The `Bell babies' sprout as businesses and investments
THE companies left behind to run the telephone system have done anything but remain old-fashioned and slow-moving. Although United States District Judge Harold H. Greene worked out the broad picture of the AT&T breakup, state and federal regulatory must fill in the details.
This is an enormous task -- one that doesn't easily lend itself to speedy results.
Under Judge Greene's order, the 22 local operating companies in the AT&T fold were regrouped into seven regional holding companies (RHCs) and left to run as regulated monopolies. They are Pacific Telesis Group, US West, Southwestern Bell, Ameritech (American Information Technologies), Bellsouth, Bell Atlantic, and NYNEX.
To the surprise of most observers, the holding companies came out of their corners swinging. They slashed at labor and operating costs and pushed hard to diversify, poking into every crevice of the telecommunications field for new profit centers.
Their stocks turned in star performances as early as the second quarter of 1984, rising to premiums on the strength of high dividends, profits, and cash flow.
Return on equity ranges from 13.2 percent to 15.2 percent, better than any of the companies achieved before divestiture. The stocks have attracted both long-term investors, looking for safety and yield, and short-term traders eyeballing quick price moves based on yield changes.
Internal cash flow is so strong, due largely to increased efficiency and layoffs, that some managements are looking at stock repurchases, following the lead of US West which wants to bring 2 million shares back in house. Regionals beat the estimates
All seven ``Bell babies'' exceeded analysts' earnings estimates, even despite lower than expected revenues and slow going in the regulatory jungle. Analyst Neil Yelsey of Salomon Brothers in New York expects each holding company to either match or outperform the Standard and Poor's 500 index over the next six to 12 months.
In addition to the regulated part of their businesses, which currently provides 95 percent of their $7 billion to $10 billion in combined revenues, the RHCs were allowed unregulated competition in publishing (largely the Yellow Pages), cellular mobile phones, and customer premise equipment.
Huge opportunity and problems of equal proportion top the strategy plans of all seven RHCs. Opportunity in that the companies have a head start in the telecommunications race. Problems in that they face an exhausting maze of obstacles, not only to their abilities to compete in the telecommunications business but in their ambitions to run the telephone business.
The regional phone companies face major regulatory challenges. Important among the changes the RHCs want from the Federal Communications Commission (FCC) are the following:
Private lines, those dedicated to the use of a specific -- usually corporate -- customer have historically been priced below cost. The phone companies want the FCC to increase the rates. Resistance comes from the customers who have made investment decisions based on current rates.
The charges for inquiry billing (operator assistance) are subsidized, and the operating companies want to recoup that subsidy from other revenue sources.
Long distance charges -- those within a holding company's operating area -- aren't high enough to earn the holding company's its allowed rate of return. The RHCs want to raise rates to achieve that return.
All three of these crucial decisions have been delayed. Depreciation, pricing are crucial
At the local level, the industry is intent on two major issues: depreciation and ``rate design'' (telephonese for pricing). ``To date, plant has not been depreciated to reflect its true life,'' says Mr. Morris of Montgomery Securities.
Every dollar of depreciation means a dollar in rates, which explains why the phone companies are so eager to shorten plant life and why regulators, in the past, made them so long. Regulators have been reluctant to tamper with depreciation. Southwestern Bell, in June 1983, filed for $400 million in increased depreciation but was granted only $70 million.
The other issue -- pricing -- sinks regulators and RHCs alike into a quagmire of subsidies. The old AT&T inclosed a delicate ecosystem of uneven rates; one group of customers paid high rates so another could pay low rates. With AT&T gone, regulators must decide which prices should mirror costs -- and when.
Toll calls generally support local calls. With varying degrees of success, operating companies are pushing local regulators to even out the charges. NYNEX, for instance, now separates its equipment charges from user charges. Deregulation vs. affordability
Mountain Bell is pushing a Colorado bill that would completely deregulate local phone rates. Opponents claim the move would double phone bills by 1990.
``When you look at the average telephone bill, it's about $10 or $13 a month,'' says Mr. Morris. ``But the cost of providing that it is $24. So even if you double the bill, you're still only paying for the cost. Subsidies provide the rest, and they come out of the business sector. The toll business also heavily subsidizes local calls.''
A case in point: Pacific Telesis was recently granted a local rate increase from $7.72 per month to $8.25 per residential customer. The cost, however, is $28, with the difference taken out of business customer rates.
Regulators generally don't like to raise residential rates, and the bulk of rate increases granted to operating companies in 1984 were carried by business customers.
Observers worry that such inequality will encourage ``bypass,'' the process where corporate customers turn to Bell competitors to install dedicated lines at rates much lower than Bell companies are allowed to charge. So far, NYNEX is the only holding company allowed to bid competitively against bypass. Because the New York market is home to hundreds of interconnect firms, NYNEX is the most susceptible to bypass. Regionals eye diversification
While regulators sort out the telephone problems, the holding companies are poking their noses in a wide range of new fields, including communications consulting and management, equipment leasing, cable television, real estate, and real estate communications. They have pursued diversification so vigorously that Judge Greene stepped in and capped potential new revenues at 10 percent of the total.
``Given that these are seven giant companies all entering new businesses . . . and almost all generating substantial excess cash, the line of merger and acquisition specialists stretches across town,'' says Mr. Yelsey of Salomon Brothers.
Bell Atlantic has been the most aggressive at diversification. Among other acquisitions, Bell Atlantic plunked down $175 million for Sorbus Service, a computer maintenance company. Bell Atlantic's vigor stems partly from the slow population growth in its service area.
It is by no means alone. US West markets security devices that hook into phone lines; Bellsouth and Dow Jones & Co. are test marketing an information service that attaches a microprocessor to customers' telephones and cable television. Ameritech claims $100 million in sales so far for its equipment sales subsidiary.
US West launched a series of separate subsidiaries to run each non-telephone operation. US West ``has been a leader in trying to operate formerly regulated businesses in a competitive, non-prejudicial manner,'' says Mr. Yelsey. With its subsidiary approach, ``US West is able to learn about the businesses as they grow . . . and reduce the risk of overextending its management as often occurs at rapidly growing conglomerates.''
None of the operating companies show much respect for Ma Bell -- or each other -- in the competitive ring. AT&T and the operating companies frequently bid fiercely against each other for the same equipment business. Bell Atlantic reached down into Southwestern Bell's territory to buy Telecommunications Specialists Inc., a Houston business communications systems company. US West also raided Southwestern via a joint venture with Fluor Corporation to provide cellular moble radio service to energy rigs in the Gulf of Mexico.
Cash fuels much of the diversification drive. The RHCs, thanks to cost cutting and popularity among investors, boast strong cash flow, and some are itching to spend it. That worries Mr. Morris. Moving through the corporate marketplace with cash drives prices up and returns down, he notes. ``What's wrong with being a telephone company? The holding companies are trying to change the perception that they are `widows and orphans' stocks. They are trying to be growth stocks. That clouds the marketplace perception of what they are and why to invest in them.''