use rosy ROI assumptions to push Aura on the Nortel users, including theoretical savings from the maximum amount of eliminated or consolidated telephony infrastructure. Of course, it's ultimately up to AT&T, Verizon or others to propose such complete exchanges of traditional rate elements for dynamic VoIP call allocation in their own SIP trunking proposals. But think about the size of Nortel's base. Avaya's plan means that a huge number of telecom buyers will be getting proposals at a time of unusual urgency -- after their major equipment supplier has been bought out of bankruptcy -- in which the new vendor will be highlighting the maximum savings that a carrier should be offering them in service of the new equipment vendor's roadmap. An insta-poll taken during the webinar showed that 48% of the attendees with Nortel gear (and there were at least 230 live users on the conference) are initially inclined to go the "due diligence, find another vendor" route. So I'm sure Avaya won't be shy about its ROI claims for Aura, including what it thinks the carriers can do! Like the pressure-from-below that I recently highlighted in the smaller carriers' discovery of a potential gold mine in SIP trunking, this Avaya-Nortel transition will thus provide another pressure point on the big carriers to make solid VoIP/SIP trunking deals. At some point soon, a little roadmap discussion of your own with current and prospective carriers on this matter could prove quite rewarding.

Vodafone and Verizon Wireless: A difficult history but a better future?

Wed, 30 Sep 2009 10:55:00 -0400

The following is a guest post by TC2 managing director Ben Fox, who is based in London. The relationship between Vodafone and Verizon Wireless is a constant source of interest for TC2's clients. Many global companies have significant relationships with Verizon Wireless in the U.S., and with Vodafone in Europe and beyond. However, despite the major equity relationship between Vodafone and Verizon Wireless, this has rarely translated into any benefits for end-customers. Let's start with some history. Verizon Wireless began as a joint venture in 2000 between Vodafone (which held US wireless network assets through its earlier merger with Airtouch Communications) and Bell Atlantic (which later became Verizon Communications). The ownership split was Vodafone 45% and Verizon Communications 55%, where it still stands today. Vodafone has grown massively over the last decade, initially fueled through multiple acquisitions led by its ambitious CEO Christopher Gent, who headed the company from 1997 to 2003, and more recently through a strategy to focus on emerging markets. In 2009 Vodafone is a global wireless service provider with networks in 20 countries and wireless partners in 44 more countries. And of course Verizon Wireless has also grown hugely, now accounting for fully 58% of Verizon Communications' revenue. Yet, despite all this success separately, Verizon Wireless and Vodafone struggled to find an approach to go to market together. Indeed, to all intents and purposes, it was as if Vodafone's relationship with Verizon Wireless was no more than an equity interest -- they seemed like a silent partner in the joint venture. There seemed to be two key barriers to any kind of deeper connection: -- Vodafone and Verizon Wireless had incompatible technologies. Almost all of Vodafone's networks were GSM whereas Verizon Wireless had a CDMA network. Thus, even when Vodafone's users were in the U.S., they were not even able to roam on Verizon Wireless' network, because Vodafone's mobile devices do not work on a CDMA network. (Even now, Vodafone tends to be relatively expensive for users roaming in the U.S. compared to other service providers.) -- Vodafone and Verizon Wireless are both huge companies that are market leaders in their respective territories. To approach global companies with a joint market proposition, one of the service providers was going to need to take the lead, but neither seemed content to play second fiddle. This rather dysfunctional relationship between Vodafone and Verizon Wireless reached a low point in 2004 when Vodafone made public overtures to acquire AT&T Wireless. AT&T Wireless' network was built on GSM technology, offering a much better fit for Vodafone, and it would have had a controlling interest, not a 45% stake. Ultimately, the US wireless company then known as Cingular beat out Vodafone for AT&T Wireless, an especially important milestone because Cingular at the time was owned by two US "Bell" companies. One of those Bell companies was SBC, which ultimately also bought the venerable AT&T wireline business and then renamed itself AT&T, rolling up all these businesses into one giant competitor to Verizon. Perhaps partly as a result, more recently, and slowly but surely, Vodafone and Verizon Wireless have been working on their relationship. Vodafone has made significant investments in its Vodafone Global Enterprise group, including basing much of its sales team in the U.S. (much to the bewilderment of some of Vodafone's European customers who have an account manager based on a different continent). And the two service providers seem to have worked out an approach to the market. Verizon Wireless will now agree to participate in Vodafone contracts that span multiple countries by providing US services under a Vodafone master agreement, thereby at some level providing global companies with a single contract with Vodafone/Verizon Wireless. And importantly, when Vodafone and Verizon Wireless join forces to respond to a Global Wireless Request for Proposal, or some other sales initiative, you don't get the impression that the Vodafone and Verizon Wireless teams only just met in the lobby before the sales presentation. Going forward the relationship should continue to improve, in particular because Vodafone and Verizon Wireless are finally going to overcome the technology barrier that exists between them when they both deploy LTE based 4G services. It will take some time for this technology to become mainstream, but Vodafone and Verizon Wireless clearly (and I think correctly) see this path to having a common technology platform as crucial to building their relationship. Overall, Vodafone and Verizon Wireless finally seem to have embraced the concept that their relationship is a differentiator for global customers, are now starting to work together to service those customers, and, in the longer term, have a technology strategy that will pull them closer together, not push them apart. Ultimately though, Vodafone and Verizon Wireless still have much work to do; there remain many challenges for global customers wanting to do global and regional wireless deals (with any supplier), and users need to be wary of sales teams that over-promise and under-deliver.

Report: Deutsche Telekom evaluating a play for Sprint

Sun, 13 Sep 2009 20:01:00 -0400

The Telegraph newspaper out of Britain is reporting over the weekend that Deutsche Telekom has hired Deutsche Bank to evaluate a possible acquisition of Sprint Nextel Corporation. This report presents a fascinating set of cross-currents between the likely public discussion of such a prospective deal and the actual enterprise impacts as we see them. We could see lots of press reports analyzing how Deutsche Telekom pulling together T-Mobile (its currently owned subsidiary) with Sprint and Nextel would create a mobile voice/data behemoth. And of course, a DT-Sprint merger would accomplish that from a corporate standpoint. But from an operational standpoint, it's actually not obvious where there are immediate synergies. T-Mobile (GSM), Sprint (CDMA), and Nextel (iDEN) operate on three different wireless protocols. Long rumors of a possible merger between Vodafone and Verizon Wireless (who already share an ownership interest) have foundered on the fact that they mix GSM and CDMA user bases. And the Sprint/Nextel merger itself has had enough problems dealing with two protocols. Three protocols in one shop doesn't necessarily buy corporate users anything in the immediate term. On the other hand, we may see few press reports about a DT-Sprint merger impact on wireline enterprise networks. But in our view at TC2, that's where the real story might be found. Sprint, through its almost exclusive management focus on the wireless business, has been running the risk of ultimate irrelevancy in the enterprise market -- where for so many years it was an important player in corporate data networks, long distance, and call center services. But DT has a strong motive to reverse this trend at Sprint. Right now, when multinational corporations, especially those based in the U.S., put out a global RFP, they tend to solicit bids from a "Global Big Four" -- AT&T, Verizon, BT, and Orange Business Services out of France. Deutsche Telekom has long been known to covet a place at this multinational RFP table, and one reason it hasn't been there is that a long-ago loose alliance with Sprint fell apart and its assets, and customers, scattered to the winds. But owning Sprint outright would reconnect this channel in a firm way, give DT by far the best remaining U.S. corporate user base that's available (while it still exists at Sprint), and combine important assets globally. We have long said that Sprint is likely to be sold in one piece or in parts, and that it may actually be best if such a deal takes place soon, and involves someone (like DT) that actually knows something about Sprint's history and user base in frame/ATM, MPLS, IP networking in general, and basic long distance outbound and inbound platforms. That sort of deal is likely to have a far different complexion than if either a private equity firm, or a foreign state-owned venture capital arm (as we see in some Asian countries) comes in to buy Sprint with little or no history invested in America's No. 3 carrier. Now, this is only the first step. For Germany's biggest telecom carrier to hire Germany's biggest bank to evaluate the acquisition of a company with whom it had a prior alliance is not terribly surprising, and doesn't pre-suppose a final result. Deutsche Bank would have to evaluate all of the above factors -- and then figure out how to make the deal pay off, given the fact that Sprint has a greater debt load than its entire stock market valuation. That means that DT (or anyone) would have to pay more than twice Sprint's actual equity valuation to pull off the deal, although as we have also said before, we believe that factor is already discounted into Sprint's stock price. But there's no question that the global mergers and acquisitions field is opening back up, and that DT has a lot of energy and motivation for deals -- witness its just-signed joint venture with Orange UK for its T-Mobile UK mobile operations. It may be time for this sort of activity. Other players may even come in for a play on Sprint. But our focus in following this will be on the impact on enterprises, because the name of the buyer -- and the method (full acquisition, piece-parting, or joint venture)-- will have a huge difference on the Sprint Nextel customer base in all its forms.

Friday is a red-letter day for Nortel ... and the entire PBX industry

Wed, 09 Sep 2009 15:34:00 -0400

You may remember that earlier this year, Avaya struck a deal to buy Nortel's enterprise division out of bankruptcy for $475 million. But the process has always been set up to make Avaya's offer a "stalking horse." That means that Nortel's bankruptcy trustee has always planned ultimately to hold an auction to see if anyone wants to outbid Avaya. That auction is due to take place this Friday, September 11. In a narrow sense, the auction is obviously key for Nortel users. For its wide base of voice equipment users -- including many companies that may use other vendors, but have lots of Nortel installations too -- the question is whether Nortel products will be actively supported, or slink along to end-of-support and ultimately end-of-life status. Siemens' enterprise group, which itself has had a rocky few years, is mentioned as a possible bidder, as are some less likely players. But you do have to remember that much of the traditional PBX industry has already been sold out (in full acquisitions or joint ventures) to various private equity groups, who are all managing debt loads and may be wary of taking on further leverage to expand by acquisition. So Avaya could walk away with the prize with little or no further effort. But in a larger sense, the question is whether the PBX or enterprise/unified communications industry (by whatever name) is heading inevitably for duopoly, like so many other industries. If no one outbids Avaya, then Avaya -- the ultimate successor to the original AT&T PBX business -- will gain Nortel's big if somewhat degraded distribution channel. That will leave two major players: Avaya, the champion of the traditional phone switch business, and Cisco, the behemoth data networking company that successfully clawed its way into the premises voice communications market. For all intents and purposes, enterprise managers going forward would be left with a binary choice on their strategic unified communications partner. Does that simplify matters in the historically fractured voice equipment market, or is it an anti-competitive warning shot? And should the government step in? That's a fascinating parallel with the emerging situation of AT&T and Verizon in the network transport (and managed) services market -- one that would have been unthinkable until recently, given the dozens of players that have given the PBX market a fair shot. Right now there is a lively debate on the matter hosted by our friends at NoJitter.com. Kind of a portal to the debate can be found in one of NoJitter editor Eric Krapf's recent e-newsletters. We'll examine the matter more after the results of Friday's auction are known, and we look forward to your views as well.

T-Mobile UK and Orange UK in joint venture

Tue, 08 Sep 2009 10:41:00 -0400

The following is a guest post by TC2 managing director Ben Fox, who is based in London. Deutsche Telekom and France Telecom announced today that they intend to merge their UK mobile operations (T-Mobile and Orange respectively) into a 50:50 owned joint venture. The joint venture would combine the networks, operations and retail outlets of the two network providers, with the announcement touting significant expected cost savings and improvements to network coverage, quality and customer support. The marketing strategy for the joint venture appears to be unclear with the announcement stating that the Orange and T-Mobile brands will co-exist whilst the joint venture's management spends its first 18 months developing a new branding strategy. (You can see where they might struggle -- "Orange-T" isn't going to sound very appetizing to the tea-drinking British public...) It is no secret that Deutsche Telekom has been looking to off-load its struggling UK operation for some time -- all three of the UK's other main networks have been flaunted in the press as potential buyers over the last few months. Analysts seem to regard the planned joint venture (as opposed to an acquisition by France Telecom) as a good deal for both Deutsche Telekom and France Telecom -- Deutsche Telekom avoids the major write-downs that it looked to be facing from selling T-Mobile UK, and France Telecom ends up with a stronger mobile market position without significant cash investment or increase in debt. The joint venture is, of course, subject to regulatory approvals. So what might this mean for business customers? T-Mobile seemed to enter the business market slightly later than O2, Vodafone and Orange, and hence was always playing catch-up. One result of this was that over the past few years T-Mobile led the UK mobile market in terms of driving down prices for business customers as it tried to grow its enterprise business. However, that pricing aggression did not necessarily result in winning new business, and often the incumbent supplier simply improved their pricing enough to retain their business. T-Mobile (probably unfairly) was also often regarded as the weakest of the four UK mobile network providers in terms of coverage and network quality, a hangover of its origin from the One2One network which telecom managers had difficulty forgetting. On the pan-European stage, Orange and T-Mobile already collaborate as the main members of the FreeMove Alliance. When FreeMove participates in a pan-European procurement or negotiation, the UK divisions of Orange and T-Mobile do not compete with each other -- typically, whichever of Orange and T-Mobile has the closest relationship with the customer provides the UK component of the pan-European bid. So Orange and T-Mobile already have a track record of working together in the UK market which should stand them in good stead for the proposed joint venture. This also means that for pan-European procurements, these events will have little impact since users have typically only been receiving three bids for the UK market for some time (from FreeMove, Vodafone and Telefonica-O2). However, there has to be a concern that the joint venture will damage ongoing price competition in the UK business mobile market, because there will no longer be a hungry and highly competitive T-Mobile looking to win business with its market leading pricing. We also anticipate the normal concerns with M&A-style events in terms of reduced customer focus whilst the parties work out how to merge their networks and operations -- and lay off staff in order to realise the announced cost saving synergies. However, medium and longer-term savings should also come from the new shared infrastructure where significant rationalization should be achievable. But we could also see an analogy with the U.S. telecoms market, where AT&T and Verizon Business are still fiercely competing for national business even as they're creating an emerging duopoly via mega-mergers. Likewise, this joint venture could result in a re-energised Orange/T-Mobile in the UK with a burning desire to capitalise on now being the UK's largest mobile network provider by aggressively pursuing Vodafone and O2's business customers, just as T-Mobile has done in past years. Perhaps this could also invigorate Vodafone and O2 in responding more strongly to the "new" threat. This is very much the early days of this story; Deutsche Telekom and France Telecom do not expect to finalise the joint venture until November, and much scrutiny from the regulatory and competition authorities will occur before then. I commented in April on the pricing pressures then that were pushing European mobile carriers to extend initiatives to share infrastructure with their competitors in order to reduce costs. Today's announcement is far more significant than those initiatives, but is driven by the same price pressure points. Such pricing and cost pressures across the whole telecom industry, not just mobile, mean that today's news is also likely the first of a number of M&A-style events that will occur in the European and global telecom markets over the next one to two years. We will bring you updates as they unfold.

What antitrust law has to say about the next wave of telecom mergers

Tue, 12 May 2009 14:04:00 -0400

The following is a guest post by Hank Levine, a partner with our law firm affiliate, Levine, Blaszak, Block & Boothby, LLP. It's spring, and a young investment banker's thoughts turn to ... telecom mergers. Since the original 1984 AT&T divestiture, there has been a spate of wireline and/or wireless mergers every few years. The last big wave saw AT&T gobbled up by SBC and the corpse of MCI bought by Verizon. Those were announced in early 2005 and closed about a year later. It's been over four years since those deals were hatched, so it must be time for another round. Sure enough, reports are now circulating that Qwest has put its long distance network up for sale. And every week brings a fresh round of rumors about Sprint merging with ... someone. Usually AT&T and Verizon are named as likely buyers. But we're looking at a different world than we were in 2005, and for two (related) reasons, I think that neither of the surviving telecom mastodons is a likely buyer of Qwest's LD assets or Sprint. First, the market is different than it was ten or even five years ago.Wireless services are a much larger factor, and AT&T and Verizon are by far the two largest wireless players, particularly in the enterprise market (where Sprint is weak and T-Mobile is virtually absent). In wireline interexchange services, Sprint has declined from a reasonably strong to a very weak third. Qwest has largely stood pat while working through a huge debt hangover. Although mergers and acquisitions over the past eight years have made the next tier of players (Level 3, XO, Global Crossing and tw telecom) larger, none is capable of being the principal network services provider to large enterprises. The bottom line is that the AT&T-Verizon duopoly really does look like a duopoly -- something AT&T and MCI never achieved. Second, the Bush Administration's tolerance of market concentration and aversion to antitrust law as a tool for addressing it has given way to what promises to be a much more activist approach on the part of the Obama Administration. From 2001 through 2008 the Justice Department rarely came across a proposed merger it didn't like. No one expects that to be true from 2009 to 2012. It's fair to ask whether it matters who buys Sprint or Qwest's LD assets. There are two major players, after all, so whatever the shape of the market it's not a near-monopoly and won't be unless AT&T buys Verizon or vice-versa. Should even a vigilant antitrust enforcer care if a major player acquires one of the half dozen or so smaller participants in a market? To answer that it's worth remembering 1999, when MCI (then flying high under the leadership of the charismatic but felonious Bernie Ebbers) announced that it was acquiring Sprint in a move designed (according to CNET) to "create a telecommunications titan able at last to take on market leader AT&T on relatively equal terms." To snatch the prize, MCI beat out a (then-independent) BellSouth. Eight months later, in July of 2000, the Clinton Justice Department filed a lawsuit to block the deal, and the merger was promptly abandoned. There were a number of rationales for the Justice Department's opposition to the MCI-Sprint deal. One that received a lot of press at the time was the theory that the combined company would have a monopoly over Internet traffic. But with one exception, all of the objections could have been answered by requiring the new entity to divest itself of certain assets, standard operating procedure in large mergers. That exception -- and the reason I'm remembering the story -- was the difference between two and three strong competitors in a market. Despite outward appearances of intense rivalry, duopolies are actually quite stable -- each of the two participants in the market is aware of (and able to react quickly to) the pricing and price-related behavior of the other, with the result that robust pricing competition is less common than parallel price increases. The classic example in telecommunications is the cellular market in the 1980s and early 1990s, when, due to government licensing policy, there were two providers in each market and prices were high and stayed that way. When there are three competitors, by contrast, the weakest often "cheats" on the oligopoly, benefiting customers and competition by offering pricing or other concessions to gain market share. Four is better than three, five is better than four, and so on. But the big break from a competitive standpoint is between two and three providers, which is why the deal rumor of the day has to be judged by whether it preserves the third major carrier option. As an attorney who has been representing large users in negotiating telecom agreements for 20+ years, I have some experience with this phenomenon. Indeed, I was interviewed and then deposed by the Justice Department when it was investigating the MCI-Sprint merger. I testified that AT&T, MCI and Sprint were the only three carriers capable of serving as the primary provider of interexchange services to enterprise customers, and my deposition was cited a number of times in the papers filed by the Justice Department to block the merger. MCI was well aware of the concern, and sought to counter it by arguing that Qwest was also a substantial provider of telecom services to large enterprise customers. To prove that, it filed a list of (as I recall) 80 deals between large users and Qwest -- of which all but three proved on examination to be with telecom resellers, not end-users. Ten years later, Sprint is weaker, but it remains the only carrier other than AT&T and Verizon that serves as the primary provider of complex network and wide-area services to large enterprise customers. Qwest is fourth, but a distant fourth, and its enterprise business remains thin and concentrated in commodity services -- voice minutes, not managed MPLS networks. So at least from a customer perspective, the acquisition of Qwest's LD network or Sprint by anyone but AT&T or Verizon would be a positive development -- it would strengthen competition in the enterprise market by strengthening the market's "Chrysler." Conversely, the acquisition of Sprint or Qwest's LD assets by AT&T or Verizon would disproportionately weaken competition in the enterprise market. In another nod to automobiles, note that it doesn't matter from a competitive perspective if the buyer is foreign or domestic, or if it is a big supplier in another market (such as IBM, which actually once owned 20% of MCI). In 1999 Deutsche Telecom was widely viewed as a potential purchaser of Sprint, and while that might have dismayed the breast-beating flag-wavers, it would have preserved/enhanced competition. All that matters is that the third provider not be bought by one of the first two. As the capital markets recover, a play for Sprint is about as likely as clouds in Seattle, heat in Atlanta, and hot air in Washington, D.C. We'll see how it plays out as the season progresses.