Wireline Telcos Under Stress; Some Seen Struggling to Survive, Others Coping but Challenged

"The battle has basically been fought and lost by the telcos," said Mark Stodden, senior vice president at Moody's, which gives four ILECs "speculative grade" credit ratings. While cable pushed broadband to counter satellite TV, the telcos for years "harvested copper voice" revenue, paid "very generous" dividends and underinvested in broadband, he said, partially blaming the 1996 Telecom's Act's ILEC wholesale "unbundling" discount duties. CenturyLink and Frontier Communications bulked up on legacy businesses and "milked them," said Chris Antlitz, Technology Business Research analyst: "These guys are in dinosaur businesses that are going extinct."

Wall Street punished wireline telco shares over the past year as the broader market (S&P 500) gained about 19 percent, through Monday's close. Frontier's shares dropped 81 percent, Windstream's 77 percent; CenturyLink's 34 percent and Consolidated Communications' 19 percent. "Those are some dark storm clouds," said Blair Levin, Brookings Institution nonresident fellow. The two largest ILECs did better -- Verizon gained 1.7 percent and AT&T lost only 4 percent -- but they are also the largest wireless carriers. Meanwhile, Charter Communications jumped 33 percent and Comcast rose 12 percent. (Stocks, charts here.)

"The market has chosen cable infrastructure over ILEC infrastructure ... particularly for anything that’s not Fios or U-verse,” said analyst Tom Seitz of Washington Analysis. “In the not-too-distant future, 5G is supposed to be competitive with fixed infrastructure, so the environment looks like it’s going to get tougher for everybody that’s not Verizon and AT&T, and it’s no picnic for them, either.” All telecom and content providers are being undermined by "intermediary online platforms ... commoditizing and devaluing what traditional players own," said Scott Cleland, chairman of ISP-backed NetCompetition. Facebook, Google and Amazon "are just killing" carriers, "like parasites sucking the life out of them," Antlitz said.

The FCC's broadband, deregulatory agenda is seen as helpful, though no panacea. “These companies have a very supportive regulator who is hyperfocused on strengthening rural broadband,” said Paul Gallant, Cowen analyst. “It’s not a magic bullet.” The FCC gave price-cap ILECs much business data service relief, and CenturyLink, Frontier and Windstream were major recipients of Connect America Fund broadband support. Key policymakers also want broadband included in any infrastructure bill. "I hope there is one, but I don't see how you can be optimistic," Levin said. Consolidated's top regulatory priority is reduced reporting requirements, CEO Bob Udell said.

Frontier hopes a planned FCC rollback of Communications Act Title II net neutrality regulation gives broadband providers more freedom to explore new market arrangements, and believes internet edge companies should do more to fund networks (see 1708220051). Gallant said that “at the margins, greater telco ability to collect new interconnection fees will help.”

Carrier Strategies

Consolidated is more a broadband fiber provider than a telco due to "methodical" deployments and acquisitions, including of FairPoint Communications, said CEO Udell, noting an increasing business and cloud focus. About 40 percent of the company's network is hybrid fiber-coaxial cable and 50 percent is hybrid fiber-copper, he said: "We’re a bit flabbergasted by the market’s reaction of putting us in the [ILEC] bucket."

Windstream, which has CLEC assets, believes its operational strategy and results "differentiate us from many of our wireline telecom peers," it emailed. "Our advanced network and robust technology solutions position Windstream to grow market share and improve revenue trends." It said a recent network upgrade is delivering "faster broadband speeds to more customers, improving our competitive position against cable." Frontier said it believes strongly "in the quality of our assets, including the extensive fiber" acquired in 2016 from Verizon in California, Florida and Texas. CenturyLink didn't comment.

Wireline telcos have "extremely valuable networks that provide a critical infrastructure in rural areas. ... They're much more robust than people give them credit for," said Frank Louthan, Raymond James analyst. He said carriers need to market services better and increase business revenue. Telcos are shifting from a residential-voice focus to a data-centric, business-oriented platform, said Mike Balhoff, Charlesmead Advisors investment banker. CenturyLink and Consolidated have adapted the best, developing growth opportunities and "defensible" business plans, he said, citing CenturyLink's pending buy of Level 3 as illustrating the shift and Consolidated as "firing on all cylinders."

Stodden noted "pockets" of high-speed wireline residential service, and said CenturyLink and Consolidated "invested more." But the telcos “haven’t figured out the cost structure,” and cable has a clearer path to 1 Gbps, he said: "It doesn't get any better from here." Telcos will be competitive where they have fiber-to-the-home, said Nick Del Deo, MoffettNathanson analyst. Where they have fiber-to-the-node, they'll be "somewhat" competitive; and where they rely on copper, "they're going to get blown out of the water," he said. It's expensive and burdensome to deploy fiber, Antlitz said: telcos "are trying to do this, but their debt load is choking them."

“These companies actually have a solid outlook on their enterprise business," said Gallant. The long-term question "is how do they integrate wireless," he said: "If Comcast and Charter’s organic wireless service ends up working," that could "be a path forward for these telcos.” Others were skeptical of a wireless play. "They don't seem very interested or creative about it," Levin said. Wireless "is fundamentally a duopoly," Balhoff said. "It’s going to be difficult for anybody to compete with AT&T and Verizon.” Wireline telcos can still tap wireless growth. "Somebody has to backhaul traffic to the cell tower," Louthan said. Consolidated is looking to connect macro and small cells to fiber, Udell said.

CenturyLink's Level 3 buy will increase its enterprise exposure, Stodden said: "That's an area where they can carve out defensible market share." Before the deal, "CenturyLink's trajectory was just abysmal. They were going from bad to worse," Del Deo said. "Synergies" with Level 3 will help stabilize the business, but debt leverage remains very high, he said. "A lot of people say their dividend is going to be safe. I'd say it's going to be safer."

Frontier is "much more exposed" to the residential erosion, Del Deo said. Stodden said Frontier's buy of Verizon's assets made "strategic sense" but was flawed in execution. "They didn’t have all the bugs ironed out, and they still don’t,” allowing competitors “to vacuum up disgruntled customers,” he said. Balhoff said video was Frontier's biggest integration challenge, and "they are beginning to stabilize those operations." In recent months, "Frontier has hired talented and deeply experienced leaders who are sharply focused on improving our financial performance and customer metrics,” said Executive Vice President Mark Nielsen in a statement. “We have learned some hard lessons from the 2016 integration, lessons that strengthen the company and make us a long-term player.”

Credit Concerns

"The bond market is signaling that Frontier is going to default, and yet they still pay a dividend," said Stodden: "The market is not always right, but it exerts pressure." The Moody's long-term credit rating for Frontier is B2 (five notches below investment grade) with a negative outlook; for Windstream, B1 (four notches below investment grade), negative; for Consolidated B1, stable; and for CenturyLink, Ba2 (two notches below investment grade), rating on review for downgrade pending acquisition. Antlitz said wireline debt loads are raising concerns and Windstream "is going to be one of the earlier ones" to reorganize. "Our cash flow is strong," Windstream said. "We have no debt maturities until 2020 and will continue to be opportunistic to reduce debt and further improve the balance sheet."

The path to sustainability is "consistent investment in broadband," which is replacing pay TV as the "lead product," Stodden said. He said telcos also need to cut costs: "These are very old, bureaucratic entities. There are a lot of opportunities to streamline."

Further mergers and acquisitions are expected. “I think we’ll see more," with CenturyLink and Consolidated best positioned, Louthan said. "We feel pretty good about our acquisitive capability," Udell said. Expect to see a "constant series of scale-related purchases, notably among the larger players," Balhoff said. Levin said "scale is important, but I think most bankers would say if you have a troubled company with troubled economics buying a [similar] company, it wouldn't exactly solve anything." Several doubted wireline telcos are acquisition targets for others. "Nobody wants to buy into those problems," Antlitz said.