[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

                              ----------                              
                                                                   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.]

                                  
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