Telecommunications Industry

INTRODUCTION

The telecommunications industry provides a wide range of services such as cellular, paging, Internet, cable, voice and data communications, local and long-distance services. For the purpose of this industry analysis we will focus on the long-distance sector of telecommunications.

Telecommunications industry revenues have grown at an average of 9% over the past 5 years. Sales in 1998 exceeded $430 billion and are expected to continually rise. The top competitors in this growing industry are AT&T, Sprint and MCI WorldCom. As reported by the Federal Communications Commission (FCC) in 1997, AT&T holds a majority of the long-distance market share with 47%, while MCI WorldCom contains 25%. In addition, Sprint holds 10% of the market with the remaining 18% belonging to 400 smaller companies. The analysis of this industry will focus on the major market shareholders noted above as well as GTE.

Long-distance service providers in this industry are subject to several driving forces. These driving forces include regulatory agencies, technological innovation, the threat of new entrants, and competition and mergers amongst existing companies.

INDUSTRY ANALYSIS

Economic Characteristics/Conditions

Table 1: Dominant economic characteristics of the telecommunications industry

An obvious trend in the telecommunications industry is the convergence of voice and audio communications. Telecommunications companies are restructuring their operations and offering themselves as holistic providers for these services. Implementation of this communications structure will require time, "It could be a decade before carriers feel a strong enough business demand for integrated services to upgrade their infrastructures to carry truly converged voice, video, and data communications. Although a converged network is inevitable, many observers see a multitude of networks co-existing for many years to come."

Company mergers are a trend that is constantly reshaping the industry. In a recent merger that was completed in 1998, WorldCom acquired MCI Corp., which was the second largest long-distance company. Within the 100-year history of the telecommunications industry, mergers have played a strategic role in the remaining company’s success.

Another major trend is for companies to offer dial-around services. The service consists of dialing a 7-digit prefix to the phone number you are dialing. This offer temporarily allows you long-distance service from a company other than your contracted long-distance provider.

Porter 5 - Forces

Rivalry among competitors: The telecommunications industry is a very competitive environment. The major competitors are extremely large in terms of assets, product distribution and brand name recognition. AT&T is the dominant market leader, however a few strong competitors are successfully acquiring consumers from AT&T’s market. There is no cost to switch to an alternative long-distance provider, therefore the primary incentive for acquiring and retaining clients is to offer the lowest price. Competition is fierce within this industry and the providers’ primary efforts are focused on minimizing cost in order to offer the lowest priced service.

Potential new entrants: The long-distance telecommunications market is on the verge of a significant change. The Telecommunications Act of 1996 enabled cable and local carriers to offer long-distance services. This means that the long-distance company’s markets will be opened to more competition. These new competitors are formable opponents. They will be entering the long-distance market and bringing with them the experience of operating in the local and cable communications industries. The new competitors will enter with a brand name, strong customer base already in existence and significant capital.

Substitute products: There are many substitutes to paying toll charges for long-distance telecommunications transmissions. Among other things, consumers have the option to e-mail, utilize wireless communication (cellular phones and 2-way radio), switch to an alternative provider in the form of dial-around numbers or phone cards, and use postal service. The cost of switching to an alternative provider, if any, is relatively low and often times insignificant. The substitute products stated above are a threat to long-distance communications; however, the long-distance telecommunications parent companies also provide many of these substitute services. Therefore, there is little negative impact of switching to a substitute service so long as the consumer retains the same provider. Recent home and personal usage trends in communications have a negative impact on the long-distance industry but a positive effect on the parent telecommunications company.

The power of suppliers: The primary suppliers to the long-distance telecommunications industry would include fiber optics providers, hardware suppliers and employees. The suppliers possess minimal leverage. Many of the hardware and fiber optics providers have been integrated either through acquisitions, alliances or cooperatives. The labor force is unionized and there are periodic labor disruptions within the organizations. Many of the jobs available do not require "extraordinary" skills and therefore most of their labor force may be easily acquired or replaced.

The power of buyers: Telecommunications industry consumers possess significant leverage. Perhaps their most threatening capability is the ability to switch to an alternative provider at little, or no cost. If a long-distance company is too "pricey" they will quickly loose clients, market share and revenue. Secondly, buyers are extremely well informed as to prices offered by alternative providers. Marketing for long-distance service is intense. Frequent telemarketing, TV advertising, celebrity endorsements, billboards, radio and bulk mail inform consumers of the various long-distance rates and services that are available. Consumers are very informed as to pricing structure and are unlikely to withstand rates that deviate too far from the lowest possible rate.

Although consumers possess significant leverage, long-distance providers are fortunate in that the product they offer is virtually a necessity. Usage may vary but every developed area will employ these services regardless of the cost. This is why the government is so involved in protecting the consumer. Additionally, long-distance providers have an extremely large pool of consumers to target. The impact of loosing a few clients is relatively insignificant considering the billions they still have the opportunity to acquire.

Government regulation: The federal government heavily regulates the long-distance telecommunications industry through the FCC. "The mission of this independent government agency is to encourage competition in all communications markets and to protect the public interest." The FCC is directed by the federal government to develop and implement communications policies that protect consumers. The FCC’s presence significantly impacts the telecommunications industry.

Industry Attractiveness

The long-distance telecommunications industry is a very attractive industry for mature and experienced companies. There are many consumers to serve, and the idea of an "all-in-one" provider is attractive to many consumers. With the demand for long-distance services not likely to decrease, companies that offer the full range of services (ISP, wireless, etc.) can have a significant impact on the market.

The competition within the industry is somewhat minimized when one considers the growth occurring in the computer and technology industries. Considering the frequent advances occurring in the communications industry, market saturation is highly unlikely. As Americans eventually mature in their quest for the "complete" home communications center, telecommunications companies may look forward to conquering foreign and less-developed markets.

COMPANY ANALYSIS

AT&T

Of all the long-distance telecommunications companies, AT&T boasts the most market share. The AT&T strategy is reflected in their mission statement which reads as follows:

AT&T is committed to providing a wide range of services such as voice, data and video telecommunications services, cellular telephone, Internet and cable services. At the present time AT&T is attempting to expand services by purchasing MediaOne, the nations 4^th largest cable television operator. "AT&T plans to use cable systems to deliver local and long-distance phone service, high speed internet access and interactive entertainment to millions of US homes" This acquisition would make AT&T the nation’s largest cable operator.

Since 1997 C. Michael Armstrong has managed the AT&T Corporation as CEO. AT&T’s home office is based in New York, NY. Their major divisions include Customer Markets, Business Services, AT&T Solutions, AT&T Wireless Services, AT&T Local Services, Network Services and AT&T Labs.

After a 3-year decline in sales, AT&T’s 1998 net sales showed an increase of 3% over 1997. Sales for 1998 reached $53.22 billion. Their net income in 1998 rose 23% from 1997’s figures, to $6.398 billion.

According to Market Guide, one is recommended to buy or hold their present stock in AT&T Corporation. Since 1997 AT&T’s earnings have met or exceeded analysts projections. AT&T’s current stock price is listed at $50.50 per share, and earnings have continually risen over the past four years.

MCI WorldCom

MCI WorldCom is a global business telecommunications company. Operating in more than 65 countries, the company is a provider of facilities-based and fully integrated local, long-distance, international and Internet services.

The recent merger of MCI and WorldCom created the world’s 2^nd largest long-distance provider, MCI WorldCom. Their mission statement reads as follows:

MCI WorldCom’s mission statement reflects the desires of the entire telecommunications industry to be the "single-source" provider of communications. Their one-source strategy is reflected in their product line which includes, cellular and paging, local phone, international telecommunications, information technology consulting and outsourcing, and multimedia services.

MCI WorldCom’s headquarters are located in Jacksonville, Mississippi and is managed by CEO Bernard J. Ebbers. Due to the 1998 completion of the merger between MCI and WorldCom, 1998’s sales more than doubled to $17.678 billion. The $37 billion acquisition caused net income to plummet to $-2.669 billion. MCI WorldCom’s products include UUNET, MCI WorldCom Advanced Networks, Business Services and Customer Services.

Each year earnings have met or exceeded analysts’ expectations therefore, analysts strongly recommend the purchase of MCI WorldCom stock. Currently the stock price is $82.19 and beta is listed at 1.44. Compared to the industry average, MCI WorldCom’s beta indicates there is a higher risk factor associated with this stock.

Sprint

Sprint is a global communications network involved in long-distance, local, wireless and Internet communications. Sprint built and operates the United States' only nationwide all-digital, fiber optic network and is a leader in advanced data communications services. Sprint has $16.02 billion in annual revenues, $1.54 billion in net income and serves more than $17 million businesses and residential customers.

Sprint’s goals are to maintain exceptional customer satisfaction, inspire, innovate and empower employees, as well as producing superior financial results. The Sprint vision reads as follows:

The CEO of Sprint is William T. Esrey. The Sprint World headquarters are located in Westwood, Kansas and Sprint’s Long-distance headquarters are located in Kansas City, Missouri. Sprint is divided into three major divisions: long-distance, local communications, and product distribution / directory publishing. Sprint is involved in joint ventures with Global One (world and Europe) and Sprint PCS.

Analysts recommend buying or holding stock in Sprint. Currently Sprint stock is selling at $102.56 and their beta is .64. Their beta indicates low volatility in comparison to the industry standard.

GTE

Domestically, GTE provides local service in 28 states and wireless service in 17 states. Services include nationwide long-distance and internetworking services ranging from dial-up Internet access for residential and small-business consumers to web-based applications for Fortune 500 companies; as well as video service in selected markets.

GTE’s headquarters are located in Irving, Texas and their CEO is Charles R. Lee. Their philosophy consists of a commitment to the future of the organization as well as the professional growth of each employee. GTE is committed to focusing on its core operations. Their mission statement reads as follows:

Revenues in 1998 increased 9.4% to $25.5 billion, however net income fell to $25 million, nearly an 11% loss from 1997. Analysts recommend holding or conservatively buying stock in GTE. The recent quarters’ earnings have either failed to meet or exactly matched analysts’ projections.

GTE’s major divisions are as follows:

PERFORMANCE ANALYSIS

Profitability

In this industry, the five-year profitability trend shows returns on assets have gradually increased. The gains are minimal, however all of the companies except GTE exhibited growth. This would indicate that either their profit margin or their turnover rate was increasing. GTE’s return on assets performed opposite to that of the telecommunications industry and has declined over the past three years.

The industry ROE has declined approximately 10% since 1994, indicating that new investments have offered a lower return than past investments. The industry as a whole has been using more leverage. All of the companies analyzed exhibited this trend except Sprint whose return on equity rose 58.3% from 1997 to 1998.

Liquidity

Industry liquidity was measured by analysis of the current ratio. With the exception of Sprint, all of the companies exhibited a declining trend in the five-year analysis of the current ratio. Once again this indicates an increased usage of debt and possibly a decrease in physical assets. Many of the companies have current ratios that indicate that they are not liquid, however the ratios are in line with the industry average. In the case of the telecommunications industry there are relatively few current assets, this contributes to the low current ratios.

Leverage

In the telecommunications industry, the percentage of funds provided by creditors has been relatively stable over the past five years. The industry debt-to-asset ratio has hovered 48.8% over the five-year period. AT&T is currently reporting a debt-to-asset ratio which is approximately 17% higher than the industry average. However, AT&T has obviously made commitments to reducing this ratio. In 1995 their company was leveraged 80.6%. Of the companies evaluated, GTE is the most significantly leveraged. Their debt-to-asset ratio was 79.9% in 1998 and their four-year average was 80.8%.

According to the five-year industry average of the debt-to-equity ratio, creditors provided slightly more funds than stockholders. The five-year average debt-to-equity for the industry was 96.02%. There was not an obvious correlation between the industry and the four companies analyzed. AT&T and MCI WorldCom had ratios well below the industry average indicating that they had fewer funds supplied by owners, or perhaps lower debt. Sprint and GTE’s ratios were significantly above the industry average.

RECOMMENDATIONS

We recommend that the telecommunications companies proceed in their quest to offer a full range of communications services to consumers. This can be achieved through mergers, acquisitions and formations of strategic alliances. This goal may also be a achieved by emphasizing technological innovation.

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