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Special Report: Why AT&T Isn’t Really in a “Death Spiral”

Dave Burstein’s entire article (original) is repro’d here for readability.

It turns out that AT&T (and almost all wireless companies) have powerful incentive to keep wireline alive because the wired backhaul is crucial to wireless success. Although Randall Stephenson’s first speech as AT&T CEO was “We are a wireless company,” they are backtracking on letting the wired side die. Suddenly this quarter, AT&T and Verizon are massively promoting DSL. Wireless companies, they decided, need the copper to provide more bandwidth to wireless. DSL can thrive in a wireless world.

That’s a crucial transformation that will preserve DSL/fiber’s role long into the future. It’s the path to “Thriving DSL in a Wireless World.” Wireless spectrum has important constraints and a crucial part of the solution is moving as much as possible over the existing wires. 40-50% of mobile calls are from home or office and can be carried via a femto or WiFi gateway. That’s the design of the AT&T, Verizon, and most European networks in the next few years, wildly accepted in the industry.

The three parts

AT&T has a sensible filing that they should replace their big old switches with VOIP/softswitches, otherwise known as “turning off the PSTN.” I reported that back in 2003 from their CTO Ross Ireland (“it will take about ten years” because they were cutting capex) and BellSouth’s CTO Bill Smith (who wanted to do it in five.) In effect, that’s the architecture inside FiOS and U-Verse. No big news here, just common wisdom in the industry. Verizon’s Paul Lacouture and Mark Wegleitner also planned this 2002.

AT&T has gone much further in their filing, talking about a “death spiral” and using that to demand:

• major money ($billions) in increased universal service funding
• knocking the remaining unbundled competitors off the network
• eliminating any service quality requirements
• and, most extreme, eliminating the fundamental requirement to serve everyone, which is absolutely required as part of public policy.

To justify such an extreme step, they make some extraordinary claims about their wireline network “death spiral” and the impossible costs they would face maintaining service. No government can accept ending universal service unless the company’s financial situation is dire.

Unfortunately for the credibility of AT&T policy people, their CEO and CFO, as well as all their financial filings, suggest they are doing just fine.

My best guess (and Craig Moffett’s analysis) is that AT&T is being somewhat optimistic on Wall Street (but not fraudulent). The FCC filing comes out of the rear end of a male cow. I welcome more facts.

AT&T’s Death Spiral (?satire)

AT&T is telling the FCC they face a “death spiral” on the wired side. The solution they suggest: change USF to give them $billions in subsidy. “To achieve the “universal broadband” – a good thing – AT&T is asking for “explicit support” (Page 19) for their lines. Nearly none of the AT&T lines currently get USF, so this would be a substantial additional subsidy to AT&T.

The FCC has long argued that the Bells generally don’t need a USF subsidy, which makes sense to me. As things stand, they are among the most profitable companies in the world. If that’s really about to change unless they get “explicit support”, they need to amend their financial filings.

AT&T also wants to kill any state or federal laws allowing competitors access and want the feds to eliminate any state “service quality requirements.” Above all, they cannot accept the obligation to provide service to all, generally considered a crucial policy goal. (USF funding is about “universal service” in name only. Far too much is just a government giveaway like tobacco subsidies, unrelated to real needs.) To make the argument, T tries to separate their “POTS” business from DSL, but that’s disingenuous. They run over and support the same physical network. Switching, fiber, and even billing systems are already in place and today contribute relatively little to the cost. T runs wireline as one network and the costs are shared.

If AT&T is telling the truth in D.C. about how desperate their finances are on wireline, CFO Rich Lindner apparently committed securities fraud in the last quarterly investor call. Half of T’s revenue remains wireline; problems there imply severe problems for the company finances. If that’s so, the December dividend increase was wildly inappropriate and the dividend should be heavily cut or perhaps eliminated. S & P would almost certainly need to drop the company’s credit rating. Their last investor presentation would be “wildly misleading.” (Suggestion: ask yourself whether it’s more likely that AT&T’s CFO and financial filings are fraudulent or that they are stretching the truth at the FCC?)

AT&T reported for the last quarter

• ” $13.9 billion free cash year to date versus $ 7.9 billion over first three quarters of 2008″
• “Directional 32.1% year-over-year growth in Improvement in Wireline Consumer Trends”
• “Stable Consolidated Margins [with] Wireline operating expenses down 2.8%”
• “Continuing cost-improvement opportunities, including areas such as organizational and systems integration, order and billing center consolidation”
• Free cash flow of $13 9 for the first three quarters and dividends paid of $7.3B
• “Stable margins  – cost discipline across operations, wireline operating expenses down”

Three quarter capital expenditures totaled $11.6 billion versus $14.8 billion
Wireline revenues per household served increased 2.5 percent versus the year-earlier third quarter and were up 1.3 percent sequentially. This marked AT&T’s seventh consecutive quarter with year-over-year growth in wireline consumer revenues per household.

As Craig Moffett points out in “End of the Line(s)” wireline is definitely hurting. But with $20B in cash flow annually, T is far from requiring a handout or a massive change in the regulations to favor them. Nor do they need this to cover the cost of extending broadband to the “unserved” beyond some fantasy figures. The September broadband plan estimate to bring ten megabits to 100% of the U.S. is $35B, of which the share covered by AT&T would be a total of perhaps $15B. Because the last 1% is truly remote and exceedingly expensive to serve, there’s an emerging D.C. consensus that improved satellite is right for about 1%, which will cut that cost by a third. So the total cost to reach 99% of AT&T territory is about $10B, of which some will be covered by cable, profits from the customers reached, and government subsidy including the stimulus. Three months of AT&T cash flow – or 10% of three years spending – is enough for 99% coverage, without any additional subsidy. That’s less than they have cut capex from 2008 to 2009, and clearly not an intolerable burden

Michael Balmoris of AT&T writes
“Our filing was the latest in a series of filings we’ve made over the last couple of years pointing out that the traditional POTS business model is in decline.  We did not ask for any additional USF in this filing; that is not that same thing as saying our view is that no additional USF funding is needed to achieve whatever broadband goal the administration may announce in its plan.

The POTS model is a collective model for all LECs.  Most of the remaining POTS lines are served by LECs for which the decline of the POTS model will be catastrophic. As consumers abandon POTS for other ways to communicate, the subsidies needed to maintain universal POTS will only increase, forcing carriers to spread the cost of providing POTS over a smaller customer base. At the same time, policy makers are intent on transforming the USF from a program that supports POTS to a program that supports broadband.   We can continue to meet the goals of universal service in a broadband world, but not as quickly or as efficiently as possible if we don’t plan for the end of the POTS model.  That is the point of our filing.”

AT&T Wrong About ~Half the Broadband Unserved

“The customers who are easiest to serve already have access to broadband; the remaining unserved customers overwhelmingly live in sparsely populated, high-cost areas that cannot economically be served absent government support”, from AT&T seems to make sense and similar is often said in D.C. Actually, it turns out that something like half the remaining unserved do not “live in sparsely populated, high-cost areas that cannot economically be served absent government support,” as AT&T’s filing presents as though it were fact. Getting this right leads to policy that would reach the unserved at billions less than the commonly estimated cost. Combined with using improved satellite for perhaps 1%, the $20B and $35B projections in the September broadband plan can easily be cut in half. So this is important.

• Between 25% & 70% of the “unserved” do not cost prohibitively much because of sparse population but instead are hard to serve because backhaul locally is not competitive and costs 5-20 times what backhaul costs in competitive markets. I can buy transit for $5-15/megabit across several hundred U.S. cities, but some rural carriers are asked to pay $100 and even $200/megabit because there aren’t competitive suppliers. This came up time and again at the FCC broadband workshops. This is not because of a shortage of fiber capacity; fiber in place can easily handle any likely increased load at very modest cost. Sometimes, this is monopoly suppliers “charging what the market will bear” when there’s no effective market. Other times, the sole fiber supplier is the telco who does not want to make backhaul available to a possible competitor at a fair price.
• This is the whole “middle mile” problem so visible in D.C. these days. There are some places without fiber, but they turn out to be amazingly few. The problem is cost. As I explain elsewhere, overbuilding to create a little competition is rarely the right policy. I believe the FCC will use “special access” to get rid of the worst examples. Bringing reasonable prices for backhaul to a very narrow set of poorly served rurals is the single most important thing Jules can for rural broadband. Really.
• Between 10% and 25% of the unserved are not “high-cost” but are held back by problems at their local carrier. Earlier this year, there were 600K probably “unserved” at Charter alone, which was in bankruptcy. So they couldn’t make even ordinary upgrades. That’s perhaps 10% right there, an obvious target of opportunity. There are a significant number of similar but smaller cases.
• A substantial number of the “unserved” are on systems held back because the carrier wanted to sell them. That applies to the better part of 1M in the territory Verizon wants to spin off with Frontier, and presumably others.
• AT&T & Verizon refuse to use well-proven modest cost technologies if they only apply to a scattered few percent of homes, because they aren’t committed to serving all customers. My source on this is former AT&T CEO Ed Whitacre, who told me he was able to serve “100%” with inexpensive DSL repeaters. Repeaters now go up to 5 megabits. 82% of the “unserved’ are in AT&T, Verizon or Qwest territory, many (perhaps most) of whom can get megabit service at a cost the company recoups in a year or three.
• When 95% are served, the remaining homes are Black Swans – exceptions that don’t fit what seems like the logical pattern. While it true that “normally” a carrier would serve all but the uneconomical, high cost, there will always be some exceptions. Many, perhaps the majority, of the unserved fit one of those exceptions.

My best guess is that truly high cost are between 1% and 3% and less than half the “unserved.” But there’s no good data yet. Rob Curtis is working hard on this, since it’s probably the most important data to drive the broadband plan.