CapEx, QOS, Rates Possible Sticking Points in Verizon-FairPoint Deal

FairPoint will balloon with the transaction. The company has about 285,000 lines in 18 states. Verizon’s business in each of the 3 New England states exceeds FairPoint’s. Verizon has about 525,000 lines in Me., 600,000 in N.H. and 325,000 in Vt. This situation has some officials asking if FairPoint has the resources to maintain network investment and service quality for the acquired Verizon properties.

Me. PUC Chmn. Kurt Adams said the main legal standard for merger reviews in Me. is “no harm to consumers.” He said the “burden is on Verizon” to show that this transfer meets that standard. With capital investment, service quality and rates big bones of contention in Me. PUC utility merger reviews, “I expect these to figure into this one as well,” he said. Verizon is in talks with the Me. PUC staff on a successor to a price cap regulation plan that expired last July but continues pending adoption of a new program.

Sue Hudson, Vt. Public Service Board clerk, said: “We will review it, and given that Verizon is our largest local exchange carrier we probably will be holding hearings.” There is no statutory timetable for review, but the board will be mindful of the companies’ completion schedule she said. The board must see the filing before deciding how to proceed, she said.

David O'Brien -- top official of the Vt. Dept. of Public Service, the autonomous utility consumer advocacy agency -- said this spinoff “isn’t necessarily a bad thing for consumers. Vermont is a marginal market for Verizon but will be a major revenue source for FairPoint. This could translate into much more attention being paid to this state and its telecom consumers. We're a very small frog in a huge Verizon lake but could be a very large frog in FairPoint’s pond.” He welcomes a company committed to extending broadband to rural areas, he said.

The adequacy of FairPoint capital matters for consumers, O'Brien said: “Can they muster the capital resources they'll need to fulfill their promises? We'll be looking very closely at that.” He expects FairPoint’s broadband investment plans to get close scrutiny given recent state commitments to turn Vt. into an “e-state,” he said. FairPoint has indicated it will assume a Verizon commitment to widen broadband access to 80% of the state by 2010, he said. Verizon made that vow last year in an agreement to renew its price cap regulation plan until 2010. But Vt. also will be scrutinizing FairPoint plans for plain old telephone service, he said: “Maintaining dial tone has been an issue here. POTS needs investment. It’s not a glamorous or high- margin product, but try living without it.”

In a similar vein, N.H. Asst. Consumer Advocate Ken Traum said FairPoint must assure the state it will have the capital to keep investing in costly cutting-edge technologies when it displaces Verizon. A small rural carrier like FairPoint might better serve former Verizon customers, because for FairPoint N.H. would be a large market, whereas the state is marginal for a giant like Verizon, he said.

N.H. PUC telecom staffers said major issues remain between Verizon and the PUC, including service quality, pole maintenance and replacing Verizon’s rate-of-return regulation with a more flexible pricing approach. It’s too early to tell how the sale will affect these, but the hope to have a better idea once Verizon files for approval of the spinoff, they said. N.H. Gov. John Lynch (D) met Wed. with FairPoint on the sale possible effects on employment, economic development, broadband deployment and consumers.

Regulatory staffers in Me. and Vt. said video service isn’t likely to be a merger issue there, since Verizon hasn’t deployed FiOS video and the commissions have no jurisdiction over cable service. Video could be an issue in N.H., though. Verizon deployed fiber to connect 80,000 homes in 23 communities in southern N.H., intending to upgrade those facilities to offer video. But Verizon abandoned its N.H. video plans early last year.

Most analysts framed the deal as a Verizon debt-dump, with FairPoint looking to pick up an appetizing customer base. The move helps Verizon management “transform… the carrier into a large cap growth company” said UBS analyst John Hodulik in a brief on the transaction. He predicted deteriorating “fundamentals” -- growth, earnings, etc. -- in markets where Verizon has no fiber plans, while increased competition from Time Warner Cable and Comcast should accelerate wireline line loss and stagnate ARPU for Verizon in the New England region. Meanwhile, Moody’s placed Verizon New England’s credit rating on review after the company shed $2 billion-plus debt, while affirming FairPoint’s B1 rating with a “stable outlook.”

The divestiture lets Verizon “focus on operations in other markets” where fiber is installed or planned, said a spokesman for the carrier. And FairPoint’s expertise in small urban and rural markets poises the company to make use of the customer rolls there, he said.

Calling the deal a “win-win,” Wintergreen Research analyst Sue Eustis said it’s about more than unloading debt from Verizon. “These things are always complex because you can’t just drop debt.” Verizon didn’t like the math on fiber investment in those sparse areas and didn’t foresee using an alternate technology, she said, while FairPoint “will most likely go with WiMAX for the region. The customer roll better serves FairPoint for that reason, she said.