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For ILEC with 210k-Mile Network, IPTV Just "Another Application"

It appears CenturyLink didn't want to miss making an announcement at last week's Citi Entertainment and Media Conference, going with a "me too" approach to IPTV services. The "announcement" was modest, as CenturyLink revealed that they would be extending their IPTV services to one or two new markets in the former Qwest territory. Currently CenturyLink's Prism IPTV service passes 1m homes in select markets and, as of 3Q11, had 50k subscribers. For a telecom provider as large as CenturyLink, however, those numbers are relatively small—but what's interesting is how CenturyLink executive vp and cfo Stephen Ewing characterized IPTV: as just “another application.”

Ewing said, “The incremental cost of us rolling out IPTV is not significant. Once you get a 20 Mbps service out there to a customer the incremental cost of layering IPTV on top we view it as another application.” These sentiments, of course, square with what we've been saying for a while—that since so many providers spent so much time and money on network build-outs and improvements, this was the year to capitalize on those networks with new services, content, and applications.

But CenturyLink's "announcement" seems pretty modest, and offering IPTV in only two markets seems like a paltry "expansion," considering that the company has 210k miles of fiber. With its acquisitions and its expansive network, rollouts like IPTV appear to be an obvious next step. For now, Ewing said that, “The (IPTV) customer base is still small, but we did increase the customer base 25% during the third quarter.”

CenturyLink's network design also makes IPTV easier to distribute, as all of its video content is put into a head end in Missouri and, from there, distributed to each of the 8 markets currently served with IPTV. Each market also has its own mini-head end for local content, and all content is delivered over CenturyLink's fiber network.

Last fall, the company denied speculation that it would expand its Prism service to former Qwest markets. CenturyLink had just inherited Qwest's 1m DirecTV subscribers and was committed to satellite TV. But now the Louisiana-based ILEC says it's following a two-pronged approach to video services: satellite and IPTV. It's a strategy that allows CenturyLink to hedge its bets, capitalize on the satellite subs it's already inherited, and continue to anticipate consumer trends, as greater numbers of Americans access over-the-top video services like Netflix. Ewing said, “If over the top eventually takes some of the traditional TV market, we think we'll be well positioned with the bandwidth with have to our customers to participate in that.”

What is surprising, however, is that CenturyLink does not seem to have an overarching strategy to build out broadband to former Qwest markets. So far the company has just said, vaguely, that it plans to "expand its broadband footprint." Broadband has been a key component to the ILEC's business strategy for a while now, and in 3Q11, the service provider added 57k high-speed Internet subscribers, versus only 12k in 2Q11. Part of these gains, however, come from Qwest's FTTN initiative, which CenturyLink has continued after the acquisition. By the end of this year, CenturyLink estimates that it will pass 5.4m homes with FTTN.

In FTTN service areas, 75% of customers enjoy 20 Mbps speeds, while the remainder of subscribers have speeds of 10 Mbps or higher. As for CenturyLink's big picture, about 20% of subscribers can get 20 Mbps, over half can get 6 Mbps, and two-thirds can get 6 Mbps or higher. According to Ewing, “The speeds will continue to improve over 2012 and future years as we continue to build out the IPTV footprint and the Fiber to the Node footprint in the Qwest markets primarily,” he said.

Of course, CenturyLink will find itself increasingly in competition with LTE services (which we will look into more next week), but for now Ewing said CenturyLink seemed to have an edge, due to its increasing bandwidth. Ewing said that average customer usage is continuing to rise to about 18 Mbps, double where it was a year ago.


Standing Rock Telecom Approved as CETC

Tribal Company Looks to Collect USF Funding, Expand Wireless Service & Broadband

Earlier this month, the FCC granted Dakotas-based Standing Rock Communications competitive eligible telecommunications carrier (CETC) status, which will open the door for Standing Rock to receive rural, high-cost Universal Service Funding at the same rate as incumbent carriers who also provide service in the area; currently, these rates are about $23-66 per line per month. With the extra revenue, Standing Rock hopes to improve its wireless service and broadband capacity, in order to compete with CenturyLink (former Qwest market) and West River Telephone, the area's ILEC. The decision comes as the FCC attempts to phase out the CETC designation of the USF, but grants exceptions to tribal phone companies who often provide coverage in unserved or underserved regions.

The USF funding will also help free up revenue for Standing Rock's wireless expansion, as the company currently is rolling out Phase I of its build out – installing towers, equipment, and antennas throughout the reservation. In Phases II and III, the company plans to also add more towers and equipment to improve its service area.

“This decision, long-awaited, but most welcome, means that we will receive federal support to operate our state-of-the-art-network and deliver desperately-needed wireless service to Tribal residents throughout our rural reservation,” said Charles Murphy, chairman of Standing Rock Sioux Tribe.

As a tribal-owned wireless communications provider, Standing Rock operates both fixed and digital cellular service throughout 4k square miles in North and South Dakota – an area corresponding to the Standing Rock Sioux Tribe Reservation. Landline subscriber rates are quite low on the reservation, and according to Standing Rock Communications general manager Mike McAllister, there is evidence that wireless voice and data service would be well-received by residents.

Doug Bonner, a spokesperson for Standing Rock Communications and the lawyer representing Standing Rock during its FCC petition, said that for the past three years the company has invested in a CDMA network with 18 cell sites and that “without Universal Service funding, it has been a huge financial commitment and a burden on the part of the tribe.” Bonner also noted that the USF funding could help provide more opportunities for families on the reservation, where “the average income is $10k and the high-school graduation rate is 60% or less.”

Standing Rock currently offers the Lifeline Program, which helps by subsidizing monthly phone bills for low-income subscribers, but hopes even more opportunities and education will come from improved communications and data access. Broadband may be key to these new opportunities, and Standing Rock says it will also be offering broadband wireless services capable of supporting download speeds of 3 Mb/s and up. McAllister noted that the higher speeds will be possible by using fixed wireless. “Because of the way we built our network we can implement it without deploying LTE or WiMax,” he said.

The official FCC Order states that it is important for the Standing Rock Sioux Tribe to “own and operate the critical communications infrastructure needed to protect the health and safety of Tribal consumers, spur local economic development, preserve Tribal language and culture, and further the education of consumers through distance education programs.”

The Commission's decision might also set a precedent for future regulation of communications services on tribal lands, as the Commission ruled it unnecessary to redefine a rural telephone company's service area when the ETC is designated throughout the rural service areas in the FCC's jurisdiction (such as the rural service areas within reservation boundaries). As a result of this decision, Standing Rock will not have to wait for state commission approval of its ETC status – a process that had been delaying USF subsidies.

Bonner argued that the FCC's order reflects a strong commitment to communications development on tribal lands: “[This decision] is a strong federal agency statement of the importance of Tribes being empowered to own and operate critical infrastructure (such as a ubiquitous wireless communications network) throughout a federally recognized Reservation to meet the needs of their communities and historically underserved Tribal lands.”


National Broadband Map Not All It's Cracked Up to Be

Shopping for Broadband Reveals Cable Still Out Front

It’s been a week since the National Broadband Map was unveiled, and as fate would have it, I’ll be moving into a new home soon, so this seemed like a perfect opportunity to test the tool and select my broadband service provider for the new place at the same time.

Sadly, I have found the tool to be disappointing, buggy, and the data incomplete.  Sure, the site asks you to let them know if you don’t see your provider, but in my southern New Mexico community it seems a fair bet that cable provider Comcast (Nasdaq:CMCSA) is probably the largest broadband service provider around—and in repeated tests Comcast didn’t even appear in the list.  

Not only is this an obvious omission, it’s also disconcerting because NTIA awarded nearly $150m to all the states for gathering this information every six months.  That’s $3m per state—I’d like to bid on the contract for NM, please!  Here's what the map showed me when I plugged in my zip code:

As for what was revealed, the map is really nothing more than a starting point.  But it was interesting to compare and contrast the current options as a consumer rather than an analyst…our ILEC readers, however, may be sad (unsurprised?) to find I’m going with Comcast as my broadband service provider. Here are the reasons why:

The National Broadband Map listed Qwest (NYSE:Q) and Covad as the only two wired options, but a quick glance at the yellow pages confirmed that Comcast too serves this area.  Covad targets business users and its cheapest service is $80/month for DSL—not an option for Richelle.  

Qwest has a special for the first six months where you can get any speed DSL service for $15/month and you don’t have to be a landline customer…sounded interesting, but the devil’s in the details—or rather the speeds.  You will pay $100 up front for a modem, or lease it from Qwest for $8/month.  After six months, the monthly rates without a “qualifying home phone plan” range from $40/month up to $70/month, based on the data speeds.  As a video cord-cutter who occasionally streams Netflix movies, I want a pretty high speed, probably 12 Mbps or 20 Mbps for download.  These will run $50 or $60/ month after the first six months, and the upload speeds are just 896 Kbps.  All in, I figure I’ll spend $41 or $42 /month with Qwest for the first year, more if I decide to lease rather than buy the modem, but the second year we're talking $60/month. 

Next I looked at Comcast.  Comcast’s current promotion is $30/month for the first six months for its Performance package, with a download speed of 15 Mbps and upload speeds of 3 Mbps.  The plan is $45/month for months 7 – 12, and could range as high as $50-$60/month thereafter.  Here you can provide your own modem (which run about $50 at Staples, with WiFi), or lease theirs for $7/month.  I figure I would buy my own.  So the pricing looks slightly lower than Qwest's DSL service--not a lot less, but its speeds are also higher.

The national broadband map lists four wireless providers in my area, and Verizon’s (NYSE:VZ) is actually listed as the fastest provider included, with speeds of 3 Mbps to 6 Mbps (of course, if Comcast were actually in the list, it would be the fastest!).  When I plug in my zip code on Verizon’s web site I’m given the option of acquiring a 4G USB modem for $100 with a 2-year contract or for $170 with a one-year contract.  The data plans are $50/month for 5 Gigabytes of monthly use and $80/month for 10 Gigabytes.  But how much is a gigabyte of use?  Before I pondered that question, however, I read the product reviews for the two modems presently available and at least half of the reviewers were unhappy with the product; many said it didn’t hold the 4G signal—reverting back to 3G instead—and it lost its connection often.  I’m not in a high population area so I have my doubts as to whether I would actually get a 4G signal here.

AT&T Wireless’ (NYSE:T) web site had a very cool data usage estimator that helped me answer the gigabyte question.  Based on 140 emails/day with no attachment, 100 emails/day with a photo or other attachment, 200 web page views per day, and 30 minutes of streaming video per day, my estimated monthly usage according to AT&T Wireless would be 3.74 Gigs.  But the calculator wouldn’t even let me figure on streaming more than 50 minutes of video per day, which tells me their service isn’t really an option for a cord cutter. 

The other odd thing about AT&T’s site is that it promotes a DataConnect 4G service as well as DataConnect 3G.  We all know AT&T doesn’t actually have a 4G service at this time, but both it and T-Mobile have decided to call their HSPA+ system 4G.  Speeds, however, are closer to those of DSL, well below the 5 – 12 Mbps that LTE systems are delivering.  Nevertheless, AT&T’s DataConnect 4G service is just $50/month for 5 gigabytes, whereas its DataConnect 3G service is offered at $60/month.  For what is essentially a 3G WiFi hotspot, however, AT&T did have very good reviews.  In fact, it didn’t have any bad reviews, a fact which gave us pause…

The last two wireless “broadband” providers in my area are Sprint (NYSE:S) and Leap (Nasdaq:LEAP), which markets its service under the Cricket brand name.  Sprint (Clearwire) doesn’t have 4G service in my market yet, but it offers a 3G/4G USB modem for free with a 2 year contract, which is $60/month and limited to 5 gigs of data per month on the 3G network. Data usage is, however, unlimited in markets where 4G is available.  Speeds here are reportedly less than 800 Kbps according to the national broadband map. 

Cricket actually had a better deal for 3G data:  the modem is free after a mail-in rebate, you don’t have to sign a contract and the plan is $60 per month for 7.5 gigabytes of data.  Cricket says its speeds are up to 1.4 Mbps, though the national broadband map has it at the under 800 Kbps rate.

So, while I was initially hopeful there might be a wireless option that would work for me, the speeds simply aren’t there yet (not here anyway).  And compared side by side, for the speeds I find the cable broadband option more palatable.  Of course, if Qwest didn’t insist on a home phone line for its cheaper pricing, I might have come to a different conclusion…(something for you ILEC managers to think about).

As for the National Broadband Map, it was a year in the making, it cost an awful lot of money, and it doesn’t seem to be fully baked just yet.  Ah, government at its finest… 


Large ILECs Lessening Reliance on Consumers

RLECs…Not So Much

Several of the publicly traded ILECs that we follow have made a concerted effort over the past few years to shift their customer base from residential consumers to enterprise customers and small/medium business customers.  The rationale is clear—business users, regardless of the type of product or service they offer—have been considered less likely to cut the cord, or at least more willing to opt for a bundled plan that includes a wired voice offering along with broadband connectivity.  Windstream (Nasdaq:WIN) has been a vocal proponent of this strategy and its desire to shift its revenue base from consumers to business was a clear factor in several of the acquisitions it made over the past two years.

We decided to take a look at the trends in business versus consumer lines for those public companies that report the breakdown.  We then compared those trends with data we collect in our annual Phone Lines census, where we survey the nearly 1,200 LECs nationwide on their connections.  Several hundred respondents each year provided information on the breakout between consumer and business lines.  

What we find is that the largest LECs (i.e., RBOCs) have been reporting steady increases in the proportion of business lines in the mix.  RLECs, on the other hand, have been reliant upon consumer lines for approximately 80% of their lines since 2003, with no notable shift in the breakout between consumer lines and business lines.


First the public companies.  We found that 10 of the public ILECs reported a breakdown for business versus residential lines for at least some of the years between 2006 and 2009.  And where in 2006 the percentage of business lines was about 36%, by the end of 2009 that percentage had grown to nearly 42%.  These figures are, of course, heavily weighted by the two RBOCs—Verizon (NYSE:VZ) and Qwest (NYSE:Q)—that report the breakdown. 

Next we had a look at the public companies excluding the RBOCs.  The eight remaining public companies reported that business lines accounted for 31% of total lines in 2006; by 2009 that figure had grown to 35%.

Of course, the larger LECs, and the RBOCs in particular, have suffered the steepest overall access line declines in recent years.  If you assume that a large proportion of cord cutters are (were!) residential customers, than the shift makes sense. Most RLECs on the other hand, have lost lines at a rate of just 3% - 5% on average for the past several years. 

Based on data gathered in our annual Phone Lines census, where we survey each of the nearly 1,200 RLECs nationwide on their connections, we were able to find nearly 300 companies that had provided the business versus residential breakout for at least two of the years examined.  And while the number and composition of companies included in the analysis varied from year to year, the proportion of business to residential lines was uncannily stable, going all the way back to 2003.

In 2003 our analysis indicated that nearly 80% of the access lines served by RLECs were for residences and just more than 20% were identified as business lines.  Fast forward to 2009 and we find that 79% of lines were for residences and 21% served businesses.

So what does it all mean?  Obviously, change comes more slowly to rural markets, and particularly in areas where wireless coverage may have been sub-par, mobile substitution has not occurred as rapidly.  On the other hand, in those places where coverage is solid, or attractive VoIP options have been available, small business owners looking to save money may have made the switch at roughly the same pace as consumers.

Looking ahead, however, we wonder if there isn’t more that rural LECs can do to build up their importance to local businesses.  Getting there first with a VoIP option may be a solid strategy, particularly if the local cable company is aggressively promoting the service.  Fixed wireless solutions with a VoIP component may also work well in some areas, especially for those who’ve warehoused spectrum over the past decade.  At the end of the day, both consumers and business customers will be seeking the best value for their dollars, but a healthy relationship with local business owners could well be one of the best defenses an RLEC can employ.


Defining RLEC Ownership Strategies

Target Growth, Hurry Your Harvest.....or Find the Door

The telephone industry is changing so rapidly, and from so many different directions, it’s almost impossible to keep pace.  The National Broadband Plan, Google Voice, LTE, DOCSIS 3.0, Magic Jack and the Connect America Fund are just a few of the emerging developments casting a shadow on the industry.  With so much going on, it’s easy to become a “deer in the headlights,” frozen by the magnitude, volume and pace of change.

With so much change and uncertainty facing RLEC owners, it is more important than ever to take the time to critically and objectively assess where you are and, more importantly, where you are going.  As they say, “No wind favors he who has no destined port.”

To assist RLEC owners with this task, we’ve defined six RLEC ownership strategies.  Three of those strategies – horizontal growth, vertical growth and organic growth - involve the pursuit of, you guessed it, growth.  Two strategies – the current exit and the smart exit – emphasize planning for the near- or long-term sale of your company.  The final strategy – the Harvest Mode - is for those that, for one reason or another, are restrained from either growing or exiting.

There is one more strategy, which we’ll reveal at the end.  Suffice it to say, you’re better off embracing one or a combination of the initial six strategies.

We have ordered the six ownership strategies in order of their ease of execution.  Our first ownership strategy, a current exit, is a relatively easy task.  On the other hand, our final ownership strategy, organic growth, is far easier to describe than execute.

Current Exit - Sometimes it seems like an increasing number of RLEC owners are opting to make for the exit rather than weather the uncertainty of what looks to be coming down the road.  Over the last few years, we’ve seen a number of high-profile names sell their companies including Walt Clay of Hutchinson Telephone Company, Bob Eddy of Sherburne Tele Systems, Mike Coltrane of CT Communications, Chris Dupree of Graceba Total Communications, and, more recently, the Henning Family of Cameron Communications.  These are stalwarts of the industry whose identities and legacies are permanently intertwined with the small and rural telephone company industry.  When folks such as these decide its time to “throw in the towel,” it’s got to be a bit disconcerting to those left carrying the torch.

While the number of annual ILEC sale transactions has remained relatively stable over the last decade, the percentage of ILECs hitting the market each year continues to tick upwards.  With about 20+/- ILECs changing hands each and every year, ownership churns at a rate of about 2.5% a year.  Discount that for the number of cooperative telephone companies, which have contributed only nominally to the number of ILEC sales over the last decade, and the annual rate of churn jumps to more than 5%.

You can’t really blame those who have opted to cash in their chips.  At some level its boils down to the preservation of wealth and security.  It’s generally fairly easy to pencil out how a current sale best achieves those goals.

Others have avoided this alternative, either because they are committed to the execution of one of our other ownership strategies, or because they are waiting for a renaissance of ILEC values before committing to a sale.  While the latter is possible, it seems increasingly unlikely.  The industry has experienced a steady decline in valuation multiples over the last decade.  There is likely a point through which valuation multiples will not descend; however, the same can not be said about the performance metrics to which multiples are applied.  Over the next decade, it will be competition and regulatory uncertainty (or change) that will erode financial performance and overall values.

Owners who pursue a current exit must prepare themselves and their properties for sale.  A sale process can often last as long as nine months to a full year and sometimes even longer (just ask someone who owns an RLEC in New York).  In some cases, particularly for smaller properties, owners must prepare themselves for the very real prospect that a qualified and motivated buyer of their property may not exist.

Harvest Mode - So what happens if you can’t find a buyer?  Or what happens if you can find a buyer, but by the time you finish paying the bank, the broker, and the IRS it doesn’t make financial sense for you to sell?  As we have suggested in the past, in light of current trends within the telephone industry many owners may be faced with the reality that their best course of action is to take “as much money out of the company as [they] can, ride it into the ground, and turn the keys over to the PUC when [they are] done.”  This is what we call the “Harvest Mode.”

The goal of the Harvest Mode is to maximize benefits realized by shareholders and owners of the company.  Often, these benefits are not limited to financial gain but include sustaining a family legacy, employing friends and family members, and/or honoring commitments to communities.  Typically, however, financial gain is a critical driver of the Harvest Mode, manifesting in the form of increased or enhanced owner salaries, dividends, benefits and/or perquisites.

But a harvesting strategy can be an emotionally draining process in a declining business.  This year’s gut-wrenching cost cuts must be followed by next year’s equally draconian cuts, and so on and so on.  It can easily be perceived that the objective of the Harvest Mode comes at the expense of the welfare of a telephone company’s employees and customers.  For this reason, the Harvest Mode is often viewed with suspicion or outright contempt, particularly by employees and regulators.

But there is nothing sinister about the Harvest Mode.  Properly executed, the strategy balances the needs of all stakeholders and can extend the viability of existing operations.  While it is not a growth strategy, it remains a very viable strategy that will increasingly serve as a default in cases where a satisfactory alternative is not available.

Horizontal Growth - You might wonder why, given the decidedly negative current prospects of the telephone industry, someone would pursue an ownership strategy centered on the objective of acquiring ILEC properties.  The industry is hemorrhaging access lines, top line growth is all but non-existent, and improvements in cash flows - if any - are more the result of cutting costs than growing revenues.  Doesn’t an ownership strategy dependent solely on the pursuit of horizontal growth simply create a bigger “Melting Ice Cube” (see The Default Strategy below)?

Perhaps, but there are nonetheless a number of groups pursuing a primarily “horizontal growth” strategy.  The former CenturyTel, which has morphed into CenturyLink through the acquisition of Embarq and the pending acquisition of Qwest, falls into this category.  Frontier Communications, with its recently completed acquisition of 4.2m Verizon lines (it was 4.8m access lines when the deal was first signed) in 14 states is another horizontal acquisition advocate.  American Broadband, which recently announced plans to acquire Cameron Communications from the Henning Family, has for many assumed the role of the industry’s buyer of last resort, a role previously held by the likes of FairPoint Communications and Telephone & Data Systems.

But with values continuing to decline, why are groups aggressively pursuing horizontal acquisitions that, if recent history is an indication, will likely be worth less tomorrow than today?  There are several likely answers to that question including the desire to capitalize on real or perceived synergies with existing operations; the need to capitalize on scarce RLEC acquisition opportunities; or the pursuit of the scale necessary to realize operational efficiencies, capitalize on vertical and/or organic growth opportunities, and to attract capital and management talent.  A somewhat more nefarious objective includes using horizontal acquisitions to mask the decline of existing operations.  And, of course, there’s always the belief that one can operate a property better than the former owners.

Growth through horizontal acquisitions is a strategy that can work, but frequently fails to enhance value.  Success is dependent on the ability to buy right and execute well.  Once all the pieces are put together, it would appear that the former CenturyTel will be able to claim it bought Embarq and Qwest at the right price.  On the other hand, Hawaiian Telcom’s ill-fated acquisition of Verizon’s Hawaii lines and FairPoint Communications’ disastrous acquisition of Verizon’s Northern New England lines are two high-profile examples of what happens when execution falls short of expectations.

Smart Exit - A “smart exit” strategy often involves using complex tax-advantaged techniques to maximize the after-tax proceeds (as opposed to before-tax proceeds) realized from a sale of a business.  In some cases, the goal of maximizing sale proceeds is subordinate to the ability to structure the transition of ownership to a target group (e.g., younger family members and employees).

The title “smart exit” isn’t meant to imply that this ownership strategy is wiser than other alternative ownership strategies including a current exit.  Rather, it’s intended to recognize the typically complex nature of these exits.  Smart exits usually unfold over longer periods of time and are typically engineered by legal and tax planning professionals.

For example, back in September 2009, the shareholders of Midvale Telephone Exchange filed paperwork with the FCC announcing their intention to transfer control of the 3,000-line Midvale, Idaho based RLEC to an employee stock ownership plan (ESOP).  The formation of an ESOP, and the transfer of control of an RLEC to that ESOP, is a complex, specialized transaction that requires significant planning and the involvement of qualified professionals knowledgeable in ESOP transactions.  Properly executed, the sale of an RLEC to an ESOP can result in exiting owners receiving tax-advantaged liquidity and cement their legacies by transitioning future ownership to employees.

Other examples of smart exits include the many creative estate and tax gifting strategies that, with an appropriate long-term planning and execution time frame, can result in the efficient transfer of some or all of a company to next generation family members.

Smart exits can also take the form of an amped up current exit.  For example, Verizon used a smart exit to facilitate the sale of its Northern New England properties to FairPoint Communications back in 2008 and the recently completed sale of its operations in 14 states to Frontier Communications.  Verizon employed a “Reverse Morris Trust” to transfer the ownership of the properties to FairPoint and Frontier on a tax-advantaged basis.

A well planned and executed smart exit is the closest thing the M&A field has to hitting for the cycle.  Unfortunately, the industry’s declining prospects and values have dulled the allure of these techniques.  After all, the objective of a smart exit is to make future generations or employees appreciate the opportunity of ownership, not leave them holding the bag.

Vertical Growth – A vertical growth strategy involves expanding into complimentary vertical services, typically via an acquisition.  Examples of notable recent vertical growth initiatives include Shenandoah Telecommunications’ (Nasdaq:SHEN) acquisition of JetBroadband Holdings’ cable operations in Virginia and West Virginia, Telephone & Data Systems’ acquisition of VISI, Inc., Ntelos Holdings’ (Nasdaq:NTLS) planned acquisition of FiberNet from One Communications, and Alaska Communications System’s (Nasdaq:ALSK) recent acquisition of 49% of information technology services firm TekMate. We view Windstream Corp. (NYSE:WIN), which in February 2010 completed its acquisition of Nuvox, Inc. and has recently announced plans to acquire Kentucky Data Link and Norlight, as the industry’s petri dish for vertical growth initiatives.

If you lack internal capabilities necessary to penetrate a new market, or lack the time necessary to gain an adequate foothold, growing through vertical acquisitions can be a viable and compelling strategy.  By marrying complimentary assets and services, vertical growth initiatives can not only realize significant operational efficiencies, but also position a telco for organic growth as well.

Similar to a horizontal growth strategy, identifying and realizing synergies between the two operations is critical to value creation under a vertical growth strategy.  However, unlike horizontal growth, which positions a company to provide legacy services to new customers, vertical growth positions a company to provide legacy and new services to legacy and new customers.  Properly executed, a vertical growth strategy can not only open up opportunities for growth through cross-selling new services, it can also enrich a company’s relationships with its existing customers, resulting in lower churn.

A vertical growth strategy has its share of risks.  The strategy involves buying into new and complimentary lines of business.  Not only are there execution risks as well as the risk that expected synergies fail to materialize, but because vertical growth strategies involve acquiring entities operating in unfamiliar lines of business, it is often necessary to rely on the abilities of a new, and often unfamiliar management team (who often come along in the deal).

Organic Growth – In the perfect world, organic growth would be plentiful and limitless.  Unfortunately, the world is not perfect, organic growth is neither plenty nor without limit, and recent efforts to fuel organic growth have proven illusory.  This is clearly the most difficult growth strategy to successfully execute.

Organic growth is typically realized by either increasing the number of customers served (other than through acquisition) and/or increasing the number of products and services sold to any given customer.  Back in the good old days of the 1990s, organic growth was plenty as customers hooked their dial-up modems and fax machines to second and third lines. Since then, the industry’s growth drivers have all but dried up.  Access lines are rapidly declining and the adoption of broadband services, the engine that fueled much of the industry’s growth through the better part of the last decade (or, in many cases, slowed the decline), has slowed significantly.

The industry continues to pursue organic growth.  Enhancing broadband speeds by extending fiber to the customer premise and continuing efforts to provide competitive video services represent the most significant organic growth initiatives.  Wireless isn’t the opportunity it used to be, but a handful of RLECs are nonetheless attempting to leverage their spectrum positions (and companies) to provide various flavors of wireless service.  Additionally, a number of companies continue to experiment with a myriad of ancillary services such as information technology services, Geek Squad-type computer services, security services, on-line data back-up, managed services and unified communications services.  The level of success realized by these ancillary initiatives is company-specific, but there is little evidence that any one of these emerging services can yet be considered a break-out opportunity for RLECs.

Hybrid Strategies

It would be nice if all ownership strategies fit neatly within one of the six alternatives outlined above.  In reality, many companies combine two or more of these strategies into a hybrid strategy.

Several companies are executing a combination of vertical and organic growth strategies.  For example, Windsteam’s recent acquisition of Lexcom was a horizontal acquisition while its acquisitions of D&E Communications and Iowa Telecom had characteristics of both horizontal and vertical acquisitions.

Other companies have arguably combined horizontal and vertical growth strategies with a harvest mentality.  Consider, for example, the so-called “High Yield Dividend Stocks” including Frontier Communications, Otelco (Nasdaq:OTT) and Consolidated Communications (Nasdaq:CNSL).  These companies have adopted a financial strategy that looks to maximize dividends paid to shareholders, an objective firmly rooted in the Harvest Mode.  But without sacrificing dividend levels, each of these companies has been active on the acquisition front over the last several years.

The Default Strategy

That brings us to our final ownership strategy, which is arguably the strategy followed by most RLECs.  This is a default strategy effectively followed by those which have not embraced one of the other six ownership strategies.  It is a strategy characterized by denial, ineffectiveness, or simple inaction.  RLECs falling within this category are called “Melting Ice Cubes” (at least that’s what we call them).

We don’t mean to be glib or pithy (well, not overly so).  Rather, we mean to make a point.  Inaction (or ineffectiveness) is not an alternative.  A deer frozen by the headlights of an oncoming car usually doesn’t survive the impact.  The trends in competition, technology and regulation are increasingly clear.  For RLECs, business as usual is not a strategy that promotes a sustainable future.  Failure to embrace a strategy that either effectively identifies and pursues opportunities for growth, that targets a current or smart exit, or that “harvests the hay while the sun shines,” relegates RLECs to a drawn-out and painful existence as a Melting Ice Cube.

All RLEC owners need to make an objective assessment of their companies current operating and financial realities and their realistic roles going forward.  If life as a Melting Ice Cube is acceptable, we predict easy sledding.  On the other hand, if preservation of wealth is your goal, you’ve got some serious work to do.