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Prepared Witness Testimony The House Committee on Energy and Commerce
The Current State of Competition in the Communications Marketplace
Subcommittee on Telecommunications and the Internet
Mr. Ned P. Zachar CFA
1. Introduction I am pleased to be a resource for the Committee and am honored to have been
asked to participate in today's hearing. 2. Telecom Competition is a Major Factor in our Analysis Today's hearing -- of course -- addresses the state of competition in the telecommunications marketplace. Several reports we have recently completed, including our "2004 Outlook - For Some the Recovery Will Continue" and "Race for the RGUs" -- address this issue head-on. My comments today are a summary of those reports and I have included them for the record. The increasingly competitive environment for US Communications companies is a major factor in our overall investment thesis. It directly impacts which sectors we are steering investors towards - and which sectors we are steering investors away from. Generally speaking, we have favored investment in companies that can maintain current market share (usually because of a product or technology advantage) while stealing successfully from others. In general, the wireless and cable industries fit that profile while the RBOCs and especially the long distance companies do not. Let me elaborate briefly. Based on our Firm's estimates, the US Communications Services industry - not including equipment sales - is comprised of nearly $400 billion of annual end-user spending. As a % of GDP, annual telecom spending is about 3-1/2% of the U.S. economy and has been growing on average, roughly in line with the US economy. Thus, the pie of spending is quite large but not growing all that fast. Average annual spending has been reasonably consistent overall -- though there can be some year-to-year variability within each subsector. However, beneath this veneer of consistency, there are subtle but powerful undercurrents occurring that we think should be noted. First, the effects of the 1996 Telecom Act - along with subsequent agency and judicial interpretation - have applied and continue to apply steady pressure on the established incumbent companies such as the RBOCs and the interexchange companies like AT&T Corp. and the reconstituted MCI. Our market share statistics in Figure 2c illustrate the point. Second, in or view, technology is accelerating competition between the various subsectors - and is a phenomenon that is clearly benefiting businesses and consumers. For example, because of much improved wireless network coverage and rapidly falling per minute prices, it has been estimated that as many as 5% of US households have dropped wireline service altogether - choosing instead to manage their relatively mobile lives via a cell phone. Changing US demographics will likely accelerate this trend, in our view. At this point in time, we believe that the US Communications marketplace is approaching a significant "knee in the curve" whereby the combination of a) generally pro-competitive policymaking and b) additional technology advances -- are set to provide US businesses and consumers with new choices in service providers and/or new services that will set us apart from the rest of the world competitively. There are several tables at the end of my written testimony that illustrate the competitive dynamics I noted above. A few key factoids from our tables are relevant to mention: 1) We expect the share of residential lines controlled by the traditional
iLECs to fall from 79.2% as of the end of 2003 to 68.6% by 2008. Key market
share gainers will be the wireless, LD and cable television industries. 3) We expect the number of wireless users to increase from 153.8 million at the end of 2003 to 196.7 at YE 2008. While we do not estimate how many of those users will be "wireless only", with roughly 5 million having already "cut the cord" it's reasonable to believe that number would be 2-3x as high in 2008. 4) We are estimating that the number of cable television "telephone" customers will increase from 3.2 million to 13.0 million between YE 2003 and YE 2008. 5) We estimate that residential high-speed data connections will increase from 23.4 million at YE 2003 to 46.4 million at YE 2008. We have also estimated that the cable industry will have about 65.4% market share with the balance held by the iLECs. 6) In pay television, we estimate that the DBS industry will have about 30.1% market share by YE 2008, compared to the 23.2% market share they have today. Overall, we expect total pay television subscribers to increase from 93.1 million at YE 2003 to 103.5 million at YE 2008, representing 90.5% penetration of U.S. television households. Based on our work, the wireless and cable industries - and our data supports
this - are gaining market share, and thus deserve more investment attention -
than the RBOCs and the LD companies, which are treading water at best. At this point, let me shift the discussion toward predicting the future, which is usually a difficult endeavor -- but one that our customers clearly think is "part of the job". We see three major "Telecom Tailwinds" impacting the competitive landscape within the communications marketplace -- each with their own distinct timeframe. We would define Telecom Tailwinds as technology or regulatory trends that are likely to be major catalysts for changes in behavior - either by the service providers or their customers. 1) The first Telecom Tailwind, Wireless, is not a new trend but it remains a powerful change agent in the communications marketplace. In our view, it really gained momentum in 1996 with the auction of 1900 MHz PCS spectrum. We expect this tailwind to last for at least several more years as US penetration drives toward 70% of the US population. The increasing popularity of wireless is being driven primarily by ongoing improvement in network quality and changing US demographics. Since 1996, the number of wireless customers in the US has grown at a compound rate of 20.9% and the number of minutes of use has grown at an astounding compound rate of 46.5% annually through 2003. At present, we believe the share of minutes on wireless networks is approximately 13.1% of total reported dial minutes, up from 1.6% in 1996. 2) The second Telecom Tailwind is Voice over Internet Protocol which is really a breakthrough technology that enables voice traffic to make use of highly efficient packet-switched networks. VoIP has been talked about extensively for several years but is now coming into its own - literally as we speak. We are enthusiastic regarding the prospects for VoIP technology and its ability to change the economics of telecom. It reduces the necessary capital outlay for new competitors and enables - for example - the cable industry to generate attractive returns on capital with modest penetration assumptions. With regard to the incumbents, we do not see VoIP as a significant new tool (other than as a mechanism to potentially avoid established regulatory constructs) given that their embedded investment in circuit switching remains viable and has already been paid for. 3) And the third Telecom Tailwind we see is Wireless Broadband which is a more obtuse concept that we would define as a mix of established wireless standards - that is 3g -- and emerging technologies that will likely eventually enable high speed access - that will allow business and consumers to truly "cut the cord" for data service. Substantive wireless data projects should begin in 2005 and could provide added competition for wired data service to homes and businesses. While one usually thinks of established European and U.S. 3G standards for wireless broadband, other new technologies such as those developed by Flarion Technologies, Navini Networks and IP Wireless represent new opportunities for consumers as well. Additionally, the IEEE wireless standard 802.11 (commonly known as WiFi) is literally spreading like wildfire despite several inherent technology disadvantages - especially the limited range of signal. In our view, the best hope for affordable, ubiquitous broadband access will likely be developed within the wireless sector -- rather than by the established cable/telecom high-speed duopoly. 4. Conclusion I finish my statement with a handful of observations recapping the current
state of competition in telecom. b) The increasingly competitive environment is clearly a key factor in driving our investment recommendations within our research franchise. c) There are several new technologies that are likely to intensify the competitive environment moving forward. d) While I was not asked to opine on policy directly, we think there are several items that Congress and the FCC could prioritize which would help the industry overall AND consumers including: a) spectrum management issues, b) haphazard local zoning restrictions c) E-911 capability d) UNEP reform e) more refined definitions for telecom versus "information services" and f) access charge reform. On behalf of myself and my Firm, I would like to thank the House and specifically the members of the Energy and Commerce Committee for listening to my presentation and I would be happy to answer questions at the appropriate time. Respectfully submitted, Ned P. Zachar, CFA Cc: Howard Waltzman Attachments: (Website note: Available attachments are Adobe PDF documents) Biography U.S. Communications Services - Residential and Business Revenue Breakout (Figure 1) Selected Residential Market Share Analysis (Figure 2a, Figure 2b. Figure 2c, Figure 2d) U.S. Communications Services - Residential Revenue Breakout (Figure 3) U.S. Wireless Data Statistics (Figure 4) TWP Telecom Coverage List (Figure 5) "2004 Outlook -- For Some, the Recovery Continues" "Race for the RGUs"
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