Posted: 10/1999

Bell InterLATA Approval To Catapult Competition
Forward
By Kim Sunderland

Bell company interLATA (local access and transport area) service approval will be the
booster rocket that gets competition off the ground and into orbit, a remarkable event
that will change forever the current telecommunications landscape. And once the regulatory
restrictions are lifted and the playing field begins to level, how the interexchange
carriers (IXCs) and the Bell operating companies (BOCs) function may become one and the
same.

When a Bell does get in-region long distance approval, it won’t matter "whether a
company provides long distance or local service. That will become irrelevant," says
analyst Robert Rosenberg, president of Insight Research Corp., Parsippany, N.J.
"What’s inevitable is that we will have telecommunications carriers that provide
whatever services you need in a bundle. And a bundle can be anything."

What this means generally for all competitors is that the communications services
landscape will continue to morph, says Wayne D. Gantt, president of the Ansley Group,
Atlanta.

"The major reasons have more to do with competitive markets and technological
innovations than with regulatory approval," Gantt says. "There is a revolution
under way. Both vertical and horizontal integration accelerates. Cable joins with local
phone service. ISPs (Internet service providers) marry up with RBOCs. Long distance and
local become one. The most well-managed, well-capitalized communication services companies
prosper. Global consolidation comes to the U.S. markets. This is good news for all
consumers of these services, both from the simple to the complex."

A wave of consolidation also can be expected to continue as providers work to get all
the capabilities and services under one roof. But the development of competition in local
markets, with carriers that can bundle all services, is going to take a lot more time than
anyone thought, according to Rosemary McMahill, manager of regulatory services for Cathey,
Hutton & Associates Inc., Austin, Texas.

"I don’t think the landscape will change much–you will still have the large Bell
companies dominating the telecom landscape, along with MCI WorldCom [Inc.], AT&T
[Corp.], Sprint [Corp.], GTE [Corp.] and probably Qwest [Communications International
Inc.]," she says. "The little companies may get eaten up, or there could be
enough market share to go around that they stay around just like they are now."

"I expect more mergers to take place, but perhaps they will have global rather
than domestic impact–like Daimler-Chrysler in the automotive world," says Ernest B.
Kelly III, president of the Telecommunications Resellers Association (TRA).
"Mid-sized carriers with network/facilities operations are the ones who will get
squeezed the most to get big or get out. And look for wireless properties and cable
properties to continue to be hot, as well as ISPs buying or being bought by telecom
companies."

Where It’s At

Bell Atlantic-New York (BANY) is the BOC closest to receiving federal approval to
provide interLATA service. With the support of New York regulators, and successful
third-party operations support system (OSS) testing completed, Bell Atlantic is quite sure
the Federal Communications Commission (FCC) will approve its Section 271 application
before the year ends, says Tom Tauke, New York-based Bell Atlantic Corp.’s senior vice
president of government relations. And "within a year of the New York application
being approved by the FCC," Tauke says, "it is possible we then will file an
application for Pennsylvania and Massachusetts, followed by New Jersey, and then Virginia
and Maryland would be the next group." This chain of events is slated to begin in
early 2000, he adds.

Hot on BANY’s trail is SBC Communications Inc., San Antonio, which seeks FCC interLATA
approval in Texas. State regulators are ready to approve SBC, although sources say the
application probably won’t pass muster at the FCC, which considers the Texas process much
less strict than that in New York.

Recently passed legislation in Texas (Senate Bill 560) has caused concern among
competitors, which say it gives SBC pricing flexibility, putting the Bell in a position to
predatorily price. Competitors say that the new law must be preempted before they will
endorse SBC’s in-region long distance filing. Meanwhile, SBC also is gaining ground in
California, and may seek interLATA approval in Illinois when its merger with Hoffman
Estates, Ill.-based Ameritech Corp. is completed.

"We are very close to a tremendous change in the paradigm of telecommunications as
the RBOCs [regional BOCs] get into long distance," says consultant Jeffrey Binder,
president of Jeffrey Binder & Co., Brookline, Mass. "What we will end up with are
huge players that can deal with customers in a more complete way." Prognosticating,
Binder also believes a Bell’s interLATA entry is "the harbinger of things to
come" as the industry’s movement accelerates toward having four or five
"supercarriers" that offer any or all services any customer wants.

Short-Term Outcome

When the FCC determines that a Bell has met the 14-point competitive checklist of
Section 271 of the Telecommunications Act of 1996 and grants in-region long distance
approval to that company, there will be several immediate effects. Most notable are lower
prices to residential and business consumers and increased local competition as the long
distance carriers and Bells target one another’s markets.

Right now, prices are declining as the phone wars heat up in the consumer market, TRA’s
Kelly says. "I would not attribute it directly to the Baby Bells, I would attribute
it more to intensive competition between the existing long distance players," he
says. "In particular, the newer network providers–like Level 3, [Communications
Inc.] Qwest and, eventually, Williams [Communications Group]–are exerting downward
pressure on prices."

Kelly also says the Big Three long distance carriers "are really slugging it out
right now," maybe in an effort "to solidify market share before the advent of
the BOCs in long distance." He notes that long distance prices have come down
continuously on a per-minute basis since passage of the Telecom Act, forcing the BOCs on
the sidelines to watch price wars that have knocked off two-thirds of potential margins.

Eventually, Bell Atlantic’s Tauke says the whole pricing structure "will change
dramatically or even collapse." While pricing once was based on regulations, the
future telecom industry will have no use for LATAs, local exchanges, toll charges, etc.
Pricing of wireline services may go the way of wireless services, he says.

"There will be more competition at the local level," Tauke says, "as
lots more services are offered from different carriers," further crunching down
prices and increasing the pressure on carriers to offer bundled service packages.

But competition won’t be limited to price, according to Daniel Ernst, a telecom analyst
with Ferris Baker Watts, Baltimore, "because everyone is going to push their ability
to leverage data. Local is definitely part of the mix–it’s no surprise why AT&T has
bought TCG (Teleport Communications Group–business), TCI (TeleCommunications
Inc.–residential), etc. And why Sprint and MCI WorldCom have bought broadband wireless
spectrum. Everyone is looking for end-to-end capability," Ernst says.

And this is where the prospect of more mergers and acquisitions comes in.

Down the Road

Michael J. Morrissey, AT&T vice president of law and government affairs, admits
that total AT&T revenues from the residential market are projected to drop this year
to 35 percent from 50 percent. "While the consumer market is a cash cow now," he
says, "it’s not a growth vehicle."

That’s why down the road, AT&T and others will continue searching for sustainable
revenue, which is part of AT&T’s theory behind its $120 billion investment in cable
companies. Many analysts, in fact, think the telecom industry’s transition will transform
today’s players from the phone companies of yesterday to the bandwidth companies of
tomorrow.

"The Bells being on the verge of long distance approval is part of the mix,"
says Jeffrey Kagan, an Atlanta-based telecom industry analyst, "but deregulation and
new technology are the main drivers in heating up the phone wars right now. Customers are
demanding more than ever."

More consumer demand will force the trends in growth markets–data, Internet, broadband
and wireless–to continue as the focus of industry players, says economist Bruce L. Egan,
senior research fellow at the Columbia Institute for TeleInformation at Columbia
University in New York.

"Voice is passe and even the ‘dinosaurs’ of the industry are in general agreement
that it will not guide their future, but will simply be part of it–albeit a small
part," Egan notes. He predicts that broadband subscriber Internet access is the focus
of the future.

"Voice long distance is not nearly the carrot it used to be, so the ILECs
(incumbent local exchange carriers) will continue to fight the stick of cost-based
interconnection and unbundling and not cooperate for the carrot of voice long distance
market entry," Egan adds. "Of course [the Bells] want long distance entry, but
at what cost to their total future business?"

To handle the future of competition, today’s players will get larger. They’ll remain
focused on corporate deals "to consolidate and control end-to-end operations and
leasing those parts, which one cannot both own and control," Egan suggests. Such
corporate deals surely will include the smaller and mid-sized competitors.

"The impact will not be immediate or dramatic as a result, but once the long
distance restriction is entirely gone, a whole spectrum of mergers becomes both feasible
and highly economic," Ernst says.

Competitors, though, also might lay bets that maybe the bigger players won’t try to eat
them; the larger carriers may leave them alone to handle the consumer market. Most
mergers, says Insight’s Rosenberg, are driven by two base assumptions: the primacy of the
consumer market, and that the only way to reach the $128 billion consumer market is with
access to copper loops. This poses questions for the larger players such as: Can I be a
valuable player without being in the residential market? Can I be highly profitable
without servicing it?

"I think the big telcos can," Rosenberg speculates, "so consumers may
not be the future path a company takes, whereas serving businesses is."

"Once the Bells get into long distance, which will happen incrementally,
state-by-in-region-state, I can see more mergers and acquisitions," McMahill agrees.
"But I would point out that there is nothing that prohibits them from providing
out-of-region long distance–and what effect has that really had on things?"

She also believes the Bells won’t continue waiting for state-by-state interLATA
approval. "I would think they would go to Congress to get the whole thing in one
shot," McMahill says, "which is a lot more practical and certainly a more
cost-efficient approach."

Another long-term effect, industry observers note, is that the first Bell interLATA
approval will make it easier for others to be approved because there will be a model, a
blueprint that sets the standard. "This will put an end to frivolous 271
applications," one source says.

Enforcement Challenge

"Once a Bell is approved for interLATA authority, the legal and regulatory focus
will shift from a carrot-andstick approach of monopoly behavior modification to just using
the stick," says Robert M. McDowell, vice president and assistant general counsel for
the Competitive Telecommunications Association (CompTel). "That is, the competitive
community’s only tool available to ensure that the Bells are living up to their Section
251 obligations will be enforcement actions."

The issues of backsliding and performance measures are huge for competitors and the FCC
is considering placing such requirements on interLATA-approved Bells. "I expect that
the easy part is approval," AT&T’s Morrissey says. "The tough part is
enforcement once [the Bells] are in" the long distance market. New York regulators
currently have such backsliding and performance provisions in their agreement with BANY
that includes stiff monetary penalties. "We’ll want to know how a Bell is standing up
in terms of what it’s supposed to provide to us," Morrissey says, "and we’ll
want to know if the Bell can continue to provide the systems it’s supposed to."

The telecom landscape, therefore, surely is set to change more rapidly, from pricing to
mergers to innovation–a lot of it hinging on less regulation, sources say. Summing it all
up, Binder says that interLATA is the great geological fault that has defined
telecommunications for decades. "And once it starts moving," he says, "it’s
going to be very fast and the changes will come."