"Long, Slow Decline" for Fixed Network Telcos, Says Moody's

Not every problem has a solution, at least not a solution satisfying to the entities with the problem.

In the U.S. market, for example, an entire category of service providers--”long distance” suppliers--ceased to exist. Sure, the assets remained in service, but the firms, and the category, essentially disappeared.

Recall that AT&T and MCI were stand-alone firms engaged solely in the long distance voice (and to some small extent in the capacity market). AT&T was bought by SBC, which took the name and assets.

MCI was purchased first by Worldcom and then Worldcom by Verizon. Sprint still owns its long distance assets, but it is a smallish and declining business with little impact on overall company financial results.

The same fundamental problem is faced by the larger fixed network U.S. telcos. “Slow yet steady decline” is the fate that awaits CenturyLink, Frontier Communications and Windstream Services, according to ratings agency Moody’s.

“Constraints such as capital allocation practices that favor shareholder returns, lagging infrastructure relative to cable companies and high cost of capital will prevent wireline telecommunications companies (telcos) from taking the necessary steps to fuel growth, resulting in their slow yet steady decline,” says Moody's Investors Service.

Essentially, the telcos are caught in a death spiral (my words, not Moody’s). As they are owned by dividend-seeking investors, the firms cannot shrink or cancel their dividends without causing massive investor flight, with few “growth” investors available to replace those fleeing equity owners, since virtually nobody believes those firms can become “growth” properties.

“Telcos such as CenturyLink Inc. (Ba1 negative), Frontier Communications Corp. (Ba3 stable) and Windstream Services LLC (B1 stable) all have high dividend yields that promote a cycle that steadily erodes each company's value and scale,” says Moody’s. In other, the need to pay dividends starves the firms of the capital they might otherwise put into network infrastructure.

"These telcos have strong operating cash flows and the ability to invest more, but they are hindered by market expectations for dividends," said Mark Stodden, a Moody's Vice President and Senior Credit Officer. "Their weak market position can only be changed by increased investment, but this would threaten dividends and is unpalatable to both equity investors and management teams."

Moody's also notes that the high cost of capital has kept these companies from investing in the necessary infrastructure to provide faster-speed service to residential and small-business customers.

A widening competitive gap between these telcos and cable TV operators is the result.

Some problems just have no positive solutions. As was the case for the long distance providers, market exit will be the eventual result.