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Rural carriers future in bundling, cross-selling

NEW YORK-Rural carriers, with operating histories often many decades old, appear poised at the forefront of the strategy for long-term growth based on bundled or converged services.

Seeking to be the one-stop-shop location for their customers, these companies have in place or have plans to use their wireline base to cross-sell mobile and other communications services. Alternatively, they are building or plan to build successful wireline enterprises on the backs of their wireless businesses.

“We are currently a CLEC (competitive local exchange carrier) in two of our wireless markets. It’s likely we will go into markets where we are a wireless provider with brand identity and edge out into a CLEC,” said Stewart Ewing, executive vice president and chief financial officer of CenturyTel Inc., Monroe, La.

Scott Schneider, executive vice president of Citizens Communications Co., Stamford, Conn., said he believes wireless, rather than acting as a damper on margins, can actually improve them. Citizens is exiting its longstanding role as an electric utility by acquiring incumbent local exchange carrier properties in seven Western states, plus Tennessee, West Virginia and New York. Its goal is to build on this landline base by expanding into delivery of mobile wireless, satellite television and other services.

“We aim to accumulate a critical mass to spread our overhead, affording us a low-cost structure to provide value-added services, elegantly delivered,” he said.

“We believe margins of 50 percent are achievable and sustainable. In the near term, we want to push them to 55 percent, in the longer term to 60 percent.”

Although opportunities abound, many rural phone companies are feeling the pressures of the current general environment in telecommunications, including consolidation and capital raising. However, the source of these stresses also stems from historical norms that are more particular to the closely held among this group of carriers as opposed to larger telecommunications companies. The effects could determine their decisions about remaining independent and retaining their wireless properties.

“Most people think of rural telcos as LECs (local exchange carriers), but many, including Citizens Communications, CenturyTel, TDS (Telephone & Data Systems), FairPoint Communications and Madison River Communications, also have a significant wireless presence. And they have not shown any reluctance to monetize those assets,” said Robert F. West, senior vice president and communications division manager of CoBank.

The bank has a $2.9 billion portfolio of loans outstanding to 167 of the approximately 1,300 rural phone companies in the United States. CoBank expects that sum to increase as its operator clients pursue wireless investments, CLEC plans, fiber-optics projects and private market mergers and acquisitions, West said at the Legg Mason conference on “The Future of Rural Telecommunications.”

“There are more than 1,200 smaller phone companies in the United States. Because of generational changes (among owners), technological changes and capital requirements, there will be opportunities for public companies to joint venture with them or acquire them. They have great operating teams and reputations,” said Francis X. Gallagher, principal of investment banking for Baltimore-based Legg Mason.

“In sum, there will be a dramatic and revolutionary change in structures and ownerships and a tremendous opportunity for value creation that will challenge our way of looking at these companies.”

Although building out their coverage into contiguous areas and diversifying their service offerings afford them solid opportunities for growth, their expansion plans are caught in a dividend trap, said Dan Lascano, portfolio manager for Caxton & Associates.

“About 90 percent of their shareholder base are family members who expect dividends. Most of these companies are selling their cellular businesses in order to get into PCS. They have seen their balance sheets deteriorate because of PCS cap-x (capital expense) requirements, after-tax cash flow being used up by dividends and increases in their debt (as a result),” he said.

“They will either have to cut dividends or sell (their companies), not to financial buyers trying only to get the best deal, but to other telcos which need the access lines.”

West and Lascano said that some rural phone companies might opt to divest themselves of their PCS holdings as an alternative to selling their entire operations.

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“Conestoga Enterprises (in Pennsylvania) has valuable PCS assets covering 1 million pops, along with some towers, that they could sell to delay reducing the dividend. Pittsburgh Systems (also in Pennsylvania) is another rural company most likely to sell its wireless assets in the next two year,” Lascano said.

For some companies, like CenturyTel, the sale of some PCS properties in no way signals an exit from the wireless arena.

“We will sell some non-strategic assets, like the PCS spectrum we agreed to sell to Leap Wireless, in order to finance future growth. We are judicious in our use of shareholder capital and have not sold equity since 1989,” said Ewing of Louisiana-based CenturyTel.

“In 2001, we expect to see continued wireless growth despite decreases in roaming revenues on the order of 5 percent.”

An increase in merger and acquisition activity among rural carriers likely will follow the closing of the merger between Deutsche Telekom and VoiceStream Wireless Corp., said Richard E. Wiley, a partner in the Washington, D.C., law firm of Wiley, Rein & Fielding.

“There will be teaming arrangements or mergers with larger entities or they will generate internal growth by buying properties from larger companies,” he said.

CT Communications Inc., Concord, N.C., took the latter route in its outright purchase of wireless assets and licenses in its home territory from the BellSouth PCS partnership in which it had held a 2-percent interest.

“We are situated in a high-growth area around Charlotte and have capitalized on the growth in the Internet and digital wireless in our core area,” said Barry Rubens, senior vice president and chief financial officer.

“We also own MMDS licenses 50: 50 with WorldCom and are examining our plans for MMDS with WorldCom.”

CT Communications does not receive federal Universal Service Funds, a status that helps it avoid a significant stumbling block that can trip smaller telecommunications carriers who pursue the avenue of purchasing assets from larger carriers.

“U.S.F. (Universal Service Fund) payments to the buyer must equal those of the seller. The potential loss of USF support or the imposition of price caps limits this option, although this issue could get a sympathetic hearing at the new FCC,” Wiley said.

Although some smaller, family-owned rural operators may be forced to sell their PCS assets to satisfy the dividend demands of their shareholders, wireless remains a significant business opportunity for many others. It is an important part of the rural carrier strategy because the longer-term outlook is that it will increasingly become a substitute for traditional landline voice service, said Robert Anderson, president of the National Exchange Carrier Association.

The experience of NTELOS Inc., formerly CFW Communications, Wayneseboro, Va., is one salient example of how important wireless can be for rural carriers. The company expects that wireless will comprise 59 percent of its projected $205 million in revenues this fiscal year.

“Our roots are in the ILEC (incumbent local exchange carrier) arena, but our story in the last year has become very different. We bought PCS PrimeCo digital wireless assets, and our company is now a wireline company with a wireless add-on,” said James Quarforth, chairman and chief executive officer.

“We have done this so quietly that we haven’t yet shown up on the tables listing wireless companies.”

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