TCS Daily


Multi-Billion Dollar Fib

By James K. Glassman - March 11, 2003 12:00 AM

Immediately after last month's dramatic vote at the FCC on telecom competition, a phrase began circulating - as though it were on a sheet of talking points issued to journalists, public officials and local phone company executives.

Michael Powell, the Federal Communications Commission chairman, who was defeated by a new majority on Feb. 20, put it this way, "The major RBOCs [that is, the regional Bell operating companies] lost over $15 billion in market cap."

In almost exactly the same words, these sentiments were echoed by Alan Murray of the Wall Street Journal; Rep. Billy Tauzin (R-La), the Bells' staunchest defender on Capitol Hill; Sen. Sam Brownback (R-Kan); Jim Cramer, the vigorously pro-Bell financial commentator on CNBC; Ivan Seidenberg, CEO of Verizon, one of the four Bells; and many others.

The statements about market cap were outrageously - and, in many cases, intentionally - misleading. Their aim, it appears, was to make Americans believe that a stupid public-policy decision had "stolen" a huge amount of value from an important industry, seriously damaging the economy. That's nonsense

A company's market capitalization is theoretically the amount that investors will pay for all of its stock. To calculate market cap, you simply multiply the number of shares of stock outstanding by the market price.

For example, on Feb. 19, the day before the FCC decision, the price of a share of Verizon, the largest Bell company, closed on the New York Stock Exchange at $36.60. There were 2,736,000,000 shares outstanding, so the market cap was $100 billion. The next day, the stock dropped sharply, closing at $34.76; thus, the market cap on Feb. 20 was $95 billion, a loss of $5 billion, or 5 percent, in one day.

I performed the same math with the other three Bells and found that the losses were $6 billion for SBC Communications, $3 billion for BellSouth and $1 billion for Qwest. Total loss: about $15 billion out of a market cap which, on Feb. 19, totaled $224 billion.

Yes, the Bells lost market cap - though not a great deal by the standards of volatile equities these days. The real question is why is the stock price of a telecom company should be of any interest to regulators and congressmen at all? This isn't Japan. Public officials are not supposed to be engaged in industrial-policy adventures.

Instead, in the case of local telephony, their objective should be to enforce the law passed by Congress in 1996 and bring competition to a century-old monopoly. That mission was accomplished in long distance; now it's time to open up local service. In the process, some companies will thrive, others will suffer, some will die. The winners and losers should be of no concern to politicians - or journalists, for that matter.

In addition, the market cap of four (or even 400) individual companies is not the same as the economic health of the nation. The main reason that the Bells' stock value fell is that the FCC decided not to wipe out their rivals in local telephony. That, in turn, means that competition will continue to thrive and the cost of local service will continue to decline for consumers and small businesses, giving them extra cash to spend elsewhere at a critical time.

In other words, what's bad for the Bells may be good for the U.S. economy.

Also, what is this market-cap fetish? Stock prices in the short term are set by investors, who are notoriously fickle and skittish. Financial experts tend not to read too much into stock movements over a day - or even a year.

More important than the Bells' market caps are their assets, profits and dividends. Those are real. The assets - the things of hard value that the companies own - didn't drop at all on Feb. 20. And, in its most recent analysis, the respected Value Line Investment Survey projects net profits this year for the four Bells at $17.9 billion. SBC continues to raise its dividend each year, as it has since it was created, and its return on equity last year was a hefty 21 percent. In a struggling economy, the two largest Bells alone generated an incredible $39 billion in cash flow on $120 billion in revenues. They aren't hurting.

Exactly what happened on Feb. 20? The FCC voted to continue to allow states to set the rates at which the Bells rent the "unbundled elements" of their local networks to competitors, as the 1996 Telecommunications Act, which established a blueprint for deregulation, requires.

The Bells were very unhappy with that "UNE-P" decision, as it is called. They had hoped that a plan offered by Chairman Powell would prevail. It would have restricted the rate-setting power of the states and almost certainly would have severely damaged, or in some cases killed off, the Bells' local competitors, which have already taken away 10 million local customers and have forced down rates, thanks to UNE-P.

But the Bells benefited from the second half of the decision - which allowed them to deny competitors access to new investments in new technology that provides fast broadband connections to the Internet.

(By the way, the total market cap of the three largest competitors to the Bells - AT&T, WorldCom and Sprint - is just $25 billion, or about one-eighth the market cap of the Bells. Still, the Bells have been trying to get politicians to use weapons of mass destruction against such rivals for years.)

In addition, a gigantic part of the market-cap story, as the Bells and their allies tell it, is missing.

Yes, the Bells' market cap declined on Feb. 20, but what Powell, Tauzin and Seidenberg don't tell you is that the Bells' market cap rose even more on Jan. 6.

On that date, the market cap of Verizon jumped $6 billion; SBC was up $12 billion; BellSouth, $4 billion; and Qwest, $1 billion. The total increase was $23 billion - a gain that was more than 50 percent larger than the loss on Feb. 20.

Why did the Bells' market cap soar that day? Simple. An article appeared in the morning's Wall Street Journal that began:

"Federal regulators are preparing to stop making local phone companies rent their networks to rivals at cheap rates, a move that could reduce competition and price-cutting in the local phone market. The expected change by the Federal Communications Commission would be a huge win for the four regional Bell companies, which are trying to continue their domination of the profitable local market."

So, here's the real story about the Bells' market cap. In early January, a story comes out saying that the FCC will change the rules, squash competition and let them "continue their domination" of local service. Market caps rise $23 billion. Then, it turns out the story was premature. On Feb. 20, the FCC, in a surprise, rejects the changes. Market caps fall $15 billion.

The interesting question is not why market caps fell but why they didn't fall more. The answer may be that the Bells were successful on the broadband part of the decision.

In fact, the broadband decision - which is the regulatory equivalent of the Tauzin-Dingell legislation, sponsored by Tauzin and his Democratic counterpart, Rep. John Dingell (D-Mich.), that the Bells have pursued for years but that has been bottled up in the Senate - should have been an even bigger victory for the incumbents in financial terms.

Before the vote, Verizon said that the action would "remove regulatory obstacles that substantially hinder investment in broadband technologies." In other words, if the Bells didn't have to share their new technology with competitors (even at a price), they would eagerly start investing in such technology, boosting the economy and helping both high-tech firms and the Bells themselves.

After the Feb. 20 decision, Network World, a trade publication, quoted John Cordova, an analyst with the research firm Infonetics, as saying that the Bells "could begin investing in more equipment, such as broadband-enabled digital loop carriers, ATM switches, routers and softswitches, as a result of the FCC decision." The Bells "can now feel safe making some network upgrades."

But that's not the way the Bells saw it. Immediately after the ruling, they started bellyaching. They said that, since they lost the UNE-P vote, they wouldn't make serious broadband investments.

"I have read in recent days...that certain Bell [CEOs] have announced that they will not invest in advanced networks because they did not receive all the relief they were seeking," said Rep. Dingell after the decision. "I hope this is not true."

Ah, but it is true. Teri Rucker reported in National Journal's Technology Daily on Feb. 24 that the "Bell telecommunications companies warned that the decision would not spur much investment on their part."

Jonathan Krim wrote in the Washington Post the next day that "two of the four former Bell companies, SBC Communications and BellSouth Corp... renewed promises made after the vote that they would not invest in new, high-speed Internet networks" unless the FCC changes its mind on UNE-P, which the Bells had viewed before as a completely separate issue (as it is).

Krim continued, "The companies' posture angered several government and industry executives, who accused the phone companies of the political equivalent of holding their breath to get more candy after getting what they originally asked for."

Krim also pointed out that it was Verizon senior vice president Tom Tauke who came up with the phrase "old wires, old rules...new wires, new rules" to describe the policy the Bells sought. That's exactly what the FCC gave them on Feb. 20. Instead, Tauke's boss, Seidenberg, was called "the most vocal opponent of the FCC decision" at the recent Merrill Lynch Global Telecom Conference.

"Now there's no excuse on the regulatory side" for the Bells not to invest, said Rhett Dawson, president of the Information Technology Industry Council, quoted in the Post. "If they choose not to make the investment, that's another matter."

So here are two more reasons the stocks of the Bells reacted poorly to the Feb. 20 decision: first, the Bells and their allies badmouthed it to excess, mainly for strategic political reasons, and, second, investors and analysts were disappointed that the Bells said they would not be making substantial - and, the market was hoping, ultimately profitable - broadband investments.

But investors should not have been surprised. It's a tried-and-true principle of economics that companies make investments - not when they enjoy a protected monopoly or near-monopoly position, as some on the FCC and in Congress seem to think - but when they are being hard-pressed by competitors.

Congress bought the line: Kill off our competitors, and we will be happy to invest. But that approach makes no sense at all economically. Why invest if you have little or no competition?

The Bells' strategy, almost certainly, is to improve their broadband networks only enough to be able to exclude competitors from connecting to them. This is a sensible course. Monopolists always act to limit supply in a market with sustained demand. That way, they can raise prices with impunity - and without making costly investments.

Some of us have been warning for years that, far from unleashing new investment, Tauzin-Dingell would constrain it. That's precisely what the FCC broadband decision will do.

"The only thing that's going to get the Bells to spend is if we see cable companies launch more voice-over-IP services that begin to take away customers from the RBOCs," said Pat Hurley, an analyst with the consulting firm TeleChoice, quoted in Network World.

Forget the technicalities of VOIP. Hurley is speaking the obvious. Businesses invest when they feel the hot breath of their competitors on their necks.

"Bells' Victory Bigger Than They're Letting On," said the headline on a Feb. 28 column by Glenn Bischoff, a telecom expert. Bischoff reflected the views of most of the trade press, which saw the decision as, at worst, neutral for the Bells. "The FCC," Bischoff wrote, "did for the Bells what the Senate failed to do, which is give them virtually all the broadband relief they sought from Tauzin-Dingell."

Still, the Bells whine. No wonder investors are dismayed. Who wants to commit money to a bunch of companies that would rather continue to play political games than get down to real business? For such firms, declining market cap may become a richly deserved way of life.
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