“We’ve been talking for some time that broadband for us is not just about customer growth… it’s about revenue growth.” — Anthony Thomas, Windstream’s Chief Financial Officer

For the first time in some time, Windstream reported revenue growth during the second quarter of 2011.  The independent landline telephone company that last week acquired Rochester-based PAETEC Corporation managed to win new revenue from its business services unit and equipment sales, even as it continues to lose core landline customers, who are disconnecting service in favor of cell phones or cable telephone products.

It added up to a measurable, but meager growth of 0.1 percent for the company year-over-year during the second quarter.

Like many traditional wireline phone companies, Windstream is betting the farm in their largely rural and suburban service areas on selling broadband and maintaining the allegiance of their business customers, challenged in larger cities by increasingly aggressive “Business Class” products from competing cable companies.

Windstream executives responded to questions from Wall Street bankers during their second quarter conference call held last Friday.

While several investment firms were happy to see Windstream manage some revenue growth, several zeroed in on the company’s increased capital expenditures.  Windstream reports the company will continue major investments in fiber and broadband services, but not primarily for their residential retail customers.  Instead, Windstream hopes to capitalize on the “high margin” business of selling fiber-based cell tower services, primarily to support forthcoming 4G deployments.

Windstream officials faced some hesitancy from Wall Street about the company’s spending during Friday’s conference call, particularly from Bank of America and Goldman Sachs.

Anthony Thomas, chief financial officer for Windstream, defended the investments.

“The most important part of fiber-to-the-tower projects are the initial investments. Those are very high-margin businesses,” Thomas said. “But you have be comfortable with the upfront capital and be patient at recognizing those are 6-to 12-month investment time horizons. But once you start bringing those revenues in, the actual cost of operating a tower is low.”

Wall Street also expressed concerns about consumer broadband traffic growth, but did not broach the subject of usage control measures like usage caps or metered billing.  Windstream acknowledged the growth, primarily from online video, and said it had well-equipped data centers to handle the traffic.

Windsteam’s Consumer Strategy: Bundle Customers & Keep Them Away from Cable TV

It's all about the bundle.

Online video may be an asset for Windstream, which is facing increasing challenges retaining landline customers and up-selling them other products like broadband.  That competition comes primarily from cable companies, who are targeting Windstream customers with invitations to cut their landline service and bring all of their telecommunications business to cable.

Traditional phone companies have a major weakness in their product bundle: video.  Independent phone companies, in particular, are usually reliant on satellite TV partners to support the television component of a traditional “triple play” bundle.  Windstream’s network is capable of telephone and slow speed broadband in most areas, but the company’s involvement in video is largely left to a third party satellite-TV provider.

Customers who do not want satellite TV service may be easily attracted to a local cable provider.  But as an increasing amount of video viewing is moving online, Windstream may find customers increasingly tolerant of doing their viewing online, reducing the importance of a video package.

Windstream’s strategies to keep customers:

• Sell customers on product bundles, now enhanced with online security/antivirus options and on-call technical support for computer-related technical issues;
• Pitch Windstream’s Lifetime Price Guarantee, which locks in a single price for basic services, good as long as you remain a customer;
• Challenge cable competitors head-on with its “Quitter Campaign,” which tries to convince cable customers to “quit cable” in favor of Windstream;
• Offer faster broadband speeds in limited areas to satisfy premium customer demand.

Windstream Tries to Convince Customers the Broadband Speeds It Doesn’t Offer Do Not Matter for Most

Windstream’s efforts at winning over new broadband customers have been waning as of late.  One of the primary issues Windstream faces is the cable industry’s effective portrayal of DSL as “yesterday’s” technology, incapable of delivering the broadband speeds consumers crave.

Instead of investing in improved broadband speeds for everyone, Windstream spends its time and efforts trying to convince most customers they don’t need the faster speeds being pitched by most cable companies in the first place.

Windstream tries to convince customers they can make do with less speed (as low as 1.5Mbps), and there is no difference in speed between different providers — both questionable assertions.  (4 minutes)

The COO says 3Mbps is Windstream's biggest seller -- their website says something else.

Windstream chief operating officer Brent Whittington says his customers “don’t want to pay for incremental speed,” but is expanding their capacity to offer somewhat faster speeds.

“We still see that long term as [an increased revenue opportunity] because we know the demand is going to be there,” Whittington told investors.  “As we’ve rolled it out currently, it’s largely to — from a marketing benefits standpoint to talk about our competitiveness relative to our cable competition, but [consumers] are largely buying at 3Mbps.”

Either Whittington is mistaken, or Windstream’s website is, because it promotes the company’s 6Mbps $44.99 option as its “top seller.”  Many of Windstream’s cable competitors charge less for almost twice the speed, which may be another reason why Windstream’s broadband signup numbers are lagging behind.

Finding More Revenue: Universal Service Fund Reform & Business Services

Among the most important components of Windstream’s strategy for future growth are reform efforts underway in Washington to overhaul the Universal Service Fund.  Rural, independent phone companies like Windstream have reaped the rewards of this subsidy for years in its rural service areas.  But now Washington wants to transform the program away from simply underwriting rural landline phone service and redirect revenues to enhancing broadband access in areas too unprofitable to service today.

Windstream sees the reform as a positive development.

“It focuses USF on high-cost areas,” said Windstream CEO Jeff Gardner. “If you were a customer in a rural area of Windstream versus a customer in a rural area of a small carrier, your subsidy would much be higher, and we would get very little USF for that going forward. In this proposal, USF is really targeted towards those high-cost areas, so we kind of deal with this issue that we refer to as the rural-rural divide.”

Gardner says USF reform will end disparity of access.

“All rural customers are going to have the opportunity to get broadband out to them under this plan,” he said. The more customers paying monthly service fees, the higher the company’s revenues, assuming nothing else changes.

While redirected subsidies may help rural broadband customers, Windstream’s capital investments in expanding their network are going primarily to benefit their business clients, not consumers.

“On the small business side, our service there is very superior to our cable competitors,” said Windstream’s chief financial officer Anthony Thomas. “We’ve made investments in our network to offer VDSL and higher-speed data services. That’s going to be directed predominately toward those small business customers.”

Whittington added most of the company’s efforts at deploying VDSL technology are focused on the company’s small business segment to bring faster speeds to commercial customers.  For consumers, Windstream’s efforts are targeted primarily at keeping up with usage demands.

“Like a lot of folks in the industry, we’ve definitely seen increases in network traffic really due to video consumption,” Whittington said. “No question Netflix and other related type services are driving some of that demand. We continue to invest in broadband transport like we have in years past. And the good thing with a lot of things we’ve been doing from just a network perspective like rolling out as I mentioned before, VDSL technology in our larger markets. That’s really all about fiber deployment, which helps solve some of those transport issues. So we feel like we’ve been in good shape there, but it’s certainly something we’ve been very focused on operationally so our broadband customers don’t see a degradation in the quality of their experience.”

Independent phone company Windstream this morning announced its intention to acquire business telecommunications provider PAETEC Holding Corp., in a transaction valued at nearly $2.3 billion.

“This transaction significantly advances our strategy to drive top-line revenue growth by expanding our focus on business and broadband services,” said Jeff Gardner, president and CEO of Windstream. “The combined company will have a nationwide network with a deep fiber footprint to offer enhanced capabilities in strategic growth areas, including IP-based services, data centers, cloud computing and managed services. Financially, we improve our growth profile and lower the payout ratio on our strong dividend, offering investors a unique combination of growth and yield.”

PAETEC, based in suburban Rochester, N.Y., has been a business telecommunications provider since 1998, and many of its founding employees joined the company from locally-based Rochester Telephone Corporation, its long distance subsidiary RCI, and a competing long distance competitor ACC — today all long-gone.

For residents of Rochester, the implications of the merger could literally leave a hole in the center of downtown, where construction of PAETEC’s pre-merger headquarters was just getting underway.  With the recent demolition of Midtown Plaza, what local residents today call “the big hole in the ground” could be there a long, long time if Windstream abandons construction plans.

In December, then-mayor Robert Duffy (now New York’s Lieutenant Governor) took PAETEC founder and CEO Arunas Chesonis at his word that the company’s new headquarters would be built in downtown Rochester — a project that would never have been started without substantial tax credits, loans and grants backed by New York taxpayers.

“More than three years ago, Arunas Chesonis called me on the phone and said if the City and State would demolish Midtown Plaza, he would build the corporate headquarters of PAETEC on that site,” said Mayor Duffy late last year. “Despite the worst economic downturn since the Great Depression and having endless options to locate his company, Arunas Chesonis stayed true to his word. The rebirth of downtown Rochester now has a key cornerstone to build on.”

Now those plans may be gone with the Windstream.

Midtown Plaza was demolished to make room for PAETEC's new downtown Rochester headquarters, a project which may now be up in the air. (Picture courtesy: YNN)

The all-stock deal is expected to close in six months, and Windstream hopes to capitalize on PAETEC’s extensive fiber network and data centers to bolster service to its own business customers.  The increased capacity would also deliver improved service for the company’s residential DSL customers with a more robust Internet backbone.

Windstream, based in Little Rock, Ark., has been transforming itself away from its roots as a residential landline provider into a business and broadband services company, and today’s deal is an extension of that.

The company expects to win at least $100 million in new synergies from the merger, based on reduced capital expenditures required to build out Windstream’s own network, and from reduced costs from being a larger volume player.

But Windstream is also well-known for other cost-savings, through massive job cuts at the firms it acquires.  Last June, hundreds of workers at Iowa Telecom learned that.  After Windstream’s acquisition of D&E Communications in Pennsylvania, nearly 80% of D&E’s employees were shown the door.

For nearly 5,000 PAETEC employees, almost 900 of which live and work in Rochester, updating resumes may have just become job number one.

That’s ironic for a company whose founder wrote his own book: It Isn’t Just Business, It’s Personal: How PAETEC Thrived When All the Big Telecoms Couldn’t.

The first chapter is called “Putting People First,” and explains how the management of PAETEC recognizes the value its employees bring to the company: “Success in business begins and ends with people: the people you hire, the ones you partner with, and the ones you serve as your customers.”

Employees this morning may be wondering if Windstream shares Chesonis’ philosophy.

On this morning’s conference call, Windstream executives spoke about efforts to identify and preserve talented members of PAETEC’s executive management team as part of the newly-expanded company.  They had nothing to say about rank and file employees.

[flv width=”640″ height=”380″]http://www.phillipdampier.com/video/WHAM Rochester PAETEC Deal 8-1-11.mp4[/flv]

WHAM-TV spoke with George Conboy of Brighton Securities about this morning’s merger announcement, and the major implications the deal will have on PAETEC’s home base — Rochester, N.Y.  (5 minutes)

Vincent, one of our regular Stop the Cap! readers sent along a link to a story about the decrepit state of American broadband: it’s a real mess for those who can’t get it, can’t get enough of it, and compare it against what other people abroad are getting.

Cracked delivers the top five reasons why American broadband sucks.  Be sure and read their take (adult language), but we have some thoughts of our own to share:

#5 Some of Us Just Plain Can’t Get It

Large sections of the prairie states, the mountain states, and the desert states can’t get broadband no matter how much they want it.  That’s because they are a hundred miles or more from the nearest cable system and depend on the phone companies — especially AT&T, Frontier, CenturyLink, and Windstream to deliver basic DSL.  AT&T is trying as hard as possible to win the right to abandon rural America altogether with the elimination of their basic service obligation.  Verizon has sold off some of their most rural territories, including the entire states of Hawaii, New Hampshire, Maine, Vermont, and West Virginia.  CenturyLink has absorbed Qwest in the least populated part of America — the mountain and desert west.

Frontier and Windstream are betting their business models on rural DSL, and while some are grateful to have anything resembling broadband, neither company earns spectacular customer ratings.

So long as rural broadband is not an instant profit winner for the phone companies selling it, rural America will remain dependent on dial-up or [shudder] satellite fraudband.

#4 Often There are No Real Options for Service (and No Competition)

Cracked has discovered the wonderfully inaccurate world of broadband mapping, where the map shows you have plentiful broadband all around, but phone calls to the providers on the list bring nothing but gales of laughter.  As if you are getting service at your house.  Ever.  Stop the Cap! hears regularly from the broadband-deprived, some who have had to be more innovative than the local phone company ever was looking for ways to get service.  Some have paid to bury their own phone cable to get DSL the phone company was reluctant to install, others have created super-powered Wi-Fi networks to share a neighbor’s connection.  The rest live with broadband envy, watching for any glimpse of phone trucks running new wires up and down the road.

Competition is a concept foreign to most Americans confronted with one cable company and one phone company charging around the same price for service.  The most aggressive competition comes when a community broadband provider throws a monkey wrench into the duopoly.  Magically, rate hikes are few and fleeting and speeds are suddenly much better.  Hmmm.

#3 Those Who Have Access Still Lag Behind the Rest of the World

We're #35!

This is an unnerving problem, especially when countries like Lithuania are now kicking the United States into the broadband corner.  You wouldn’t believe we’re that bad off listening to providers, who talk about the innovative and robust broadband economy — the one that is independent of their lousy service.  In fact, the biggest impediment to more innovation may be those same providers.  Some have an insatiable appetite for money — money from you, money from content producers, money from taxpayers, more money from you, and by the way there better be a big fat check from Netflix in the mail this week for using our pipes!

Where is the real innovation?  Community providers like Greenlight, Fibrant, and EPB that deliver their respective communities kick-butt broadband — service other providers would like to shut down at all costs.  Not every commercial provider is an innovation vacuum.  Verizon FiOS and Google’s new Gigabit fiber network in Kansas City represent innovation through investment.  Unfortunately Wall Street doesn’t approve.

Still not convinced?  Visit Japan or Korea and then tell us how American broadband resembles NetZero or AOL dial-up in comparison.

#2 Bad Internet = Shi**y Economy

The demagoguery of corporate-financed dollar-a-holler groups like “FreedomWorks” and “Americans for Prosperity” is without bounds.  Whether it was attacking broadband stimulus funding, community broadband endeavors, or Net Neutrality, these provider shills turned broadband expansion into something as worthwhile as a welfare benefit for Cadillac drivers.  Why are we spending precious tax dollars on Internet access so people can steal movies and download porn they asked.  Why are we letting communities solve their own broadband problems building their own networks when it should be commercial providers being the final arbiter of who deserves access and who does not?  Net Neutrality?  Why that’s a socialist government takeover, it surely is.

It’s like watching railroad robber barons finance protest movements against public road construction.  We can’t have free roads paved by the government unfairly competing with monopoly railway companies, can we?  That’s anti-American!

The cost of inadequate broadband in an economy that has jettisoned manufacturing jobs to Mexico and the Far East is greater than we realize.  Will America sacrifice its leadership in the Internet economy to China the same way we did with our textile, electronics, appliances, furniture, and housewares industries?  China, Japan and Korea are building fiber optic broadband networks for their citizens and businesses.  We’re still trying to figure out how to wire West Virginia for 3Mbps DSL.

#1 At This Point, Internet Access is Kind of a Necessity

The United Nations this week declared the Internet to be a basic human right.  Conservatives scoffed at that, ridiculing the declaration for a variety of reasons ranging from disgust over any body that admits Hugo Chavez, to the lack of a similar declaration for gun ownership, and the usual interpretation of broadband as a high tech play-toy.  Some folks probably thought the same way about the telephone and electricity around 1911.

Yes, the Internet can be frivolous, but then so can a phone call.  Cursed by the U.S. Post Office for destroying their first class mail business, by telephone directory publishers, and those bill payment envelope manufacturers, the Internet does have its detractors.  But should we go back to picking out commemorative stamps at the post office?  Your local phone and cable company sure doesn’t think so.  We don’t either.

Phillip Dampier

Time Warner Cable has completed their DOCSIS 3 upgrade of the Rochester/Finger Lakes region and their new Road Runner Extreme and Wideband services should now be available throughout the region.  Stop the Cap! HQ will receive its upgrade to Road Runner Extreme late this afternoon, primarily for the 5Mbps upstream speed, which will make uploading content to our servers much easier and more efficient.

The cable company is insistent on their installation fee, which amounts to nearly $68 (unjustified in my personal opinion).  Some details for our local readers:

• Customers in the Rochester & Finger Lakes region almost never own their own cable modems — they are provided with Road Runner at no extra charge;
• Upgrading to Extreme or Wideband will mean either a modem swap or a second piece of equipment if you have Time Warner phone service.  The new equipment includes a built-in wireless router;
• You are not obligated to use the cable company’s equipment as your primary router if you favor using your own existing router;
• As part of the installation fee, you have a right to insist they spend the time to configure service the way you want it, especially if you want to continue using your own router;
• It is also a good time to ask them to check signal levels and clean up any wiring or service issues.  Western New York has endured a record-breaking deluge of rain this spring, and degraded outdoor wiring can create havoc for broadband and cable service.
• If you are currently receiving a promotion such as free or discounted Road Runner Turbo service, you will lose the value of that promotion when you upgrade service and will pay full price going forward.

Beyond the installation fee, Road Runner Extreme (30/5Mbps) costs $20 more than Road Runner Standard (10/1Mbps) service.  Road Runner Wideband (50/5Mbps) is priced at $99 a month, but is a much better value bundled with the cable company’s Signature Home ($199) package, which includes complete packages of digital cable, “digital phone,” and broadband service.  For most in the Rochester/Finger Lakes area, the only alternative is Frontier Communications’ DSL combined with an unlimited calling plan and satellite television or a similar package from Verizon or much smaller Windstream.  Verizon’s fiber to the home service FiOS is not available anywhere in this region.

Windstream, one of America’s largest independent phone companies, has reported lower profits in the fourth quarter, declining four percent year-over-year to $72.4 million.  Windstream’s core business continues to decline — losing another 36,000 landline customers during the quarter, as Americans continue to drop traditional telephone service.

But Windstream’s ongoing acquisitions, as structured, are helping boost revenues on the company’s balance sheet.  Windstream completed four acquisitions in 2010: the phone companies Iowa Telecom, Nuvox and Q-Comm Corp, and a data center operator, Hosted Solutions.

Although boosted revenue numbers can temporarily improve a company’s share price, investors are unlikely to ignore Windstream’s ongoing decline in profits for much longer.  Windstream officials expect revenue growth for 2011 to remain flat, or potentially edge up by 3 percent. But part of that revenue growth comes from $40 million in broadband stimulus funding the company expects to receive from the Obama Administration during the year.

Windstream's 2009 announced purchase of Iowa Telecom expanded Windstream's reach.

Windstream has made inroads in expanding broadband service in its largely rural service areas.  The company added 12,000 broadband customers during the quarter, mostly for its DSL product.

Windstream’s results show a growing disparity between its residential customers and its business services unit.  While growth on the residential side has been flat to anemic at best, the company is finding better results from its business customers.  The decision to acquire a data center is part of the company’s growing strategy towards those clients.  Windstream plans to spend a considerable amount of its capital during 2011 on improving its data hosting and wireless backhaul product lines to service these customers.

“We’ve made great strides in our business channel, which now represents roughly half of Windstream’s total revenue and importantly, these revenues are growing,” said Brent Whittington, chief operating officer at Windstream.

Windstream’s acquisition plans for 2011 appear cooler than in previous years as it attempts to reduce its leveraged debt.  Most of Windstream’s growth has been attributed to its aggressive mergers and acquisitions strategy.  The company, created in 2006 from Alltel’s landline division and Valor Telecom has grown into a national player, serving nearly 3.4 million customers in 23 states.  Among its larger acquisitions — CT Communications (2007), D&E Communications (2009), and Iowa Telecom (2010).

Despite the lower profits, Windstream’s dividend payout ratio was 57 percent for the year, and the company expects to pay between 52 percent and 59 percent of earnings for 2011.