[Senate Hearing 109-589]
[From the U.S. Government Publishing Office]
S. Hrg. 109-589
WALL STREET'S PERSPECTIVES ON TELECOMMUNICATIONS
=======================================================================
HEARING
before the
COMMITTEE ON COMMERCE,
SCIENCE, AND TRANSPORTATION
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
MARCH 14, 2006
__________
Printed for the use of the Committee on Commerce, Science, and
Transportation
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SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
TED STEVENS, Alaska, Chairman
JOHN McCAIN, Arizona DANIEL K. INOUYE, Hawaii, Co-
CONRAD BURNS, Montana Chairman
TRENT LOTT, Mississippi JOHN D. ROCKEFELLER IV, West
KAY BAILEY HUTCHISON, Texas Virginia
OLYMPIA J. SNOWE, Maine JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada BARBARA BOXER, California
GEORGE ALLEN, Virginia BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire MARIA CANTWELL, Washington
JIM DeMINT, South Carolina FRANK R. LAUTENBERG, New Jersey
DAVID VITTER, Louisiana E. BENJAMIN NELSON, Nebraska
MARK PRYOR, Arkansas
Lisa J. Sutherland, Republican Staff Director
Christine Drager Kurth, Republican Deputy Staff Director
Kenneth R. Nahigian, Republican Chief Counsel
Margaret L. Cummisky, Democratic Staff Director and Chief Counsel
Samuel E. Whitehorn, Democratic Deputy Staff Director and General
Counsel
Lila Harper Helms, Democratic Policy Director
C O N T E N T S
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Page
Hearing held on March 14, 2006................................... 1
Statement of Senator DeMint...................................... 1
Statement of Senator Stevens..................................... 1
Prepared statement........................................... 1
Witnesses
Bourkoff, Aryeh B., Managing Director/Senior Analyst, UBS
Investment Research............................................ 5
Prepared statement........................................... 7
Moffett, Craig E., Vice President/Senior Analyst, Sanford C.
Bernstein and Co., LLC......................................... 12
Prepared statement........................................... 14
Moore, Kevin M., CFA, Managing Director, Telecommunications
Services Equity Research, Wachovia Securities.................. 9
Prepared statement........................................... 11
Szymczak, Luke T., Vice President, JPMorgan Asset Management..... 2
Prepared statement........................................... 3
WALL STREET'S PERSPECTIVES ON TELECOMMUNICATIONS
----------
TUESDAY, MARCH 14, 2006
U.S. Senate,
Committee on Commerce, Science, and Transportation,
Washington, DC.
The Committee met, pursuant to notice, at 2:40 p.m. in room
SD-106, Dirksen Senate Office Building, Hon. Ted Stevens,
Chairman of the Committee, presiding.
OPENING STATEMENT OF HON. JIM DeMINT,
U.S. SENATOR FROM SOUTH CAROLINA
Senator DeMint. [presiding] Gentlemen, the Chairman is on
his way and believe me, everything that is said will be taken
down and used in our debates here in Committee, but in the
interest of your time, and out of respect for you, we would
like to get the testimonies started, because we know there is
going to be a vote sometime around 3 o'clock.
And instead of me making an opening statement, the Chairman
may want to make some comments while he is here. I would just
like to begin the testimony here. I do not have all of the
introductions here, but we have it as part of the record. And
if we could, we will just start with, is it----
Mr. Szymczak. Szymczak.
Senator DeMint. Szymczak. And the Chairman is here.
We were going to start the witnesses, but if you would like
to make a statement before they start, I think that is
appropriate.
OPENING STATEMENT OF HON. TED STEVENS,
U.S. SENATOR FROM ALASKA
The Chairman. [presiding] Well, I'll put my prepared
statement in the record. I am sorry, I apologize. We do have
votes, but I got caught in a meeting I could not get away from.
Please, sir, begin.
[The prepared statement of Senator Stevens follows:]
Prepared Statement of Hon. Ted Stevens, U.S. Senator from Alaska
Through our hearings we have heard from the different industry
segments and we have heard about many of the different communications
issues that this Committee must address.
Today, we here about how what we do legislatively and how we do it
may impact investment and jobs in America from our panel of Wall Street
experts.
In the four years after passage of the 1996 Telecommunications Act,
hundreds of billions of dollars flowed into the communications sector,
pushing stock prices up more than 300 percent. But then the bubble
burst. Some estimates indicate that the communications industry lost
more than 90 percent of its peak market value in a matter of months,
and as a whole lost nearly 500,000 jobs, $2 trillion of market value,
and accumulated nearly $1 trillion in debt.
While there were many reasons for the collapse, uncertainty
stemming from the 1996 Act certainly played a part. Former FCC
Commissioner Furchgott-Roth estimates that nearly two-thirds of the
rules passed to implement the 1996 Act have been completely or
partially overturned. And some rules remanded to the FCC still have not
been revised 10 years after passage of the 1996 Act.
As we listen to our panel today the Committee must consider how we
can be sure that any legislation we approve is clear, competitively
neutral, and readily implemented. Among the issues the Committee may
consider are whether to impose statutes of limitation in challenges to
new legislation or rules. Likewise, it may be wise to impose strict
time limitations on items remanded to the FCC.
We will also have to listen carefully to ensure that our
legislation does not arbitrarily favor one industry segment over
another, altering the flow of capital away from market forces and
consumer choice.
STATEMENT OF LUKE T. SZYMCZAK, VICE PRESIDENT, JPMorgan ASSET
MANAGEMENT
Mr. Szymczak. Thank you, Chairman Stevens, and other
Members of the Committee. My name is Luke Szymczak, and I am a
Vice President at JPMorgan Asset Management. I appreciate the
opportunity to address the Committee today and share my
perspective as an investor in telecom.
These are my views, and not those of JPMorgan.
My role at JPMorgan is both as an analyst, whose
responsibility is to have an all-encompassing view of an
industry and the stocks in it, and also as an investor, who
makes active decisions about which stocks to own in a
portfolio, and which not to own.
My specialty is telecom. I am responsible for both the
telecom services industry, and the communications equipment
industry.
Investors in telecom and technology stocks have had quite a
wild ride over the last decade. The excesses of the late 1990s
have mostly been wrung from the system. One would hope that the
outlook for the industry, from an investor's perspective, would
be getting more attractive. Unfortunately, clarity is not yet
upon us. Investors are struggling with a number of issues,
including determining how the competitive landscape will
evolve, attempting to forecast the rate of price and revenue
declines, and third, estimating the returns carriers will
realize from the large investments being made in broadband
access networks.
Any one of these factors raises risks, and the investment
analysis is dramatically more complex and uncertain than it was
20 years ago, or even 10 years ago. The questions facing
investors are not revolutionary. But we are in uncharted
territory for telecom now that freer competition has been
unleashed, and it is unclear where this will lead over the next
decade.
We have seen some positive developments in recent years.
Industry consolidation has begun to rationalize the cost base
from a regulated industry model into one of a competitive
industry. This has contributed to the strengthening of balance
sheets so that companies will have the resources and the
financial cushion to contemplate large capital spending plans.
Likewise, we have seen continued adoption of broadband access
in the consumer market. And the incumbent local exchange
companies have made good progress in refining their marketing
strategies and techniques, and the ILECs in general have done a
good job of improving their balance sheets, and this should
help them weather the storms ahead.
Nonetheless, concern is widespread that the major carriers'
positions will worsen despite some of these positive
indicators. The list of negatives is long. First, the decline
in access lines at the ILECs has a direct and immediate
negative impact on their margins and profitability. Second, as
the wireless market matures, there is an increase in concern
that wireless growth may begin to slow. Third, there is concern
that the prevailing price of voice service could be reduced
dramatically in the next few years. Fourth, there is a concern
that we may soon see new entrants using new technologies with
more attractive economics than existing operators can achieve
with their current networks. And finally, there is a high
degree of skepticism that the substantial investment underway
at the ILECs to build broadband networks to the home will
deliver a satisfactory return on the incremental investment.
The answer to this will come with time.
Fortunately, telecom is a vibrant industry. All the change
underway creates new opportunity. Good examples are the
progress in wireless and in the Internet over the last 10
years. The forecast for the next 10 years is still uncertain,
but I am very confident that it will include even more dramatic
and hard to predict change, and this will create significant
opportunities for growth.
Ultimately, the degree of carrier success will have a
significant impact on the communications equipment industry, as
well. With their long history in wireless, it is no accident
that the largest provider of wireless infrastructure is based
in Sweden, and of wireless handsets is based in Finland.
Likewise, the U.S. has leading companies in the data
networking industry as a result of the early adoption in this
country of data networking in the 1980s, and the brilliant
growth of Internet adoption since the 1990s. This has enabled
U.S. data networking companies, both large and small, to take a
substantial lead over other competitors.
In my view, the success of U.S. carriers in building great
businesses around the networks of the future will be critical
in giving the equipment companies that sell to these U.S.
carriers opportunities to develop and improve the technology of
the future.
After these companies help the U.S. carriers in deployment,
they can then sell these technologies to carriers around the
globe. If the end result is a success, this should be good for
both the stocks of U.S. carriers, as well as the stocks of the
equipment companies that supply them.
Thank you.
[The prepared statement of Mr. Szymczak follows:]
Prepared Statement of Luke T. Szymczak, Vice President, JPMorgan Asset
Management
Chairman Stevens and other Members of the Committee, my name is
Luke T. Szymczak and I am a Vice President at JPMorgan Asset Management
and I appreciate the opportunity to address the Committee today, and
share my perspective as an investor in telecommunications. My role is
both as an analyst, whose responsibility is to have an all-encompassing
view of an industry and the stocks in it, and also as an investor, who
makes active decisions about which stocks to own in a portfolio, and
which not to own. My specialty is telecom, and I am responsible for
both the telecom services industry and communications equipment
industry. As a result of over a decade of experience with the companies
that supply the equipment that is used to construct the telecom
networks, and the companies that operate the networks, I bring a very
holistic perspective on the telecommunications industry.
Investors in telecom and technology stocks have had quite a wild
ride over the last decade. Now that the excesses of the late 1990s have
mostly been wrung from the system, one would hope that the outlook for
the industry, from an investor's perspective, would be getting more
attractive. Unfortunately, such clarity is not yet upon us. Investors
are struggling with a number of issues. These include determining how
the competitive landscape will evolve, attempting to forecast the rate
of price and revenue declines, and making estimates of what returns
carriers will realize as a result of the large investments that are
currently being made in broadband access networks. Any one of these
factors raises risks, but the combination complicates the analysis
substantially, and the conclusions are sometimes far from conclusive.
The result is an investment analysis process that is dramatically
more complex and uncertain than it was twenty years ago, or even ten
years ago. The specific questions that investors face are not
revolutionary. But we are in uncharted territory for telecom now that
freer competition has been unleashed, and it is unclear just where this
will lead over the next decade. Because so many other industries have
seen brutal levels of competition following deregulation, investors are
reaching conclusions that factor in a great degree of skepticism to
reflect the high level of risk and uncertainty.
We certainly have seen some positive developments in recent years.
Industry consolidation first in wireless, and subsequently in wireline,
has begun the process of rationalizing the cost base from a regulated
industry model into one of a competitive industry. This has contributed
to the strengthening of balance sheets so that companies will have the
resources and the financial cushion to contemplate large capital
spending plans. Likewise, we have seen continued adoption of broadband
access in the consumer market. And Incumbent Local Exchange Companies
(ILECs) have made good progress in refining their marketing strategies
and techniques, and also in demonstrating that they can at least
moderate, and sometimes offset, the impact of the decline in access
lines with the sale of additional services to the customers that
remain. And, the ILECs in general have done a good job of improving
their balance sheets, which should enable them to weather the storms
ahead more sustainably.
There are many concerns. Nonetheless, there remains widespread
concern that the major carriers' positions will overall worsen despite
some of these positive indicators. Continued decline in access lines at
the ILECs has a direct and immediate negative impact on their margins
and profitability. Migration of wireline traffic to wireless continues
as one of the key factors in the access line decline, but voice
offerings from other competitors, both cable system operators and voice
over Internet protocol (VoIP), seem to be playing an increased role.
Wireless growth continues to be healthy, but there is an increasing
concern that with wireless penetration in the U.S. now in the 70
percent range, wireless growth is likely to begin to slow in coming
quarters. Even with consolidation in the industry over the last two
years, concerns that we could see intensified wireless price
competition as companies press harder to show subscriber growth seem
reasonable. And the potential entrance of new competitors as a result
of upcoming auctions remains a risk.
There is a very reasonable concern that the prevailing price of
voice service could be reduced dramatically in the next few years.
Today the average monthly revenue that an ILEC receives for an access
line is in the $50 range, with a number of companies above this.
Clearly, some VoIP services are currently at half this level, and some
pure Internet services have a price near zero. It is hard to forecast
the rate at which prices will decline. But the more exposure a company
has to traditional voice service, the greater impact this price
compression will have on its revenues, margins, and profitability.
There is a good degree of concern that we may soon see new entrants
using new technologies with potentially more attractive economics than
existing operators can achieve with their current networks. Likewise
there is a high degree of skepticism that the substantial investment
underway at the ILECs to build broadband networks to the home will
deliver a satisfactory return on the incremental investment. It is true
that sometimes investors can be too skeptical, and it seems that
telecom investors have become extremely risk-adverse. However, in the
case of broadband access network investments, the skepticism seems
entirely rational given that there has yet to be a proven business
model. Memories of the telecom meltdown that started in 2000 and
resulted from the big spending programs of the late 1990s, which proved
to be based on entirely misplaced hopes and business models, contribute
to the skepticism. The big question is whether carriers' plans are more
realistic and achievable this time around. It is a question for which
one could make either a positive or negative argument, and the answer
will come only with time, and thus the caution.
Obviously my summary list of negative factors in investors' views
is far greater than my list of positives, and this helps to explain the
relatively unenthusiastic view investors have for telecom services
stocks. Clearly, this industry is tougher to analyze now than in the
day when investment decisions were made on dividend yield, dividend
coverage ratios, and return on assets.
In response, many investors have shifted out of U.S. telecom
stocks, into telecom in other regions, particularly emerging markets
where growth is the dominant element of the story.
Even so, the U.S. market has some positive attributes relative to
alternatives. Most notably it is further along in the deregulatory path
than some other mature markets, notably Europe. The regulatory
environment here is likely to be more investor-friendly than it may
prove to be in Europe. But it will take time for one to be able to
prove this conclusion. On some measures, it appears that Europe is at
least three years behind the U.S. in wireline deregulation. For
example, a decision on whether carriers will have to resell usage of
newly-upgraded broadband access facilities to competitors has yet to be
taken in Europe, whereas the policy in the U.S. was set in the last
Triennial Review. And in contrast to the U.S., where major carriers
have made large commitments to upgrading access facilities, in Europe
there remains uncertainty as to the attractiveness of upgrading access
facilities.
There are opportunities ahead. Fortunately, telecom is a vibrant
industry and all the change underway creates new opportunity. Look no
further than the progress both wireless and the Internet have made in
the last ten years. Although the forecast for the next ten years is
uncertain, I am very confident that it will include potentially even
more dramatic and hard-to-predict change. This will create significant
opportunities for growth. Even so, it will be important for carriers to
make wise choices about which opportunities to pursue, and which
business models might yield the greatest success.
Ultimately, the carriers' success, or lack of success, will also
have a significant impact on the communications equipment industry,
which supplies the products to build the telecom infrastructure. It is
no accident that the most successful competitor each in wireless
infrastructure and wireless handsets is based in Sweden and Finland,
respectively. The carriers in these two countries have always been the
leaders in pushing the boundaries in the wireless business for over
twenty-five years now. And this has created the ecosystem that keeps
Ericsson and Nokia on the leading edge. Likewise, it is also clear that
the U.S. has the leading companies in the data networking industry.
This is a result of the early adoption of local area networking (LAN)
in this country in the 1980s, and also the brilliant growth of Internet
adoption over the last decade and a half. This has given U.S.
companies, both large and small, a substantial lead over other
competitors.
In my view, the success of U.S. carriers in building great
businesses around the networks of the future will be important in
giving the equipment companies that sell to these U.S. carriers the
opportunities to develop and refine the technologies of the future.
After these companies help the U.S. carriers in deployment, they can
then take these technologies and sell them to carriers around the
globe. If the end result is a success, this should be good for both the
stocks of U.S. carriers, as well as the stocks of the equipment
companies that supply them.
The Chairman. Thank you. Mr. Bourkoff is the Managing
Director of Media for Cable Satellite Entertainment Equity and
Fixed Income. We appreciate you being here, thank you.
Mr. Bourkoff. Thank you.
STATEMENT OF ARYEH B. BOURKOFF, MANAGING DIRECTOR/SENIOR
ANALYST, UBS INVESTMENT RESEARCH
Mr. Bourkoff. Good afternoon. I am honored to be here today
to present my perspectives on the cable television and
telecommunications landscape in front of this Committee. I will
provide a brief overview of the current Pay TV landscape and
then discuss investor sentiment and viewpoints of valuation,
highlighting key investment considerations.
In the mid-to-late 1990s, the cable industry deployed
approximately $90 billion of capital in order to materially
upgrade its network capacity to better position the industry to
offer advanced digital video services, interactivity, and other
applications. The majority of this investment was financed with
internal cash-flows and through public market debt financing.
The cable industry has historically enjoyed access to the
capital markets given the overall stability and predictability
of its financial model.
During this period, the Pay TV marketplace became
increasingly competitive. Satellite operators aggressively took
market share, driving cable's share down from a peak of roughly
95 percent in 1994 to about 63 percent today. In fact, cable's
penetration is now as low as 50 percent for many of the cable
operators.
As a result of the heightened competition for video
services, the cable industry is seeking to differentiate its
product by offering a robust suite of services to homes passed
by its high-capacity network.
Today, with the network upgraded and advanced offerings in
place, the industry is at the very early stages of potentially
its most operationally successful period. Nearly 85 percent of
the country's homes will have voice available from the cable
operators by the end of this year, with consumers receiving a
bundle of voice, video, and high speed data products at lower
packaged prices with the convenience of a single bill.
Evidence suggests that consumers have embraced the bundled
product offering. Penetration of voice services has
proliferated at a rate above expectations with operators like
Cox, Cablevision, and Time Warner Cable reaching approximately
20 percent penetration of homes in certain markets already.
Cablevision recently reported a full 24 percent of its
subscribers now take the ``Triple Play'' bundle a figure we
expect to grow to nearly 50 percent by the end of 2007. Other
advanced services including high-definition, digital video
recorders and video on demand are also growing in popularity.
Despite these promising prospects, the cable companies'
share prices remain depressed, with valuations that are at or
near historical lows.
In my opinion, there are several key topics affecting
investor sentiment toward the sector, and I highlight several
of the most prominent here. First is the onset of intensifying
video and bundled competition from the telecommunications
operators, who are in the process of constructing robust
wireline-based fiber networks themselves. Increased competition
could result in higher customer acquisition costs and lower
pricing in the mature U.S. Pay TV industry. Second is the
perpetual concern over another capital expenditure upgrade
cycle, particularly as more capacity is devoted to high
definition services. Both of these factors depress expectations
of future free cash-flow which impact valuation.
Last, and perhaps most prominent, are the risks associated
with disintermediation and regulatory uncertainty. Key issues
that we consider in this category include the availability of
content over various mediums with direct access to consumers;
for example, Apple's iPod, Google Video, et cetera, as a la
carte cable pricing proposals, the net neutrality debate and
the video franchise licensing process.
As a result of these concerns, investors who typically make
decisions based on fundamental views of valuation and the
prospects of the business model are likely to shy away from
cable industry investments, given the increased risk to the
predictability of cable model cash-flows.
A heightened level of uncertainty and the diminished
predictability will continue to weigh on valuation for the
sector. Further, the capital structures for the group could be
at risk given an estimated $80 billion of debt that is
currently outstanding and held by investors. This is relevant
given that the access to capital in the public markets has
historically been robust due to the stability of the cable
model and the well-understood and defined regulatory
environment.
As the Committee reviews issues related to video
franchising, I stress the importance of maintaining a level
playing field among all operators while allowing consumer
preference to dictate changes to current models. Uncertainty
among investors will persist if the rules for obtaining a video
franchise fluctuate based on the nature of new entrants. In my
analysis, I assume that there will be a fully competitive state
between cable, satellite, telecommunications, and other
providers.
With respect to the buildout requirements for new video
franchise applicants, I draw a comparison to the onset of new
competition in the U.K. in the early 1990s where operators such
as Diamond, Videotron, and Telewest Cable were required to meet
certain milestones in order to preserve their licenses. Note
that these operators were competing with industry incumbents,
like BSkyB and British Telecom.
As media consumption over the Internet develops at a rapid
pace, I believe that it is too early to introduce regulation on
key issues such as a la carte packaging and pricing and on net
neutrality, as the market is still in its early stages. In
fact, the broader media and communications sector is perhaps at
its most dynamic stage of evolution, as media content is
available across multiple platforms under various pricing
structures. Changes are occurring at such a frenetic pace that
any possible regulation today carries a risk of stunting this
innovation if it does not build in enough flexibility for the
complexion of the sector in the coming years, if not months.
Thank you.
[The prepared statement of Mr. Bourkoff follows:]
Prepared Statement of Aryeh B. Bourkoff, Managing Director/Senior
Analyst, UBS Investment Research
Introduction
Good Afternoon. My name is Aryeh Bourkoff and I am Managing
Director and Senior Analyst at UBS covering the equity and fixed income
debt securities of the cable TV, satellite and entertainment sectors
within Media and Telecommunications. I am honored to be here today to
present my perspectives on the cable television and telecommunications
landscape in front of this Committee.
I will provide a brief overview of the current Pay TV landscape and
then discuss investor sentiment and viewpoints of valuation,
highlighting key investment considerations.
Industry Background
In the mid-to-late 1990s, the cable industry deployed approximately
$90 billion of capital in order to materially upgrade its network
capacity to better position the industry to offer advanced digital
video services, interactivity, and other applications. The majority of
this investment was financed with internal cash flows and through
public market debt financings. The cable industry has historically
enjoyed access to the capital markets given the overall stability and
predictability of its financial model.
During this period, the Pay TV marketplace became increasingly
competitive. Satellite operators aggressively took market share,
driving cable's share down from a peak of roughly 95 percent in 1994 to
about 63 percent today. In fact cable's basic penetration--which we
measure as basic subscribers as a percent of homes passed--is now as
low as 50 percent for many of the cable operators.
As a result of the heightened competition for video services, the
cable industry is seeking to differentiate its product by offering a
robust suite of services to homes passed by its high-capacity network.
Current Environment and Valuation
Today, with the network upgraded and a full suite of service
offerings in place, the industry is at the early stages of potentially
its most operationally successful period. Nearly 85 percent of the
country's homes will have voice available from the cable operators by
the end of this year, with consumers receiving a bundle of voice, video
and high speed data products at lower packaged prices with the
convenience of a single bill.
Evidence suggests that consumers have embraced the bundled product
offering. Penetration of voice services has proliferated at a rate
above expectations--with operators like Cox Communications, Cablevision
Systems, and Time Warner Cable reaching approximately 20 percent
penetration of homes in certain markets already. In fact, Cablevision
recently reported a full 24 percent of its subscribers now take the
triple play bundle--a figure we expect to grow to nearly 50 percent by
the end of 2007. Other advanced services including high-definition,
digital video recorders and video on demand are also growing in
popularity.
The cable financial model has evolved from a focus on annual price
hikes to drive ARPU (average revenue per subscriber) which sacrificed
customer penetration--to one focused on bundled pricing designed to
attract customers and boost take rates and unit growth. Capital
expenditure requirements are shifting toward variable subscriber
acquisition costs rather than fixed network-related costs--with 70
percent of capital budgets now devoted to set top boxes and other
consumer devices rather than backhaul and headend infrastructure
investments.
Despite these promising prospects, cable-company share prices
remain depressed, with valuations that are at or near historical lows.
Topics Impacting Investor Sentiment
In my opinion, there are several key topics affecting investor
sentiment towards the sector, and I highlight several of the most
prominent here. First is the onset of intensifying video and bundled
competition from the telecommunications operators, who are in the
process of constructing robust wireline-based fiber networks
themselves. Increased competition could result in higher customer
acquisition costs and lower pricing in the mature U.S. Pay TV market.
Second is the perpetual concern over another capital expenditure
upgrade cycle, particularly as higher capacity high definition services
begin to fill up the cable network dial. Both of these concerns would
depress expectations of future free cash flow which impact valuation.
Lastly, and perhaps most prominent, are the risks associated with
disintermediation and regulatory uncertainty. Key issues that we
consider in this category include the availability of content over
various mediums with direct access to consumers (e.g. Apple's iPod,
Google Video, etc.), a la carte cable pricing proposals, the net
neutrality debate and the video franchise licensing process. As a
result of these concerns, investors who typically make decisions based
on fundamental views of valuation and the prospects of the business
model are likely to shy away from cable industry investments given the
increased risk to the predictability of cable model cash flows.
A heightened level of uncertainty and the diminished predictability
will continue to weigh on valuation for the sector. Further, the
financial and capital structures for the group could be at risk given
an estimated $80+ billion of debt that is currently outstanding and
held by investors. This is relevant given that the access to capital in
the public debt markets has historically been robust due to the
stability of the cable model and the well-understood and defined
regulatory environment.
Conclusions and Viewpoint
As the Committee reviews issues related to video franchising, I
stress the importance of maintaining a level playing field among all
operators while allowing consumer preferences to dictate changes to
current models. Uncertainty among investors will persist if the rules
surrounding obtaining a video franchise fluctuate based on the nature
of the new entrants. In my analysis of the sector, I assume that there
will be a fully competitive state between cable, satellite,
telecommunications, and other providers with all operators given an
equitable opportunity to service the customer base. With respect to the
buildout requirements for new applicants of video franchises, I draw a
comparison to the onset of new cable/telecommunications competition in
the United Kingdom during the early 1990s where operators such as
Diamond Cable, Videotron, and Telewest were required to meet certain
milestones in order to preserve their licenses. Note that these cable
providers were new entrants in that market competing with industry
incumbents, including British Sky Broadcasting and British Telecom.
Failure to build out a defined percentage of homes within the service
territory resulted in fines and progress was closely monitored by
regulatory bodies.
The consumption of video and other media services over the Internet
is developing at a very rapid pace. I believe that it is too early to
introduce regulation on key issues such as a la carte packaging and
pricing and on net neutrality as the market is still in its early
stages. Instead, I feel that at this point it is essential that market
forces and consumer demand drive the economic model. Moving to an a la
carte pricing structure would have an impact on the predictability of
the distribution model as well as impose risks to content providers
over the longer term.
The broader media and communications sector is perhaps at its most
dynamic stage of its evolution as media content is available across
multiple platforms under various pricing structures. This introduces
investment opportunities as well as risk factors as the market place
and business models are altered to meet demands of consumers. We
believe that the most important place for regulation in the context of
this environment is to ensure a level playing field for new entrants as
well as incumbents, recognizing that we are already in a competitive
situation, as well as in the close monitoring of potential conflicts
that may arise. Further, we believe that there are profound risks of
unintended consequences in the event that key fundamental aspects of
today's landscape are regulated at such an early stage of development,
innovation, and creativity. Changes are occurring at such a frenetic
pace that any possible regulation today carries a risk of stunting this
innovation if it does not build in enough flexibility for how the
sector will look in the coming months and years.
The Chairman. Thank you. Mr. Moore, Wireline Telecom
Analyst, Managing Director, Wachovia Securities, thank you for
being with us.
STATEMENT OF KEVIN M. MOORE, CFA, MANAGING DIRECTOR,
TELECOMMUNICATIONS SERVICES EQUITY RESEARCH, WACHOVIA
SECURITIES
Mr. Moore. Thank you. Chairman Stevens, Members of the
Committee, thank you for another opportunity to discuss Wall
Street perspective on telecommunications with members of the
Senate. My role on Wall Street is to advise institutional
investors on the investment prospects of the overall
telecommunications industry and of specific companies including
RBOCs, rural local exchange carriers and competitive service
providers.
My general outlook for the industry is that both
telecommunications and media applications are going to become
increasingly more mobile and portable and more separated from
underlying physical networks over the next 5 years. However, in
my prepared comments today, I would like to focus on Wall
Street's views on telecommunications regulation.
I will start with some specific regulatory concerns we have
heard from investors over the last year, speak about what we
think Wall Street wants in general from regulation, and finish
with two areas where I think regulation can promote investment.
First, on some recent investor concerns. The rural local
exchange investors are concerned about the change in regulatory
support for the universal service funding. Competitive service
provider investors are most concerned these companies will have
continued access to unbundled network elements, at reasonable
prices.
Finally, while RBOC investors remain divided on benefits of
RBOC investments in video, the investors in the related
equipment companies are concerned that uncertainties around the
franchising process could potentially dissuade the RBOCs from
aggressively entering the video market.
On Wall Street's general perspective on regulation, first
of all it is important to note that Wall Street's role is not
to have a prescriptive view on regulatory policy, but only to
determine which companies have the best outlook for investment.
Relative to telecommunications, we believe that Wall Street's
biggest desire is to minimize the need to constantly re-
evaluate the role of regulation in its investment decisions. We
have enough to worry about in considering the rapidly changing
competitive and technological environment. In other words we
want regulatory stability and certainty.
I believe that regulation that has three characteristics
would aid in the perception of regulatory stability. First is
minimal regulation. This statement should not be interpreted as
a request to eliminate regulation, but for it to take a
minimalist form. In the past 10 years, I believe we have seen a
direct correlation between regulatory instability and
regulatory complexity.
Second is flexibility. We would all agree that the 1996
Telecom Act did not contemplate many of the subsequent
technological developments. However, I think that it's more
important that we agree now that we cannot imagine what will
happen over the next 10 years. It is then critical that any new
regulatory framework takes this uncertainty into account and is
sufficiently flexible.
Third is technological consistency. I believe this means
that regulation must not be overly application-specific; in
other words, it cannot overly differentiates between voice,
data and video. A 2006 telecom act that is built on
application-specific regulation, that doesn't take into account
the movement of voice, data, and even video, into the Internet
and into wireless technology could become unstable within a few
years of enactment.
And finally, I want to talk about a couple of areas of
regulation where we think it can promote investment. The first
is interconnection. And the second is last mile access.
Relatively low cost and non-discriminatory interconnection,
known as ``peering'' in the Internet world, have contributed to
the success of the two most investable areas in
telecommunications, wireless and the Internet, over the last 10
years.
The second key area is non-discriminatory last mile access.
This not only includes unbundled network elements but also
includes the ability for carriers to carry digital signals over
their own last mile without regard to whether those signals
contain voice, data, or video.
Thank you, Mr. Chairman. I look forward to answering any of
your questions.
[The prepared statement of Mr. Moore follows:]
Prepared Statement of Kevin M. Moore, CFA, Managing Director,
Telecommunications Services Equity Research, Wachovia Securities
Good afternoon. Chairman Stevens, Co-Chairman Inouye and Members of
the Committee, thank you for another opportunity to discuss Wall
Street's perspective on telecommunications with members of the Senate.
In 1999, I testified to the Senate Judiciary Committee hearing on
``Broadband: Competition and Consumer Choice in High-Speed Internet
Service and Technologies'' a subject that seven years later continues
to be very important. As it was then, my role on Wall Street is to
advise institutional investors on the investment prospects of the
overall telecommunications industry and of specific companies including
RBOCs, Rural local exchange carriers (RLECs) and competitive service
providers (CSPs/CLECs).
My investment research and conclusions are published and I can make
copies of it available to Committee Members. My general view on the
industry is that both telecommunications and media applications are
going to become increasingly more mobile/portable and more separated
from underlying physical networks over the next five years. However, in
my prepared comments today, I would like to focus on Wall Street's
views on telecommunications regulation. These views represent my own
observations and not those of any specific investor.
I will start with some specific regulatory concerns we've heard
over the last year, then move on to what we believe Wall Street wants
in general from regulation, and finish with two areas that we think
regulation can promote investment.
Some Recent Investor Concerns
Three specific concerns seem to have weighed on investors minds
over the last year. First, RLEC investors are concerned about the
continued commitment of regulators to universal service funding (USF).
Second, competitive service provider investors are most concerned that
these companies will have continued access to unbundled network
elements (UNEs) at reasonable prices. Finally, while RBOC investors
remain divided on the benefits of RBOC investments in video, the
investors in the related equipment companies are concerned that
uncertainties around the franchising process could potentially dissuade
the RBOCs from aggressively entering the video market.
Wall Street's General Perspective on Regulation
It is important to note that Wall Street's role is not to have a
prescriptive view on regulatory policy but only to determine which
companies have the best outlook for investment. In this context,
telecommunications companies have to compete with thousands of other
public companies for debt and equity investment. In the competition for
capital, the relative regulatory environment is important in
determining which industries and companies will get capital.
Relative to telecommunications, we believe that Wall Street's
biggest desire is to minimize the need to constantly re-evaluate the
role of regulation in its telecommunication investment decisions. We
have enough to worry about in considering the rapidly changing
competitive and the technological environment. In other words we want
regulatory stability and certainty. I believe that regulation that has
three characteristics would aid in the perception of regulatory
stability.
First is minimal regulation. I want to make sure that this
statement is not interpreted as a request to eliminate regulation but
for it to take a minimalist form. In the past 10 years, I believe we
have seen a direct correlation between regulatory instability and
complexity in regulation. This has been evident in the many legal
battles including the most recent battle over the FCC's Triennial
Review Order. We believe that all of these battles have hurt investment
in the sector.
Second is flexibility. We would all agree that the 1996
Telecommunications Act did not contemplate the impact of the growth of
broadband and Internet applications. However, I think that it more
important that we agree now that we can't imagine what will happen
technologically over the next ten years. It is then critical that any
new regulatory framework takes this uncertainty into account and is
sufficiently flexible. This flexibility would ensure that future
investment can keep pace with industry changes undeterred by constant
regulatory uncertainty.
Third is technological consistency. I believe this means that
regulation must not be application specific (i.e., it overly
differentiates between voice, video or data). A 2006 telecom act that
is built on application specific regulation which doesn't take into
account the increasing separation between physical networks and
applications and the accelerating movement of those applications to the
Internet and wireless technology could become unstable within a few
years. This destabilization would again negatively impact investment in
the sector.
Application specific regulation could hurt investment in existing
services like third-party VoIP (i.e., not provided by a facilities-
based carrier) but more importantly in the rapidly emerging area of
third party provision of video directly over the public Internet.
Specific Regulatory Issues That Can Impact Future Investment
Finally I want to focus on two specific areas of regulation that I
believe are critical to capital being available to support innovation
and competition in the future. These areas are interconnection and last
mile access.
Relatively low cost and non-discriminatory interconnection (known
as peering in the Internet world) have contributed to the success of
the two most investable areas in telecommunications, wireless and the
Internet. We believe that interconnection will continue to be important
in the future.
The second key area is non-discriminatory last mile access. This
not only includes UNEs but also includes the non-discriminatory ability
for carriers to carry digital signals over their own last mile without
regard whether those signals contain voice data or video.
Thank you Mr. Chairman. I look forward to answering the Committee's
questions.
The Chairman. Thank you, Mr. Moore.
And now, Mr. Moffett, Vice President and Senior Analyst of
U.S. cable and satellite broadcast media, thank you for being
with us.
Mr. Moffett. Thank you.
STATEMENT OF CRAIG E. MOFFETT, VICE PRESIDENT/SENIOR ANALYST,
SANFORD C. BERNSTEIN AND CO., LLC
Mr. Moffett. Chairman Stevens, and Members of the
Committee, I want to express my thanks for your inviting me
here to participate this afternoon. I cover the cable and
satellite sector. And while I have written a great deal about
issues such as a la carte retransmission consent, franchising
rules, and broadcast indecency, I am going to confine my
statements today to issues related to physical networks, and
the constellation of issues that have been given the name,
``net neutrality.'' I believe that there is a risk that we are
embarking on a course that will discourage network investment.
The net neutrality debate has become a catchall for a
number of competing public policy needs. We want to ensure the
availability of ubiquitous and reliable high-speed Internet
access, and we want to do it while minimizing consumer prices
and maximizing consumer choice. That means we need to foster
investment in the networks themselves, and we need to do that
while at the same time protecting inalienable First Amendment
principles, and creating a vibrant climate for innovation in
network-reliant businesses.
Now, with respect to the first part of that balancing act;
that is, fostering investment in the networks themselves, Wall
Street has by and large already cast its vote, and the capital
markets see a bleak future for network operators. Cable stocks
have suffered 5 years of valuation declines relative to the
broader market. Telecommunications firms like Verizon and AT&T
have been given similar treatment. Comcast stock is punished
every time the company even mentions the words ``capital
investment.'' And Verizon's stock, likewise, was punished
throughout 2005, due to the capital market's distaste for
expansive capital investments in their fiber-optic deployment.
Now ironically, that comes at a time when consumer
broadband demand is exploding. But despite that strong demand
for networks, Wall Street harbors grave doubts about the
ability to earn a return on network investments. Excessive
competition and an uncertain regulatory environment are
dampening capital formation, and slowing the pace of
investment.
That investment is critical, though, because despite a
great deal of arm waving from visionaries, our
telecommunications infrastructure today is woefully unprepared
for the widespread delivery of advanced services, especially
video, over the Internet.
Downloading a single half-hour television show on the web
consumes more bandwidth than does receiving 200 e-mails a day
for a year. Downloading a single high-definition movie consumes
more bandwidth than does downloading 35,000 web pages, and it
is the equivalent of downloading 2,300 songs off of Apple's
iTunes website.
Today's networks simply are not scaled for that kind of
usage. In a recent series of reports that I entitled, ``The
Dumb Pipe Paradox,'' that I believe provided the original
impetus for the Committee's invitation to testify today, I
tried to address the misconception that telcos are rapidly
rushing in to meet this need and provide competition for cable
incumbents.
In fact, by their own best estimate, the telcos will be
able to reach no more than 40 percent or so of American
households with fiber over the next 7 to 10 years. And most of
that will be in the form of hybrid fiber-legacy copper networks
such as that being constructed by AT&T under the banner of
``Project Lightspeed.'' Those hybrid networks are expected to
deliver 20 megabits per second average downstream bandwidth.
And after accounting for significant standard deviations around
that average, that will mean that many enabled subscribers will
receive far less than that. I and many others on Wall Street
harbor real doubts about whether those hybrid networks are
going to prove technologically sufficient to meet future
demands.
More importantly, for 60 percent of the country, there are
simply no new networks on the horizon. And the existing
infrastructure from the telcos, DSL running at speeds of just
one and a half to three megabits per second or so, simply will
not be adequate to be considered broadband connections in 5
years or so. That includes, by the way, wireless networks.
Current and planned wireless networks, including the overhyped
WiMAX technology, offer the promise of satisfying today's
definition of broadband, but they cannot simply feasibly
support the kind of bandwidth required for dedicated point-to-
point video.
Again, Wall Street's view is that even these investments
are unwarranted. Verizon's network investment strategy is
predicated largely on cost savings, not on potential returns
from providing new services. We expect Verizon's return on
investment to be marginally positive. AT&T's is less costly,
but generates even fewer cost savings, so it is significantly
worse. Without cost savings, the cost of these networks is far
beyond what the returns of the new services can provide.
The notion of ``Net Neutrality'' as it is currently
construed would, I believe, just dampen enthusiasm for
investments even further, and would trigger a host of
unintended consequences. Mandated net neutrality would further
sour Wall Street's taste for broadband infrastructure
investments, make it increasingly difficult to sustain
necessary capital returns, and would likely mean that consumers
alone would be required to foot the entire bill for whatever
network investments do get made.
Conversely, from a Wall Street perspective, allowing a
multiplicity of payers; that is, advertisers and web service
providers, to support network investments, would greatly
bolster the business case, and would offer the prospect of
better returns, and more consumer choice in the end.
Thank you for your attention.
[The prepared statement of Mr. Moffett follows:]
Prepared Statement of Craig E. Moffett, Vice President/Senior Analyst,
Sanford C. Bernstein and Co., LLC
Chairman Stevens, Co-Chairman Inouye, and distinguished Members of
the Committee, I want to express my thanks for the opportunity to
participate in today's hearings.
I've spent the past three years as an Equity Research Analyst at
Sanford C. Bernstein covering the U.S. Cable and Satellite sector, and
I believe I'm here to reflect the views of Wall Street. But you should
also note that I previously spent more than a decade consulting to
telecommunications companies as a partner and Global Leader of The
Boston Consulting Group's telecommunications practice (where I lived
through the drafting and the aftermath of the 1996 Act) and I've also
been the President of a 400-person Internet auction business, so my
views today are likely to reflect those perspectives at least as much
as the Wall Street view.
While I've written a great deal about issues such as a la carte,
retransmission consent, franchising rules, and broadcast indecency,
I'll confine my prepared comments today to issues related to physical
networks, and the constellation of issues that have been given the
unfortunate name of ``Net Neutrality.'' I believe there is a risk that
we are embarking on a course that will discourage network investment,
to the long-term detriment of the economy and our society.
The ``Net Neutrality'' debate has become a catch-all for a number
of competing public policy needs. We want to ensure the availability of
ubiquitous and reliable high speed Internet access, and we want to do
it while minimizing consumer prices and maximizing consumer choice.
That means we need to foster investment in the networks themselves.
And we need to do that while at the same time protecting inalienable
First Amendment principles, and creating a vibrant climate for
innovation in network-reliant businesses.
With respect to the first part of that balancing act, i.e.,
``fostering investment in the networks themselves,'' Wall Street has,
by and large, already cast its vote. The capital markets see a bleak
future for network operators. Cable stocks have suffered five years of
valuation declines relative to the broader market. Telecommunications
firms like Verizon and AT&T have been given similar treatment.
Comcast's stock is punished every time the Company's management even
mentions the words ``capital investment.'' Verizon's stock was likewise
punished throughout 2005 due to the capital markets' distaste for the
expansive capital investments in their FiOS fiber optic deployment.
Ironically, this comes at a time when consumer broadband demand is
exploding. Sony's PlayStation and tech companies like Microsoft talk
about ``owning the living room,'' and AOL and Yahoo! and Google are all
planning video-rich strategies. New applications like video telephony
and video surveillance over the web have barely started yet.
Despite this strong demand for networks, however, Wall Street
harbors grave doubts about the ability to earn a return on network
investments. Excessive competition and an uncertain, and at times
hostile, regulatory environment are dampening capital formation and
slowing the pace of investment.
And that investment is critical, because despite a great deal of
arm waving from ``visionaries,'' our telecommunications infrastructure
is woefully unprepared for widespread delivery of advanced services,
especially video, over the Internet. Downloading a single half hour TV
show on the web consumes more bandwidth than does receiving 200 e-mails
a day for a full year. Downloading a single high definition movie
consumes more bandwidth than does the downloading of 35,000 web pages;
it's the equivalent of downloading 2,300 songs over Apple's iTunes
website. Today's networks simply aren't scaled for that.
In a series of recent research reports that I entitled ``The Dumb
Pipe Paradox'' *--which I believe provided the original impetus for the
Committee's invitation to testify today--I tried to address the
misconception that the telcos are rapidly rushing in to meet this need
and to provide competition for cable incumbents. In fact, by their own
best estimates, they'll be able to reach no more than 40 percent or so
of American households with fiber over the next seven years.
---------------------------------------------------------------------------
* The information referred to has been retained in Committee files.
---------------------------------------------------------------------------
And most of that will be in the form of hybrid fiber/legacy copper
networks, such as that being constructed by AT&T under the banner of
``Project Lightspeed.'' These hybrid networks are expected to deliver
20Mbs average downstream bandwidth. After accounting for significant
standard deviation around that average, that will mean many ``enabled''
subscribers will actually receive far less. I and many others on Wall
Street harbor real doubts as whether these hybrid networks will prove
technologically sufficient to meet future demands.
More importantly, in 60 percent of the country, there are simply no
new networks on the horizon, and the existing infrastructure from the
telcos--DSL running at speeds of just 1.5Mbs or so--simply won't be
adequate to be considered ``broadband'' in five years or so. That
includes wireless networks, by the way. Current and planned wireless
networks--including the over-hyped Wi-Max technology--offer the promise
of satisfying today's definition of broadband, but simply can't
feasibly support the kind of bandwidth required for the kind of
dedicated point-to-point video connections that will be required to be
considered broadband tomorrow. Those demands will continue to fall to
terrestrial wired networks.
Again, the Wall Street view is that even this amount of investment
is unwarranted. Verizon's network investment strategy is predicated
largely on cost savings, not on the potential returns from delivering
new services. We expect Verizon's return on investment to be marginally
positive. AT&T's is less costly, but generates fewer cost savings, and
so is likely significantly worse. You simply can't make a case for
major new investments on the basis of voice, video, and data as
currently conceived.
In Part I of the ``Dumb Pipe Paradox,'' I noted that if a telco was
in the business of providing broadband connections only--that is, if
phone service becomes, as many predict, simply another bit stream on
top of a data connection--then the cost to provide service would be as
much as $80 per month. And from a consumer's perspective, that would be
the pipe only, before paying for any content over the web.
And the cost, and therefore the price, would likely be much, much
more. Some recent comments from BellSouth's Chief Architect, Henry
Kafka, at the Optical Fiber Communication/National Fiber Optics
Engineers Conference last week put this in perspective. He estimated
that the average residential broadband user today consumes about two
gigabytes of data per month. Heavy users who regularly download movies
consume an average of 9 gigabytes of data per month. In the future,
watching IPTV would consume 224 gigabytes, and would cost carriers $112
per month to deliver. And if IPTV is going to deliver High Definition,
then the average user would be consuming more than one terabyte per
month, at a cost to carriers of $560 per month.
That, I believe, puts the ``Net Neutrality'' debate in context. The
very valence of the phrase suggests that the First Amendment is about
to be trampled lest it be legislatively protected. And the very idea
that third parties who benefit from Internet infrastructure
investments--say, Google and Yahoo!--might economically contribute in
some way to these costs has been roundly greeted as if it is a threat
to basic liberties.
But the notion of ``Net Neutrality'' as it is currently construed
would, I believe, likely trigger a host of unintended consequences.
Mandated ``Net Neutrality'' would further sour Wall Street's taste for
broadband infrastructure investments, making it increasingly difficult
to sustain the necessary capital investments.
It would also likely mean that consumers alone would be required to
foot the bill for whatever future network investments that do get made.
That would result in much higher end-user prices, much steeper
subsidies of heavy users by occasional ones, and, in all likelihood, a
much sharper ``digital divide.'' By discouraging the deployment of new
networks, it would also likely freeze in place the status quo cable/
telco duopoly (or worse in much of the country, where we are, as
previously described, on a trajectory to a near cable monopoly for
genuine broadband). The U.S. as a whole would, in all likelihood, fall
further behind other countries in broadband availability and
reliability.
Conversely, from a Wall Street perspective, allowing a
``multiplicity of payers'' (say, advertisers, or web services
providers) to support network investments would greatly bolster the
business case for deploying new infrastructure, as it would offer the
prospect of more attractive returns. And while current network
operators would undeniably benefit in such a regime, so too would
consumers, who would likely see both greater choice and lower prices.
And despite their current howls at the idea of paying for such
services as packet prioritization (what some have referred to as a
``fast lane'' for data), it is likely that the Internet services
community would be the biggest beneficiaries of all, inasmuch as they
would be assured of an infrastructure capable of supporting innovation
in new high bandwidth Internet-based services.
The First Amendment concerns surrounding ``Net Neutrality'' are
very real. But surely these concerns they can be dealt with--say,
though anti-blocking provisions, or through the carve-out of a neutral
``basic tier''--without triggering this laundry list of unintended
consequences. Indeed, it is my belief that network operators can
feasibly meet the needs of unfettered access to any and all web-based
content by providing a ``basic access tier'' that provides for a fixed
minimum amount of bandwidth (or, alternatively, a fixed percentage of
total bandwidth) in which pure neutrality would be maintained, and that
the provision of resources over and above that minimum can then be left
entirely to market forces.
Once again, I thank you for your kind attention.
The Chairman. Thank you, gentlemen. None of you painted a
particularly rosy picture of investment in the telecom
industry, yet we see that as one of the most promising
industries in our country today. And I think as a Congress, as
a committee, what we are trying to connect is this potential
with the legislation of the regulatory structure that needs to
be in place to encourage that investment.
I had hoped to hear a little more from you about what we
need to do to create incentives for investment. Mr. Moore, you
suggested I think some consistency in regulation, and I think
several of you had other things to suggest. But in the few
minutes that we have, if you could all maybe just give us your
quick, or highest priority thing that we need to do as a
Committee to encourage more investment, more buildout in the
industry? Who would like to start us? Mr. Bourkoff?
Mr. Bourkoff. Thank you. Well, I think the key issue is
clarity. I think when you have issues like video franchising,
and a la carte, and net neutrality, these really go to the
fundamental tenets of the business models we are talking about,
creates a lot of uncertainty in the market which restrict
potential investments for future services.
I think once we have clarity on things like video
franchising, especially, which seems to be more near-term, I
think that will establish a level playing field, and will allow
the investors to make investments on a debt and equity basis
that could see a return over the next few years. I think that
would probably encourage investments.
Mr. Moore. I would also agree with that. Clarity and
certainty are probably the two biggest things the government
can do to incentivize investment. And I think incentivizing it
proactively can be very difficult. The key thing for regulators
is to do no harm, and to keep regulation on a minimal basis, so
that the market can react with a certainty as to the
opportunities.
Mr. Moffett. I would second the point about doing no harm.
I think some of the more draconian proposals that we have seen,
with respect to net neutrality for example; while they protect
very important First Amendment rights, I think they have the
unintended consequence of dampening the potential returns of
network investments, and effectively requiring the consumer to
foot the entire bill for future network buildout. That is a
very challenging future, because it suggests that consumer
prices will end up being very high. In the face of very high
prices, there are natural disposable income limits that will
dampen the demand for broadband at those kind of prices, and
you will not get the kind of innovation that I think the
network neutrality debate is actually trying to foster, simply
because it prevents the investment in the underlying
infrastructure that is necessary for that ecosystem to thrive.
Senator DeMint. Mr. Moffett, just a question about net
neutrality. I understand the clarity, the certainty of
regulations, that if you are going to invest generally for a
longer term; we do not want the regulations to change. Are you
saying that regardless of net neutrality or not, it just needs
to be done, it needs to be permanent? Or are you suggesting a
way that it is done that would work better for investment?
Mr. Moffett. Well, I am saying that the way that it is done
in this case makes a great deal of difference. And if there are
hard and fast rules that say, for example, prioritization or
what network operators have called creating ``fast lanes,'' for
example, is off-limits because it in some ways favors one over
another and therefore is deemed to be objectionable to
legislators, then that has the unintended consequence of saying
that it is therefore not possible to charge third parties for
network services; therefore, the consumer has to foot the
entire bill. That inevitably will dampen investment in the
sector even if the legislation is enacted for enviable goals.
The Chairman. I don't know if you are familiar with a book
that was written by the former FCC commissioner, Commissioner
Furchtgott-Roth. He takes the position, as we understand it,
that about two-thirds of the rules that were put into place
after the 1996 Act, were overturned, and that really created
the instability in the industry. Do you all agree with that?
Mr. Moore. Mr. Chairman, I strongly agree. As I mentioned
in my comments, I think, complexity of regulation almost
inevitably equates to investment and regulatory instability.
The Chairman. This was not complexity. This was complete
reversal. He points out many of the mandated regulations were
never issued, and two-thirds of those that were issued were
overturned by courts.
Mr. Moore. I think that is because there were too many,
that many of them had to be overturned.
Mr. Moffett. Mr. Chairman, I would concur with that. I
believe that there is also an inherent difficulty when
technology is moving as fast as it is in this sector to try to
anticipate technology changes. And much of what happened in the
1996 Act was trying to anticipate technology changes. That
turned out to be an impossible task.
We are in that same position today. We are trying to
create--to return to the network neutrality debate, for
example, neutrality with respect to things like peering sites,
and spam, and antivirus protection, and spyware, that are sort
of natural things that a network operator does. Legislatively,
that would be an incredibly difficult task, and would be
obsolete even before it was written.
The Chairman. You all seem to be saying, at least I think I
am hearing, if we try to protect the consumer, we are going to
hurt the investor; is that right? That is your position?
Mr. Moffett. Mr. Chairman, I do not mean that that is the
case. I mean that we have to be careful as we try to protect
the consumer, first to recognize that in many cases protecting
the investors and protecting the consumers are the same thing,
because a great deal of consumer welfare, here, comes about
because of creating additional choice, and that means fostering
investment.
But as was said by Mr. Moore, it is important to recognize
that a light touch from a regulatory perspective is probably
the best outcome, and does not assume no regulation. It simply
assumes that the most unobtrusive path to consumer welfare is
probably the best one.
The Chairman. Go ahead, Mr. Bourkoff.
Mr. Bourkoff. Thank you, Mr. Chairman. I would also say
that I think the consumer is benefiting tremendously right now.
The landscape is shifting so quickly that the media content is
being really demanded by consumers rather than being pushed to
them, right now. And that is evidenced by the fact that there
are different devices now like the iPod, and like Google Video,
where consumers can now go and watch different shows where they
want; video on demand, and so on.
And I think the industry is catering to that consumer. I
think the danger is to put a line in the sand as the consumer
behavior is shifting, and to sort of set it at a moment in
time, because it really may look a lot different in the next
few months.
The Chairman. All right. Any of you concerned about our
white spaces concept, of making available the white spaces to
unlicensed activities? Are you familiar with what we are doing?
Mr. Moore. Yes, Senator. I think that any kind of provision
of additional capacity or bandwidth, particularly on an
unlicensed basis, which by default means its lack of regulatory
depth, is going to be good for development. I think WiFi is a
huge example of how things can really explode when there is a
very light regulatory touch.
And you know, addressing your previous comment, I would say
look at the Internet and wireless; two of the most lightly
regulated areas. I think consumers have incredibly benefited by
that light regulatory touch, you know, beyond those people's
expectations.
The Chairman. Mr. Szymczak, you noted in your statement, I
believe, that the price for voice services is likely to fall in
the future. What services or revenue streams do you think would
make up that loss? How do you predict that?
Mr. Szymczak. Well, the driver on this decline, of course,
is greater competition, and the voice traffic moving onto
Internet-type of backbones, away from the traditional circuit-
switched network. And I think the opportunities for carriers
are to push more aggressively into broadband. We are seeing
broadband, obviously, into homes, and we are also seeing
broadband wireless, now, starting to roll out, at different
carriers here in the U.S. And so these are incremental revenue
opportunities for them. The hope is that the growth in the
high-speed can offset the decline in the voice revenues. I
think there is much risk in the calculation, and I think that
is why you see these aggressive efforts to find other revenue
opportunities to help justify the investments they want to make
in the network, which has led into the network neutrality
debate, as well as other things. So clearly, we have great
telecom networks in the U.S. And to maintain them, you need a
revenue stream to continue the investment to maintain those
networks into the future.
The Chairman. My last question for this group: the
universal service payments have been made primarily by the
long-distance carriers, by the customers of long-distance
carriers. We are looking to broaden the concept of universal
service contributions so that all communications pays in a very
minimal amount. What effect will that have on the markets? We
envision that everyone that has a number, or some similar
address, would be paying a very small amount into this fund,
and the fund will still be maintained by the industry itself.
What is that impact on the investment market?
Mr. Moore. Senator, I cover the rural local exchange
industry. And as I mentioned, one of the biggest concerns of
investors in that sector is continued support for USF. I think
broadening the base and ensuring the stability of the Fund is
going to have a tremendous benefit to both the investors,
companies, and the consumers, in the rural space.
The Chairman. Anyone disagree?
Mr. Bourkoff. Aryeh Bourkoff. Mr. Chairman, I think there
is a risk that the discrepancy of profitability will expand if
that were to happen. The RLECs enjoy margins materially higher
than the ILECs and the cable companies, right now, I think as a
result of the Fund. And if that were to redistribute, so to
speak, and I think the Bells and the cable companies may have
even more of a profitability disadvantage.
The Chairman. Disadvantage?
Mr. Bourkoff. Yes, because obviously, the cable companies
today do not pay into the Universal Service Fund. And if they
were to participate, it would drag their margins down even
further, where the RLECs right now enjoy margins above 50
percent. The cable and the ILECs are around 40 percent, right
now.
The Chairman. Let me ask you about this net neutrality
problem that two of you have mentioned substantially. Do you
think a network operator could block access to a company like
Google or Yahoo! and really get away with it?
Mr. Szymczak. I think that would be very difficult to
sustain on an ongoing basis. Because if we think about it from
a competitive perspective, if the phone company were to block
access to a website, a lot of its customers would switch within
that day or the next day to a cable operator. So it would
always offer an opportunity to the fellow who is not blocking
it to take customers. So I think that pressure will make it
very difficult for an access provider to block access to an
important service.
The Chairman. Go ahead, Mr. Bourkoff.
Mr. Bourkoff. Thank you, Mr. Chairman. I agree. I think
that blocking an access would be a devastating outcome. But I
think the middle ground is probably that there has to be a
tiering structure put into place, where some of the higher-
capacity content over the Internet that really requires a lot
more bandwidth, you may have to pay more for packet
prioritization, for some of that content.
Otherwise, there is a risk that the CapEx cycle will
continue to increase, and that there may be a sort of
inequitable distribution of that capacity. So there should be
equal access, in my view, of video content across the spectrum,
but maybe at a defined capacity level. If it gets above or
below that, there may be a tiering structure, which could help
differentiate that.
The Chairman. We were visited by some minority groups
recently about the lack of access for minority groups, in terms
of access to channels, and just general access to being able to
provide content. If we get into that, is that going to have
much effect on your testimony here today? If we mandate some
percentage participation in markets, what is the impact on the
stock market? You do not want to touch that?
Mr. Moffett. I am sorry, you are referring to inducements
for minority investment in some of these areas like in the
past, wireless----
The Chairman. I am talking about having Congress mandate
that each area must allow a participation of a dominant, or one
or two of the dominant minorities in the area, have access to
channels, and to provision of content.
Mr. Bourkoff. I am a proponent of the fact that there is
equal access that should be enabled. And if it is not
happening, it could be mandated. But the rate card, or the
prices paid for that content could vary, depending on the
market factors like demand, and obviously, viewership, and so
on.
The Chairman. Well, we thank you. I am sorry the other
members were not here today. This is what we call a ``vote-a-
rama,'' starting out there right now, at least seven votes in a
row on the budget bill, and we did not anticipate that when we
scheduled the hearing.
Thank you all for taking the time and going to the trouble
of preparing the statements and appearing here. We would
appreciate your comments as you see us keep going on this
markup, which we will take up, I think will start sometime
after Easter, and really get down to trying to get a bill out
on it. So if you have any further comments you would like to
get to us, we will appreciate receiving them.
Thank you very much for coming.
[Whereupon, at 3:20 p.m., the hearing was adjourned.]