Cluster Strategies Creating New Opportunities

Background:
Regional strategies for scope and scale economies – and market position – are beginning to take place in the telecom arena.

Analysis:
The nuclear winter for telecom is beginning to thaw with regional strategies and actions reflecting cost-effective thinking. For example, the newly announced NuVox/NewSouth merger should add economies of scale as well as scope for the CLECs. The transaction expands the territory of each firm, with more deep-south coverage for NewSouth and a broader spread across the Midwest for NuVox. With NewSouth’s strong process focus and solid customer base, as well as NuVox’s breadth of network, the two are better positioned for potential investors as both companies target small- to mid-sized companies (ideally those with T1 or better data needs). Further, this CLEC merger is an important step toward building strong local service alternatives for businesses.

While the southern CLECS are building on each other, ILECs in the north are subtracting, or investigating other alternatives. Verizon announced last week that it wants to sell off lines in Hawaii and in New York State outside of the New York metropolitan area. We can assume that the company wants to move its balance sheet toward less debt and more cash in the short run in order to finance development in the growing wireless and data services arenas.

The Hawaii lines come from the old GTE services in the islands and are clearly an outlier geographically for the company. The New York move is for consolidation as rural telephony service areas are relatively expensive to maintain and generally are not seen as worthy of investment when compared to metropolitan service areas. The 2.5 million New York State lines Verizon is selling are expected to fetch $6.5 billion. Although Citizens, one of the country’s largest rural telephony providers with 550 thousand lines in upper New York State, may have been a potential buyer of some of the lines, the company announced in December of 2003 that it was “considering financial and strategic options,” and recently engaged Morgan Stanley for assistance. CenturyTel, another steady-revenue rural provider may be a potential purchaser for at least parts of Citizens’ networks, and may be a buyer of some of Verizon’s assets as well.

SBC also has announced a rural line sale in Michigan and Texas, offering approximately 650,000 lines that are expected to fetch $1.5 billion. These funds will contribute to the company’s wireless purchase (AT&T Wireless by Cingular -- as SBC owns half of Cingular, it will owe in excess of $20 billion for the deal). Since this rural line sale will put a small dent in its share of the wireless deal, we can expect additional repositioning activities.

BellSouth is expected to borrow $10.5 billion for the AT&T Wireless purchase. We further expect that they will put some of the steady income producing local lines on the block to invest in areas of higher revenue growth.

The Bottom Line:
Cluster-based strategies can deliver significant operational and marketing efficiencies. They also create opportunities for competitive providers as asset acquisitions and divestitures by large players create both entry and exit opportunities for firms positioned to take advantage of such moves. ATLANTIC-ACM believes the networked telecom arena will mirror – from a conceptual perspective – the cluster-oriented shifts in service areas that defined much of the cable television sector’s activities exhibited in the 1990s. This marketplace dynamic will provide crafty business development teams both entry and exit strategies as they position themselves around the operational consolidation and divestment of industry giants.

We can hope for the sake of rural consumers that companies able to offer strong services with a sustainable business model will pick up their territories, avoiding the two-tiered service structure the Universal Service Fund has fought for decades.