Tier 2 Consolidation Good News for Broadband

The FCC is expected to approve the merger between Tier 2 telcos CenturyTel and EMBARQ this week, which will create the fourth-largest ILEC in the nation, with 7.7 million access lines in 33 states. The deal is part of a bigger mergers and acquisitions wave that is creating a breed of rural super-LECs—and it’s a trend that has big ramifications for customers and competition.

“Clearly there is movement in the Tier 2s to consolidate, corresponding on the other side with the RBOCs jettisoning some of their rural properties,” said John Celentano, president of research group Skyline Marketing Group. “The big phone companies, as they move on to grander schemes via fiber to the x, haven't put money into rural properties—only to the extent they're told they have to.”

Enter the independent operating companies (IOCs), which stand to gain everything from scale. They can gain economies of scale in their operations, and it enables then to end up a larger organization with a larger revenue stream and better margins than it had before—making upgrades and investments more feasible.

What that means for customers is that these burgeoning rural super-LECs will bring more broadband and more advanced services to areas the RBOCs aren’t willing to. In fact, each spends over $100 million a year in capex, and together represent $30 billion in revenue guidance for 2009. The bottom line is that these Tier 2 companies are planning a new investment wave to upgrade and modernize their amalgamated networks in order to deliver new broadband services and to drive new revenue streams.

“The mid-tier are at a point where they need to do more than what they've done and they need to upgrade,” Celentano said. “There’s a lot of market movement and they now have an opportunity to grow via M&A.”

In CenturyTel/EMBARQ’s case, the new company will be required to make "substantial additional investment" in broadband, with retail broadband internet access service at 768 kbps to 90 percent of its broadband eligible lines within three years of the merger closing date.

Another factor is wireless. Many IOCs snagged spectrum in the FCC’s AWS and 700MHz auctions—CenturyTel for instance dropped $150 million for spectrum. “They are really interested in offering broadband wireless, especially in less densely populated areas where running fiber not feasible but WiMAX and LTE make a lot of sense,” noted Celentano. “The telephone companies are interested in it as a way to offer a competitive voice service, but as a way to bring broadband to customers for right now.”

It's also worth noting that the upgrades aren't really optional from a competitive standpoint. In the new IP-centric telecom market, the rise of new competitors and new technologies has a clear impact on traditional telcos, with new opportunities emerging for non-traditional ones (this is the subject of a session at the VON Expo in September, New Competitors: Rise of the ISP, the MSO Challenge, & Others").

As it stands, the Tier 2 market segment has consolidated to Qwest Communications International Inc., Cincinnati Bell, CenturyTel, Fairpoint, Frontier, NTELOS, TDS Telecom and Windstream.

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