Consolidation of Fiber Networks

I’ve written a few recent blogs discussing the amount of fiber that’s going to be needed to support the 5G networks envisioned by Verizon and AT&T. This blog in particular cited a recent Deloitte study that estimates that the cost to build the fiber needed to support a ubiquitous 5G network nationwide would be $130 billion.

We know that adding fiber is now a high priority for Verizon. They announced in April a deal to buy over $1 billion of fiber from Corning over 3 years. (As an aside, all of the press releases and articles about that purchase say that amount buys 12.4 million miles of fiber per year, or 37.2 million miles of fiber. There are only a little over 4 million miles of roads in the US, so that obviously means miles of individual fiber strands. Pardon the interruption, but misleading statistics drive me up the wall.)

We can almost be certain that Verizon plans to build fiber for backhaul to cell sites. There are around 250,000 current cell towers in the country, but the deployment of small neighborhood cell sites is going to explode that number potentially by millions. Years ago both Verizon and AT&T elected to let other companies build and own cell towers, which spun off a major new industry. And in that process both companies largely agreed to lease fiber transport to reach those towers. But as the cell industry margins are tightening the companies are now looking to directly own as many of those fiber routes as possible to hold down lease expenses.

While Verizon plans to build a lot of fiber, they are also on an obvious path to buy existing fiber networks that supply transport to cell towers. Last year they purchased XO Communications and just last week announced they were buying a Chicago-area fiber network from Wide Open West.

I have seen several analysts speculate that Verizon will be considering more fiber purchases. Interestingly the analysts focus on the potential purchase of large ILECs like Consolidated or Cincinnati Bell, which both own a lot of fiber. But much of the fiber in these companies is last-mile fiber to reach customers, and it would be curious to see Verizon buy back into that business. Just last year they sold off a significant chunk of their FiOS fiber network to Frontier and it would be a major reversal of that strategy to turn around and invest this soon in last mile fiber. We’ve seen big companies pivot before, but this would be possibly the biggest such change of mind our industry would ever have seen.

I think it’s more likely that they will consider buying transport fiber networks rather than last-mile networks. The problem the company faces is that there are not that many big fiber providers left. CenturyLink recently purchased the largest such network from Level 3, which owns over 55,000 miles of fiber. The only other fiber transport networks left that own over 10,000 miles of fiber are Birch, Zayo, EarthLink, Cogent and Lightower/Fibertech. There are only another half dozen companies that own fiber transport networks of between 5,000 and 10,000 miles. I have to think that Verizon and AT&T have considered buying many of these companies over the last year or two.

There is one other set of big fiber networks that don’t get as much national attention. These are fiber transport networks built largely by consortiums of independent telephone companies. Most of these networks were constructed as a way for the telcos to gain cheap fiber transport to the world outside of their operating territories. Many of these smaller telcos were held hostage to incredibly expensive special access transport from the RBOCs which made it difficult for them to buy affordable Internet access. Since these networks were originally built a lot of them now have expanded throughout their operating regions and are now connected to cell towers, large businesses, governments, universities and other customers needing fiber transport.

Most of these ILEC-owned networks have joined together to form INDATEL. Here is a map showing the wide-spread footprint of INDATEL-member networks. Through this consortium many of these networks are now interconnected, providing a nearly nationwide fiber footprint. The various members have POPs in all of the biggest cities in their region but then also go to all of the smaller communities that have largely been ignored by most of the other fiber providers, with perhaps the exception of Level 3.

I have no idea if either Verizon or AT&T has considered buying these networks. For a company like Verizon these fiber routes would provide transport into many areas where they don’t have fiber today. The owners of these networks might want to explore the possibility of selling their networks. Now that the networks are in place the ILECs that built these networks are no longer isolated from the rest of the world. A sale would let them capitalize on their investment in fiber at a time when fiber networks have an all-time high valuation.

Of course, the downside to all of this is that if Verizon, AT&T and a few others like CenturyLink gobble up the few remaining independent fiber networks they will have a virtual monopoly on fiber transport. During the XO and Level 3 purchases there were a lot comments filed with regulators expressing concern about the negative impact on competition from fiber consolidation. I’d hate to see us go back to the bad old days where the only option for transport was a handful of the big telcos.

A Year of Mergers

Bell_logo_1969Our industry has seen many mergers over the years between the biggest companies in the sector. But for the most part big mergers that change the face of the industry have been sporadic. We had AOL buying Time Warner in 2000, Alcatel buying Lucent in 2006 and CenturyLink buying Qwest in 2011.

But now it seems like I can’t read industry news without seeing discussions of a new merger. During the last year or so we saw AT&T gobble up DirecTV, saw Alcatel-Lucent grabbed by Nokia and saw Charter buy Time Warner Cable and Bright House Networks. And we are now watching the regulators sorting out mergers with Verizon trying to buy both XO Communications and Yahoo, with CenturyLink wanting to buy Level 3 Communications and AT&T wanting to acquire Time Warner.

From reading Wall Street speculation it seems like the current merger mania in our industry is not over. The rumors are strong that CBS and Viacom will soon announce a merger. There is rampant speculation that several companies might try to outbid CenturyLink for Level 3. There are rumors that Comcast, Charter and Altice are interested in buying T-Mobile or Sprint. There are continuing rumors that Verizon wants to buy Dish Networks to get permanent access to the huge swatch of spectrum they own. And there have been rumors for the last year that somebody ought to buy Netflix.

And these giant mergers aren’t just happening in telecom. We see Bayer buying Monsanto, Microsoft buying Linked-In, Marriott buying Starwood, Tyco buying Johnson Control, Protection 1 buying ADT, Sherwin-Williams buying Valspar and Fortis buying ITC Holdings.

It’s really hard in the telecom world to know if mergers are good or bad for the industry. Some mergers are clearly bad because they eliminate competition and create oligopolies at the top of the market. The rumored merger between CBS and Viacom is one such merger. Today there are only five major programmers in the country and this reduces that to four. A lot of the woes in the industry today are due to the greed of programmers and consolidation at the top of the industry can’t mean anything good.

But other mergers might be beneficial. Consider the impact of Comcast or Charter buying T-Mobile or Sprint. I just saw an article this week that showed that the wireless operations of AT&T and Verizon are still showing a gross margin of over 50%. It’s been clear to every consumer that cellular service is overpriced due to lack of meaningful competition. Perhaps one of the big cable companies could drive down cellular prices in an attempt to grab market share.

But on the flip side, letting these huge cable companies develop a quad play product is bad for anybody else that tries to compete with them for broadband. A new fiber overbuilder in a city would have an even bigger challenge if they try to displace a cable competitor that offers cellphone service bundled with their broadband. It’s been clear for a long time that lack of broadband competition is bad for consumers.

The underlying theme driving all of these mergers is that Wall Street has a never-ending appetite for increased earnings. That alone is often a good thing. Many times the companies being acquired are underperforming for some reason and mergers sometimes wake them up to do better. Many mergers promise improvement earnings due to the effects of consolidation and a reduction in the management and overhead drags.

But consider what mega-mergers in the telecom space more often mean. They mean that fewer and fewer companies control the vast majority of the market. And those giant companies are driven by Wall Street to increase earnings quarter after quarter forever – and at a pace and level that exceeds general inflation. You only have to do the math on that basic concept to realize that this means price increases for residential and business customers year after year to keep meeting higher earnings targets.

Years ago we had Ma Bell that controlled 95% of the phone business in the country. AT&T would have acted like any other commercial company except for the fact that their prices were heavily restricted by regulators. But stockholders of these big companies today do just the opposite and they pressure management to increase profits no matter the consequences. It is the chase for bigger earnings that has seen programming costs and cable TV rates climb much faster than inflation for the last decade to the point where the cable TV product costs more than many households are willing to pay.

I doubt we will see the end to these mergers, but if we don’t find a way to curb them the inevitable results will be a tiny number of companies controlling the whole sector, but with none of the restrictions in the past that were put on companies like Ma Bell. It scares me sometimes to think that broadband rates are going to increase in the same manner that cable rates increased in the past. But when you look at what the big ISPs have to sell it’s hard to not picture a scenario where earnings pressures are going to do the same thing to broadband that has been done to cable rates. That is going to do great harm the country to the benefit of the stockholders of a few big companies.

The CenturyLink – Level 3 Merger

CenturyLinkCenturyLink just confirmed their bid to buy Level 3 Communications for $34 billion in the latest round of what looks like major industry consolidation. After Verizon’s purchase of XO Communications it looks like large nationwide fiber networks are going to be gobbled by larger players.

But we can’t quite put this merger in the books yet. There have been rumors floating for the last year of others interested in the company. Just this summer there were strong rumors that Comcast wanted to buy Level 3. And now there is a lot of speculation that the big wireless companies are also interested in the company. So don’t be surprised by one or more counterbids.

Why is Level 3 wanted by so many large players? The easy answer is that they have a huge fiber network, but it’s more because they have a fiber network that goes to all of the right places. Big companies like Verizon and AT&T are already connected into all of the major fiber hubs around the country. But Level 3 is connected nearly everywhere else. Their network extends out to a huge number of tier two and three cities.

And more than that, Level 3 has a lot connections to the big fiber users in local markets – the ISPs, large businesses, governments, school systems and cellular sites. The company has been busy for many years building fiber to places asking for big broadband.

This makes Level 3 a huge player in the Internet backhaul business. They are the ones that carry a lot of the Internet backbone to the smaller competitors of the giant incumbents. Level 3 also serves the supply side of the Internet and is a prime supplier of bandwidth to companies like Netflix, as well as the many large data centers for the other big web companies. Level 3’s revenues have been booming with the explosion of video traffic on the web.

CenturyLink is already a significant player nationwide for large businesses and governments. Before Qwest bought the old US West company they had built a significant nationwide fiber network and had vigorously pursued nationwide customers. That business has been extended and grown under CenturyLink and this acquisition would push the company to the top of the heap in the fiber business. There are so many benefits of the acquisition that nobody is questioning the sense of the merger (unlike the AT&T and Time Warner merger that has analysts scratching their heads).

I have a lot of clients that are going to be concerned about this acquisition (and others who will be once they understand the implications). Level 3 is one of the primary providers of fiber backhaul to reach the Internet for a huge number of small communities, and in many cases they are the only alternative to buying overinflated backhaul directly from the incumbents.

There are a lot of small ISPs and other users of broadband that are going to be worried about losing affordable backhaul – particularly those that compete with CenturyLink. It’s unlikely that these places will be denied connectivity by the combined company, but rather that over time the fear is that if you compete directly with CenturyLink that prices for backhaul will be increased. It wouldn’t take long for smaller competitors to CenturyLink to be put at a competitive disadvantage.

There is another class of carriers that might not even know that the merger could harm them. It turns out Level 3 is the primary underlying carrier for most wholesale VoIP products sold to carriers. Level 3 has developed a product called local access that gives carriers connections into all of the right places to deliver VoIP traffic to the PSTN. When somebody today pays $6.50 to buy a wholesale VoIP line it’s likely that half of that money goes to Level 3. CenturyLink could gut the VoIP world and a lot of competitors by discontinuing or restricting that product.

So the concern with any merger like this is what it’s going to do to limit competition. Every big merger decreases competition significantly in some markets. This merger holds out the possibility of harming competition over the very large geographic footprint covered by CenturyLink. Big mergers like this almost always come with restrictions against bad behavior from the FCC or the Justice Department. But we’ve seen big telcos often ignore such restrictions within a few years after a big merger.

CenturyLink is not making this purchase to eliminate competition. There are numerous benefits directly to the company that are drivers of the transaction. But we know that over time companies act to limit competition when they have the ability to do so. We’ve seen this happen in huge ways with Comcast, Verizon and AT&T. We’ve not seen nearly as much anti-competitive behavior in the past from CenturyLink (and their predecessor Qwest) – but this merger puts them into the position to act like the other large companies if they so wish. And my cynical side says that the bigger a company gets, the more it benefits them to be anti-competitive.