Ringing the changes

Telecom mergers could signal a trend

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"Room to roam"

A fresh wave of consolidations is coming to the telecommunications industry, making the future uncertain for agencies that depend on the companies to provide needed services.

The pending merger of SBC and AT&T and Verizon's acquisition of MCI show that the industry has begun a serious tightening, industry observers say.

With falling profits from voice communications, companies are scrambling to assemble portfolios of services that expand their offerings and generate new revenue.

"End-to-end delivery is the name of the game," said Michael Capellas, president and chief executive officer of MCI.

Two major mergers of wireless providers were announced late last year: Cingular completed its acquisition of AT&T Wireless, while Sprint and Nextel announced they had agreed to merge.

The SBC/AT&T and Verizon/MCI deals are expected to close in early 2006. All of the companies have active federal divisions, which likely will blend as the mergers move

forward.

"The question is what will it mean to federal users," said Warren Suss, president of Suss Consulting. "That's the $64 question. It does seem to me that if we continue to see waves of consolidation like this, that's likely going to have a limiting effect on price reductions in the long run. The fewer players there are, the more there's going to be an ability by the existing federal players to hold prices higher."

Federal agencies that use AT&T services should also be observant, Suss said. Although SBC officials say the federal market is one of great opportunity, that interest may take a back seat to more immediate concerns for the time being, he said.

"During the process of the merger, the federal customer is not going to be the primary focus," he said. "The combined entity is going to have to be careful not to lose focus on the special requirements of the government customer."

AT&T only recently became a strong federal contender, a status that must be protected during merger discussions, Suss added.

"Over just the last year or two, AT&T has been very entrepreneurial; they've been very aggressive toward the federal customer," he said. "You don't want them to lose that spark."

SBC spokesman Jason Hillery said the company has its own presence in the federal market and considers it an area ripe for growth. The company became part of the FTS 2001 telecom contract in early 2004.

Verizon and MCI officials said the government will remain an important customer. MCI's strength in the federal space was one attractive aspect of the acquisition, a Verizon spokesman said.

If the combined companies maintain a strong federal focus, Suss said, it could ultimately be good for federal agencies.

With strengths in different areas, SBC and AT&T would result in a single organization strong in local, "last mile" and long-distance service. The combined companies could be a one-stop shop, he said.

"Access is a giant issue for every

network-related federal deal," Suss said.

"If the merger will allow the combined entity to become more aggressive in bundling long-haul and access pricing together,

it could launch them to the top of the marketplace."

Start of a trend

Perhaps more importantly, the deals could be the start of a consolidation wave, Suss said. It could even spread from the long-distance carriers to the manufacturers of telecom hardware, he said.

"There will be fewer networks, which means less demand for network gear," he said. "There are also pressures for the consolidation to happen sooner rather than later."

The industry was due for a shake-up, said Frank Dzubeck, president and chief executive officer of Communications Network Architects. The cost and, therefore, the profitability of traditional voice transport is falling to near zero with the advent of voice-over-IP technologies, he said.

"It's been percolating for quite a while," Dzubeck said. "There's this whole issue of what the definition of commodity is in the networking industry, but voice has become as close to free as you can get. It rides along with data."

Companies that have historically profited from voice transport must find new ways to generate revenues, he said. Services such as voice mail, e-mail and call forwarding are likely to become more important profit-makers. Companies will need new lines of business and will see mergers and acquisitions as a way to develop those revenue streams.

"Voice is not the issue that it once was," Dzubeck said. "Data and video are going to be much more important. The security aspects are going to be much more important. In theory, voice is going to be an application. When it gets to that point, that's the shake-up point."

"I think the desire is there" to consolidate, said Bob Woods, president of Topside Consulting. "I think the industry feels in many ways they need to do this. It remains to be seen how it will work. What it says to us in general is that we've got to look at new players in coming years."

Suss said it would be harmful if too few companies remain in business. "If there are only a small handful of capable players left standing, then you begin to be concerned about whether the players are going to continue to infuse new technology, whether they'll continue to expand their networks and whether they'll be responsive to customer needs," he said.

Tom Sisti, vice president for law and policy at Washington Management Group, said agency officials must keep a close eye on the providers they do business with and plan for mergers.

"It's an open game at this point," Sisti said. "You have to acknowledge that the market is consolidating. You have to

acknowledge that the technology is changing. It's a very hard market to plan for."

Agency officials, and particularly those at the General Services Administration who will award the upcoming Networx contracts, should continue to urge competition among companies even though the total number of companies may be shrinking, he said.

"That gives people the incentive to sharpen their pencils and get the best deal," Sisti said.

Calling on GSA

Potentially big changes could affect the telecommunications industry at the same time that General Services Administration officials are preparing to award the sweeping Networx telecom contracts.

Although the Networx awards aren't expected until April 2006, consummating a merger or acquisition can take months. That means that government officials may have to begin making decisions about which companies should win spots on the contracts without being certain that those companies will exist in their current form by the time the contracts take effect.

Networx Universal, the larger of the two contracts, will offer a wide array of telecom and network services, and companies must be able to provide their services across a broad geographic area to qualify.

"GSA's big concern has to be how many Universal players to get," said Bob Woods, president of Topside Consulting. "I don't think they want it to be [only] two. Certainly not one."

John Johnson, assistant commissioner of service development and

delivery at GSA's Federal Technology Service, said the organization's officials won't worry about the future when making Networx award decisions.

"We evaluate those proposals on their merit," he said. "So what may happen is not considered in that equation."

The Networx contract is intended to withstand changes in the marketplace, he added.

"We anticipated that there would be a lot of change in the industry, and our strategy was crafted partly around that," Johnson said. "In the context of SBC and AT&T's possible merger, it may not become real until a year and a half from now. We're moving forward and looking at them as separate companies right now."

Companies involved in merger talks are legally forbidden from discussing about how they would handle potential consolidations until the deal is completed, said Phil Kiviat, a consultant at Guerra, Kiviat, Flyzik and Associates. However, he said the odds are slim that the government would end up with prime contractors that would then merge.

"The government's requirement is the government's requirement," he said. "That's not going to change. The solicitation will go out, and the companies that were going to go after it have been working on it for a long time now."

— Michael Hardy

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