Today’s merger between CenturyTel (soon to be CenturyLink) and Qwest will combine 10 million Qwest customers and 7 million from CenturyTel into a single company serving 37 states in every region of the country except the northeast and much of California and Nevada.  CenturyLink gains access to Qwest’s highly valued portfolio of services sold to business customers and Qwest gets a partner that can help manage its $11.8 billion debt and help grow the last remaining Baby Bell, formerly known as US West, into a national player capable of withstanding ongoing erosion of landline service.

The deal will impact consumers and businesses, and will challenge regulatory authorities to consider the implications of ongoing consolidation in the traditional telephone service marketplace.  It brings implications for broadband service strategies for both companies, which we’ll explore in greater detail.

Breaking Up Was Too Hard to Do, So Let’s Put It Back Together

Ultimately, the genesis of this, and most of the other big telecom deals that we’ve witnessed over the past few years comes from the 1996 Communications Act, which deregulated large parts of the telecommunications industry and triggered a massive wave of consolidation that is still ongoing.  That legislation was the antithesis of the 1984 court ruling which ultimately led to the breakup of AT&T and the Bell System monopoly in 1984.  When President Clinton signed the 1996 bill into law, it allowed much of the Bell System to eventually recombine into two major entities:

• AT&T ultimately pieced itself back together with the acquisitions of:

BellSouth — serving the southeastern United States

Ameritech — serving the upper Midwest

SBC/Southwestern Bell — serving Texas and several southern prairie states

Pacific Telesis — serving California and Nevada

• Verizon became a regional powerhouse by combining:

NYNEX — serving New England and New York

Bell Atlantic — serving mid-Atlantic states

The remaining orphaned Baby Bell was US West, which comprised Mountain Bell serving the Rocky Mountain states, Northwestern Bell which covered the Dakotas, Minnesota, the prairie states not covered by SBC, and Pacific Northwest Bell which managed service for Oregon, Washington, and northern Idaho.  US West was subjected to a hostile takeover in 2000 by an upstart telecommunications company that was laying fiber optic cable in the late 1990s alongside the railways its owner, Philip Anschutz, also happened to own.  Qwest assumed control of US West that summer and rechristened it with its own name.  Owned by a Bell outsider, Qwest has always been the company that didn’t quite fit with the rest.

The company gained respect for its enormous fiber backbone that weaves across many American cities, including several in the northeast.  It is best known for its services to business customers.  On the residential side, the story is less impressive.  The company’s customer service record is spotty and the company has accumulated an enormous amount of legacy debt left over from earlier acquisitions.  Despite the company’s repeated efforts to find a partner, it took until today for it to finally find one.  There are several reasons for this:

1. Qwest’s service area is notoriously rural and expensive to serve.  Outside of its corporate headquarters in Denver, the majority of its service area is either mountainous or rural.  Even today, Qwest serves only 10 million residential customers, almost matched by CenturyTel’s own seven million largely rural customers scattered across the country.
2. Qwest’s history has been littered with financial scandals, starting with a series of deals with disgraced Enron from 1999-2001.  That was followed with charges of fraud and insider trading in 2005.
3. Qwest does not own its own wireless division and its previous efforts to deliver television service to customers were largely unsuccessful.  That made Qwest’s ability to withstand erosion in its core business – landline phone service, more difficult.
4. Qwest’s debt is downright frightening for would-be suitors.

Why Does CenturyTel Want to Buy Qwest?

CenturyTel claims such a transaction allows a combined company to become a larger player on the national scene.  By combining Qwest’s good reputation in the business telecommunications sector with combined efforts to deliver broadband products including high speed Internet, the company thinks the combination can’t be beat.  CenturyTel envisions packages of video entertainment, data hosting and managed services, as well as fiber to cell tower connectivity and other high bandwidth services to deliver replacement revenue lost from disconnected landlines.  It also believes it can realize cost savings from the merger and keep the company relevant on a stage dominated by Verizon, AT&T, and a few large cable companies.

But there are other reasons.  For the three super-sized independent phone companies that Americans are growing increasingly familiar with — Frontier Communications, Windstream Communications, and CenturyTel, their business models depend on their ability to constantly engage in deal-making and acquisitions.  All three companies have built their businesses on investors who see their stocks as “investment grade” financial instruments that dependably return a dividend back to shareholders.  As we’ve seen in countless quarterly financial results conference calls, all three companies are preoccupied answering questions from Wall Street about the all-important dividend.  TV personalities like Jim Cramer has specifically recommended these telecom stocks based, in part, on their dividend payout.  If that dividend dramatically shrunk or stopped, the share price for all three stocks would likely plummet.

One of the side effects of companies dependent on dividend payouts is their constant need to be on the lookout for additional merger and acquisition opportunities.  Here’s how it works.  Let’s say CenturyTel’s debt load and reduced revenue, caused by customer defections to cell phones or cable phone service, delivered a bad fiscal quarter for the company.  Cash flow was down, and company officials simply couldn’t keep the dividend payout at the same level as the previous quarter.  Since many people hold CenturyTel stock specifically because of the dividend, a downward turn in that payout could cause some to sell their shares, driving the stock price downwards.

One way around this is to seek out a new merger or acquisition target.  By bringing two companies together, preferably one with a healthy cash flow, suddenly the big picture changes.  Your balance sheet now reflects the combined revenue from both companies, which incidentally makes the percentage of debt versus revenue look a lot healthier.  Cash flow immediately improves, especially if you can slash redundant costs.  Come next quarter, that dividend payout is right back up in healthy territory.

Sometimes companies become so preoccupied with their dividend and corresponding stock price, it can lead them to pay out more in dividends than a company earns in revenue.  While that’s great for investors, it is unsustainable in the long run.

Many critics of telecommunications companies employing this strategy claim it’s evidence that a company is biding time and unwilling to invest in innovation for the future.  Some also believe dividend payouts shortchange customers because they can eventually bleed a company’s ability to invest in service improvements, research and development, and capital investments to maintain their network and expand service.

As consolidation continues, the number of new buyout opportunities begins to shrink, and one shudders to think what happens when there is no one else to buy.  How long is this business model sustainable?

Both CenturyTel and Qwest also recognize the impact of ongoing disconnections from landline service, now averaging 10 percent of their customers a year.  Those departing customers are now relying on their cell phones or alternative calling services like cable company “digital phone” service or broadband-based calling from companies like Vonage or Skype.

The one service they hope can stem customer defections is broadband.  Unfortunately, telephone companies are increasingly losing ground against their cable modem competitors, who have an easier time increasing broadband speeds for customers now seeking online video and other high bandwidth applications.

Of course, one of the benefits of being a “rural phone company” is the fact cable competition is often unlikely.  In fact, some of the lowest erosion rates for landline service are in rural communities where the telephone company is the only game in town.  There is plenty of money still to be made offering high priced slow speed DSL service in communities with no cable competitor and spotty wireless broadband that is often slower and usage-limited.

All three of these big independent players are well aware of this, and maintaining a strong position in relatively slow speed DSL service also protects another revenue stream — Universal Service Fund revenue given to rural providers to equalize telephone rates.  CenturyTel recognizes the increasing likelihood much of that money will be diverted to stimulating broadband expansion, something the phone company is more than willing to do if it means preserving their subsidies.

The new combined Qwest-CenturyTel company hopes the merger can help both survive obsolescence.

For Qwest, a debt reduction may make it possible to spend more to deliver fiber-to-the-curb service, similar to AT&T U-verse.  That could increase broadband speeds and prompt them to reconsider their earlier decision to abandon IPTV in the western half of the country.

CenturyTel can continue to offer traditional DSL service with a more incremental upgrade approach in its more rural service areas, but tap into Qwest’s fiber network to reduce backhaul expenses and potentially pick up new business customers by offering Qwest-branded business services.  Company officials strongly hinted that, at least for now, CenturyTel’s existing customers will continue to find the video portion of their “triple play” package delivered by DirecTV satellite service, so no IPTV for them.

What Does This Mean for Employees of Both Companies?

Mergers like this always generate great excitement over “cost savings” made possible by the merger.  Much of these savings typically come from employee expenses.  When you hear “cost savings,” think layoffs and pay cuts for all but top management.  Based on past precedent, Qwest employees can anticipate some serious job losses if this transaction closes, especially in the business office.  The combined company will be henceforth known as CenturyLink, with headquarters remaining in Monroe, Louisiana.  That is potentially bad news for Qwest’s employees in Denver.

The transaction is expected to generate annual operating cost savings (which CenturyTel calls “synergies”) of approximately $575 million, which are expected to be fully realized three to five years following closing.  The transaction also is expected to generate annual capital expenditure “synergies” of approximately $50 million within the first two years after close.  That means spending less on infrastructure improvements.

Billing and customer service are traditionally handled by CenturyTel when a company joins the CenturyTel family.  North Carolina customers can attest to that as EMBARQ, an earlier CenturyTel target, finally moves to CenturyTel’s billing system in the coming weeks.

For the sake of pushing the merger through state regulatory agencies, cutbacks in unionized technicians who handle service installations, repairs, and maintain the lines are not expected.  The Communications Workers of America issued a statement today that mildly acknowledged the merger announcement, saying the union “looked forward to serious negotiations with both companies” regarding employment security and assurances of aggressive high speed broadband rollout throughout both companies’ territories.

What Does This Mean for Qwest and CenturyTel Customers?

In the short term, nothing.  This merger will take at least a year to complete, assuming regulatory approval in every state where a review is required by state officials.  In 2011, should the merger be approved, Qwest customers can anticipate transition headaches as the Denver-based company winds down operations in favor of CenturyTel.  Billing and customer service will both be impacted.  Long term plans for major projects are likely to be stalled until the merger settles into place.  CenturyTel business customers will eventually see Qwest’s strong business products line become available in many CenturyTel service areas.  Eventually, some larger CenturyTel-served cities may find Qwest’s more advanced DSL service arriving on the scene delivering faster speeds.

Although CenturyTel has hinted it may review whether it’s now large enough to operate its own wireless mobile division, for the near term, expect the partnership to resell Verizon Wireless service to continue.

What is the View of Stop the Cap! on the CenturyTel-Qwest Merger?

Generally speaking, most of the industry consolidation that has been fueled by a deregulatory framework established by the Clinton Administration has not benefited consumers anywhere near the level promised by deregulation advocates.  The three largest independent phone company consolidators — Frontier, Windstream, and CenturyTel are spending more time and resources looking for new acquisitions and schemes to pay out dividends than they are working to enhance service in their respective service areas.  Smaller independent phone companies are deploying fiber to the home networks and answer to the communities where they work and live.  From companies like Frontier, we get Internet Overcharging schemes combined with slow DSL service, tricks and traps from “price protection agreements” that automatically renew, rate increases, and cost cutting.  Windstream plagues some of their customers with extended service outages, and CenturyTel’s promised broadband speeds often don’t deliver.

Unfortunately, bigger is not always better in telecommunications.  While the biggest players like Verizon seek to discard rural American customers, getting one of these three companies instead doesn’t always represent progress.  Our regulators are too often satisfied with basic answers to questions about broadband and service improvements that come with few details and deadlines.  It is just as important to ask what kind of broadband service a company will bring, at what speeds and price, and what usage limits, if any, will accompany the service.

Companies engaged in these mergers hope regulators don’t pin them down to specific service commitments and standards, which could harm the financial windfall these deals bring to a select few.  But they must be the first thing on the table, guaranteeing that customers also get the enjoy the “synergies” these deals are supposed to bring.

Bell Labs, a division of Alcatel-Lucent, has found a way to extract more speed over aging copper wire most phone companies still rely on to deliver service.  Its latest achievement, in the lab anyway, proved those wires could accommodate 300Mbps downstream speeds, at least if you were within 400 meters (that’s just over 1,300 feet) from phone company facilities.  Further on, the company was able to achieve 100Mbps speeds over a distance of one kilometer (0.62 miles).

Stop the Cap! reader Jeff writes wondering what impact such improvements have when they are measured in distances more commonly associated with a sprinting event.  Phone companies are well aware of the limitations of their legacy networks.  Some, like Verizon, decided the network designed more than a century ago was destined for the scrap heap.  They began to deploy fiber-optic based networks instead.  Others are trying to extract as much as they can from copper, as cheap as they can for as long as they can.

The problem with copper wiring is that the longer the distance, the slower the data speed those lines will support.  Interference or crosstalk from neighboring cables crammed together into a bundle can also create major problems, especially at longer distances.

Bell Labs says it has devised a way around the crosstalk problem with the testing of its “DSL Phantom Mode” solution:

At its core, DSL Phantom Mode involves the creation of a virtual or “phantom” channel that supplements the two physical wires that are the standard configuration for copper transmission lines. Bell Labs’ innovation and the source of DSL Phantom Mode’s dramatic increase in transmission capacity lies in its application of analogue phantom mode technology in combination with industry-standard techniques: vectoring that eliminates interference or “crosstalk” between copper wires, and bonding that makes it possible to take individual lines and aggregate them.

In the eyes of Alcatel-Lucent, Bell Labs has found an answer to the dilemma of what role phone companies can play in a 100Mbps broadband future.

“We often think of the role innovation plays in generating technologies of the future, but DSL Phantom Mode is a prime example of the role innovation can play in creating a future for existing solutions and injecting them with a new source of value,” said Gee Rittenhouse, head of Research for Bell Labs. “What makes DSL Phantom Mode such an important breakthrough is that it combines cutting edge technology with an attractive business model that will open up entirely new commercial opportunities for service providers, enabling them in particular, to offer the latest broadband IP-based services using existing network infrastructure.”

Before getting too excited, remember these demonstration tests occurred in a laboratory environment.  No squirrels chewed up the cables. No water leaking into cracks in the cable’s insulation or a connection box caused issues.  No aging splices of corroded copper wiring up on poles since the late 1960s were found.  Your home’s own phone wiring was also never part of the equation.

Distance is still a considerable limiting factor in DSL deployments.  Most of the benefits of this research will go to companies like AT&T, which uses a hybrid fiber-copper wire network in its U-verse areas.  The fiber cuts down the distance from a phone company office to a neighborhood.  Once in your neighborhood, traditional copper wires run the rest of the way, right up into your home.  If AT&T can leverage additional speed from its weakest link — the copper-based phone line — it may be able to use the additional bandwidth to boost broadband speed or accommodate more concurrent applications they cannot support today.

For phone companies still dependent on long distances of copper wiring, the expense of bootstrapping Alexander Graham Bell’s century-old network begins to look silly.

Sometimes it’s better to build anew instead of repeatedly trying to fix the old.  And many are doing exactly that.

Hundreds of small independent telecoms, broadband service providers, municipalities and cable television companies have brought gigabit-enabled, all-fiber service to a total of more than 1.4 million North American homes – about a quarter of all fiber to the home connections on the continent – according to the Fiber-to-the-Home (FTTH) Council.

The FTTH Council noted in a recent study more than 65 percent of small independent telephone companies that have not upgraded to FTTH said they would very likely do so in the future, with another 11 percent saying they were somewhat likely. More than 85 percent of those that have already deployed FTTH said they would be adding more direct fiber connections going forward.

Surprisingly most of this expansion outside of Verizon’s FiOS service comes from small family-owned companies, cooperatives, and the remaining independent phone companies not snapped up by Frontier, Windstream, and CenturyLink.

“To continue to meet the rapidly growing bandwidth requirements for emerging applications and services, these companies know that they have to ‘future-proof’ their networks by running fiber all the way to the premises – and that’s why we are seeing all this activity,” says Joe Savage, President of the FTTH Council.

“In many cases, these small telephone companies are longtime family-owned businesses that are deeply involved in local affairs and are responsive to their community needs for faster broadband as a key to future economic development,” said Mike Render, president of RVA LLC and the author of the study. “That’s why so many of these companies are looking to get into FTTH or expand their deployments,” he said.

Next time you pay your broadband bill, consider what you are getting for your money.

Then consider Hong Kong residents can now buy 1,000Mbps symmetrical broadband service for $26 per month.  Symmetrical broadband offers identical upstream and downstream speeds, so transferring large files back and forth becomes an afterthought, not a nuisance.

This week Hong Kong Broadband Network (HKBN) introduced wide availability of its mega-fast 1/1 gigabit per second service at prices that most American broadband providers won’t match for slow “lite” or “budget” tiers.  The new gigabit service joins an even more affordable 100/100Mbps broadband service HKBN sells for $13 a month.

“Symmetric 1 Gbps broadband at US$26/month (HK$199) is a global breakthrough service, and is by far the best value in terms of cost per Mbps in Hong Kong. We are pleased to contribute towards making Hong Kong a global Fibre Oasis,” said June Lam, Associate Director, Marketing, HKBN.

Comcast, like Time Warner Cable, is slowly transitioning many of its traditional analog channels to digital, making more room for additional HD channels and faster broadband.  The latest city about to experience what Comcast calls its “all-digital migration” is Denver, Colorado.

“As part of the technology enhancement, Comcast is making available up to three devices to customers so they can hook up their (analog) televisions and not miss any channels,” said Cindy Parsons, a spokesperson for Comcast in Denver.  “What this allows us to do is provide hundreds of HD channels in the future, faster Internet speeds, better picture quality, and more ethnic programming.”

Customers with any level of service above Limited Basic with an existing digital set-top box may receive two digital adapters at no additional monthly cost; customers without an existing digital set-top box may receive one standard digital set-top box and two digital adapters at no additional monthly cost.

Parsons claims up to 90 percent of Comcast’s Denver customers already subscribe to digital cable on at least one television set in the home.  Comcast is offering free self-install kits through its Digital Now website.

Comcast intends to commence the transition to digital channel delivery starting this spring continuing into the summer.  The entire state of Colorado will follow, with the transition to digital complete by the end of the year.

Of course, customers with many analog televisions, or who dislike the notion of having to deal with add-on equipment, are out of luck.

[flv]http://www.phillipdampier.com/video/KUSA Denver Comcast Digital Upgrade.flv[/flv]

KUSA-TV Denver talked with Comcast’s Cindy Parsons about the city’s imminent “all-digital-migration” to digital cable television. (3 minutes)

The long awaited National Broadband Plan (NBP) for the United States is here.  Unveiled yesterday by the Federal Communications Commission, the 376-page plan calls itself a mandate for improved broadband service for 200 million Americans, bringing access to those who don’t have it, and better speeds and lower prices for those that do.

The report’s authors consider the broadband revolution a transformational change for the country, just as railroads opened the door to coast-to-coast transportation, electricity changed the American household, and phone service opened the door to a new era of Americans reaching out to communicate with one another.

Today, high-speed Internet is transforming the landscape of America more rapidly and more pervasively than earlier infrastructure networks. Like railroads and highways, broadband accelerates the velocity of commerce, reducing the costs of distance. Like electricity, it creates a platform for America’s creativity to lead in developing better ways to solve old problems. Like telephony and broadcasting, it expands our ability to communicate, inform and entertain.

Broadband is the great infrastructure challenge of the early 21st century.

To meet the challenge, the FCC was commissioned to develop a national blueprint for improving broadband service in the United States.  A sense of urgency over statistics showing the United States ranking in the bottom half of nations — losing ground on speed, affordability, and access to both Europe and Asia meant the NBP must deliver concrete answers to improve the country’s competitive broadband standing.

This is a broad mandate. It calls for broadband networks that reach higher and farther, filling the troubling gaps we face in the deployment of broadband networks, in the adoption of broadband by people and businesses and in the use of broadband to further our national priorities.

Nearly 100 million Americans do not have broadband today. Fourteen million Americans do not have access to broadband infrastructure that can support today’s and tomorrow’s applications. More than 10 million school-age children do not have home access to this primary research tool used by most students for homework. Jobs increasingly require Internet skills; the share of Americans using high-speed Internet at work grew by 50% between 2003 and 2007, and the number of jobs in information and communications technology is growing 50% faster than in other sectors. Yet millions of Americans lack the skills necessary to use the Internet.

The NBP goes out of its way to recognize private enterprise’s influence on broadband development in the country, acknowledging America’s for-profit, largely unregulated broadband industry has successfully cherry-picked the most profitable customers for often excellent broadband service.  For others deemed less profitable, a lesser amount of service, or no service at all is available.  The distinction between America’s free market approach and government-run universal service is noted in the report.  For America, the private approach has created a “digital divide” — the broadband have’s and have-not’s.  The reasons for bypassing certain areas varies from the expenses to reach rural homes to affordability issues in the inner city.  Sometimes, it’s a matter of being lucky enough to have a decent provider who is aggressive about deploying service.

The NBP seeks to build upon the private free market approach to broadband and fill in the gaps in service for those left behind.

The FCC’s plan envisions broadband evolution, not a broadband revolution.  The report recommends maintaining a limited government role for broadband, and limited regulations along with it.

Instead of choosing a specific path for broadband in America, this plan describes actions government should take to encourage more private innovation and investment. The policies and actions recommended in this plan fall into three categories: fostering innovation and competition in networks, devices and applications; redirecting assets that government controls or influences in order to spur investment and inclusion; and optimizing the use of broadband to help achieve national priorities.

Among the core goals of the NBP:

• Connect 100 million households to affordable, 100Mbps service within 10 years, permitting high end video streaming and medical diagnostics;
• Define broadband as at least 4/1Mbps service, which automatically disqualifies a number of rural DSL providers and satellite fraudband;
• Pole attachment reform, which would remove obstacles providers encounter when trying to hang wiring on poles, bury it underground, or access rights-of-way;
• Improve rural broadband service and low-income access through Universal Service Fund reform, shifting up to $15.5 billion towards broadband construction and subsidies;
• Target a 90 percent broadband adoption rate among American households;
• Rely on mobile broadband to be an important competitor in the broadband industry by doubling available spectrum for wireless data and expand reach beyond today’s 60 percent coverage;
• Provide $16 billion in funding for a federal interoperable mobile broadband network exclusively for public safety agencies.

The plan is a marked departure from the FCC under former president George W. Bush.  Just two years ago, the Commission suggested there were few problems with the broadband industry as-is.  Michael Powell, who served under Bush’s first term as Chairman of the FCC, advocated free market deregulation, and dismissed concerns about the digital divide, calling it a “Mercedes divide,” suggesting broadband was like an expensive car he’d like to own but can’t afford.

Perhaps Powell can afford that car today, as honorary co-chair of industry front group Broadband for America, which has made its presence known through Powell on several national cable news channels in interviews about the broadband plan.  The BfA’s role as an industry-backed player is not disclosed in interviews.

Opposition to parts of the NBP is likely to come from:

• Broadcasters, concerned about the further loss of the UHF TV dial for wireless broadband service expansion;
• Utility pole owners who will likely oppose changes in compensation formulas for pole attachment fees;
• Incumbent broadband providers who fear the NBP may lead to government-backed competition in their service areas;
• Consumers who may balk if Universal Service Fund reform adds an additional five or more dollars a month in fees to broadband bills without price reductions from real competition.

Some of the greatest concerns about the plan come from consumer groups, who recognize the plan has many good points, but relies too much on working with the same companies that got the United States into this position in the first place.

The Senate Commerce, Science and Transportation Committee has scheduled a hearing for Tuesday, March 23 at 2:30 p.m. to review the plan. The House Subcommittee on Communications, Technology and the Internet will hold its own hearing on the plan next Thursday, March 25.

[flv width=”640″ height=”500″]http://www.phillipdampier.com/video/Bloomberg National Broadband Plan Released – Controversies 3-16-10.flv[/flv]

Bloomberg Business News carried extensive coverage about the National Broadband Plan, its winners and losers, and other implications of a coordinated plan to improve service across America. (14 minutes)

[flv]http://www.phillipdampier.com/video/CNBC National Broadband Plan Implications 3-16-10.flv[/flv]

CNBC aired more skeptical coverage about the National Broadband Plan.  Clueless Michelle Caruso-Cabrera is also back still insisting 99 percent of America already has access to broadband, but she speaks in terms of zip codes, not actual broadband coverage, and it’s unclear if she includes satellite “fraudband,” which promises broadband speeds but doesn’t deliver.  Caruso-Cabrera also bashes Net Neutrality along the way. (13 minutes)

[flv width=”448″ height=”356″]http://www.phillipdampier.com/video/NBC News Channel FCC Seeks to Expand Access 3-16-10.flv[/flv]

From a less “business news” standpoint, the NBC News Channel explained the National Broadband Plan to ordinary consumers yesterday in terms of how the plan would affect them. (2 minutes)

[flv width=”640″ height=”500″]http://www.phillipdampier.com/video/WTTG Washington High-Speed Broadband Access for All 3-16-10.flv[/flv]

Local Washington, DC Fox affiliate WTTG-TV also explains the National Broadband Plan, suggesting it will bring “high speed access for all.” (3 minutes)