Informational Hearing
Telecommunications MegaMergers:
The Effect on Competition and Customers
State Capitol, Room 3191
June 21, 2005
9:30 a.m.
I. Opening Comments
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Senator Martha M. Escutia, Chairwoman
Senate Energy, Utilities & Communications Committee
II. California Public Utilities Commission Overview
-
Jack Leutza, Director
California Public Utilities Commission
III. Merger Proponents
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Jim Young, Assistant General Counsel
SBC
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Ken McNeeley, President
AT&T
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Tim McCallion, President
Verizon
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Neal Larsen, Vice President of Governmental Relations
MCI
IV. Interested Parties
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Alex Rooker, Vice President
Communication Workers of America
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Denise Mann, Telecommunications Manager
Office of Ratepayer Advocates
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Bill Nausbaum, Telecommunications Attorney
The Utility Reform Network
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Sarah DeYoung, Executive Director
Caltel
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Jeff Compton, Vice President Regulatory and Industry Relations
Telscape Communications
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Tony DiStefano, President and Chief Executive Officer
Arrival Communications
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Alice Huffman, California President
NAACP
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Laura Efurd, Director of Policy and Leadership Initiatives
Community Technology Foundation
MCI/Verizon Merger
ATT/SBC Merger
HEARING BACKGROUND
TELECOMMUNICATIONS MERGERS IN CALIFORNIA
Background
The modern telecommunications industry was created in the early 1980’s. AT&T’s longstanding monopoly gave way to a competitive long distance market as a result of an historic 1982 settlement with the United States Department of Justice (DOJ) over alleged anti-competitive activities. The settlement agreement resulted in a massive corporate dismemberment which broke AT&T into seven local telephone companies. Each of these companies was granted its own geographic monopoly for local telephone service but was barred from providing long-distance service. Those seven companies included the predecessors to SBC and Verizon, then known as Southwestern Bell and Bell Atlantic. Overlapping these seven companies was the new AT&T, which was barred from providing local telephone service, but could provide long-distance service in competition with other, including MCI, the company that broke AT&T’s long distance monopoly.
Changes in federal law led to a burst of new competitors which reached its zenith in the late 1990’s. But by the turn of the century overly optimistic usage forecasts, massive overinvestment, investment banker conflicts of interest, and fraudulent accounting led to a telecommunications bust, leaving a wreckage of 100 telecommunications company bankruptcies, $750 billion in investor losses, and over 600,000 job losses.[1] From this disaster a few companies survived and grew. Those survivors are led by SBC and Verizon, the two largest telecommunications companies in the country, both in the Fortune 50.
Both SBC and Verizon are the progeny of mergers. Since that 1982 settlement agreement those seven local telephone companies have merged to become four. SBC acquired two of those companies, one of which was Pacific Bell; Verizon acquired one of those companies as well as GTE, the largest local telephone company not affiliated with AT&T. Continuing this consolidation trend, in January 2005 SBC announced an agreement to acquire AT&T, the company from which it was created, for $16 billion. And, in an ironic reversal, Verizon is proposing to acquire MCI for $8.4 billion. Like the liquid metal cyborg of Terminator 2, the dismembered bits of the original AT&T seem to be inexorably drawn together. More importantly, the mergers represent something of a reversal, that maybe something had gone wrong with our telecommunications policy. As one analyst opined, “With the wonderful perspective of hindsight, the competitive industry structure imposed by the enforced break-up of AT&T can be seen as a failure.”[2] Worth considering then is whether the regulatory regimes created for that failed structure are serving business and residential consumers well today.
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The Case for the Mergers
Both sets of acquisition partners make compelling financial cases for the mergers. SBC expects its acquisition to produce $15 billion in “synergies”, or economic benefits, mostly from cost savings and eliminating 5000 jobs.[3] Verizon expects its acquisition to result in $7 billion in synergies, mostly from eliminating 7000 jobs.[4]
SBC/AT&T believe that their merger will benefit both residential and business customers. According to SBC, the merger “will ensure the continued competition, innovation and customer service in consumer telecommunications services. By combining networks and resources, the new company will be able to bring to market new consumer services more quickly than either company could on a stand-alone basis.”[5] For business customers, “(t)he combined company will have greater financial, technical and marketing resources to deliver customer-based solution sets and will accelerate the introduction of the enterprise product set to small- and mid-sized businesses.”[6] The merger “will result in increased innovation, lead to the more rapid introduction of new services, and prompt the development of services that would otherwise not exist.”[7]
Despite the job losses the company unions support the merger. A Communications Workers of America (CWA) white paper[8] noted that AT&T has been in a period of steep decline, having cut 27,000 jobs. The union noted hopefully that “SBC has a plan for AT&T that will create a new, vigorous provider of innovative telecommunications products for consumers and a robust provider of secure jobs in communities through the United States. It is clear that AT&T, as a stand alone business, can only go in one direction, and that involves shrinking revenues, shrinking income, shrinking investment, and shrinking jobs. AT&T employees cannot afford to miss this opportunity to stabilize their future.”
The Case Against the Mergers
Competitors and consumer groups have concerns that these mergers, both individually and collectively, concentrate too much market power within each of the companies. Opponents to the mergers observe that SBC and Verizon already control 80% of the residential local wireline market in their service areas. Consumers Union and the Consumer Federation of America argue that these two companies together control 40% of the long-distance market, and that this will increase to 70% after the mergers are completed. Moreover, SBC and Verizon have 40%-50% of the wireless market.[9] These market share numbers would be less of a concern if SBC and Verizon competed against each other. But, except for their cellular operations, the two companies compete head-to-head on a very limited basis. Instead, most of the competition in residential markets will be from cable companies that offer the product bundles that customers want: voice, Internet, video, and increasingly, cellular. This leads to worries that competition could be reduced to duopolies. “The loser is the customer,” says the president of the Yankee Group, a technology consulting firm.[10]
Smaller competing telecommunications companies believe they will be hurt by the mergers. They have recently begun a national effort urging the Federal Communications Commission to halt the merger reviews, gather a more comprehensive record, and consolidate review of the two mergers. Their concern is that the merged companies could create a market structure too overwhelming to compete against.[11] This sentiment is echoed by the Chief Executive Officer of Qwest, one of the original seven local telephone companies created from AT&T and a failed competitor to Verizon in the bidding for MCI:
If the mergers are approved, the new companies would dwarf their nearest competitors and control 79% of the business/government segment – one of the most lucrative in our industry. The reality is that this scale, pricing power and overall market clout make it extremely unlikely that any other player can grow market share. Odds are these behemoths would not compete head-to-head in most local markets but would instead flex their muscles to squeeze out smaller competitors, emptying the playing field.[12]
Regulatory Approvals are Required
These mergers require approval by the FCC and the DOJ. The California Public Utilities Commission must also approve the merger. California law has very specific requirements for evaluating large utility mergers. The mergers must be in the public interest and result in economic benefits to customers. Specifically, Section 854 of the Public Utilities Code requires that before the CPUC approves a large merger it must first find that the merger is in the public interest using the following criteria:
- Does the merger maintain or improve the financial condition of the resulting public utility doing business in the state?
- Does the merger maintain or improve the quality of service to public utility ratepayers in the state?
- Does the merger maintain or improve the quality of management of the resulting public utility doing business in the state?
- Is the merger fair and reasonable to affected public utility employees, including both union and nonunion employees?
- Is the merger fair and reasonable to the majority of all affected public utility shareholders?
- Is the merger beneficial on an overall basis to state and local economies, and to the communities in the area served by the resulting public utility?
- Does the merger preserve the jurisdiction of the commission and the capacity of the commission to effectively regulate and audit public utility operations in the state?
- Does the merger provide mitigation measures to prevent significant adverse consequences which may result?
The statute also requires that the merger:
- Provide economic benefits to ratepayers;
- Equitably allocates benefits between shareholders and ratepayers with ratepayers receiving not less than 50% of the merger benefits;
- Not adversely effect competition;
The acquiring company bears the burden of proving by a preponderance of the evidence that these requirements are met.
The History of Recent Large Mergers
As noted above, both SBC and Verizon are themselves the product of mergers, each of which was reviewed under California’s merger statute. In 2000 the CPUC found that the merger between GTE and Bell Atlantic, which resulted in the creation of Verizon, resulted in $168.1 million in economic benefits over five years and allocated half of that to California ratepayers. In 1997 the CPUC found that the merger between Pacific Bell and SBC resulted in $495 million in merger benefits, with ratepayers receiving half.
Mergers and Regulatory Structure
The SBC/AT&T and Verizon/MCI mergers are further examples of industry consolidation, a process begun in the 1990’s. And the mergers will continue. As the Chief Executive Officer of SBC has noted, “The industry definitely needs to consolidate. It’s not been a good industry for investors or capital infrastructure investments in the last few years.”[13] The Chief Executive Officer of AT&T observes that the consolidation is driven because “none of the current industry players are configured optimally for the way this business is going to evolve.” What makes sense is “the integration or convergence of wireless, broadband and corporate services on a robust ubiquitous network.”[14]
So industry leaders are reshaping their companies to provide every type of communication service. The implication is that there will be fewer competitors because the scale needed to provide such a broad scope of services is so large. If the result of the mergers is less competition then regulators will have to develop mitigation measures. That could mean placing operational or structural conditions on the merger and changing the existing regulatory framework, which is predicated on competition for most telecommunications services. The consequence of failing to recognize and deal with reduced competition will be higher prices, less innovation, limited service availability, and reduced opportunities for competitors. The effect of these mergers on competition is the fundamental question for regulators.
[1] Broadbandits by Om Malik; 2003.
[2] Fortune, “Verizon/MCI vs. SBC/AT&T, Verizon’s $6.75 billion purchase of MCI could create a duopoly that may strengthen the fractured telecom industry, analysts say;” February 14, 2005.
[3] SBC/AT&T Special Analysts Meeting; February 1, 2005.
[4] Verizon/MCI Investor Conference Call; February 14, 2005.
[5] http://sbc.merger-news.com/materials/am_fs_bfc.html
[6] http://sbc.merger-news.com/materials/am_fs_bfb.html
[7] Joint Application of SBC Communications Inc. and AT&T Corp., February 28, 2005.
[8] “SBC/AT&T Merger is Good for Employees and Consumers” by the Communications Workers of America, undated.
[9] Statement of Gene Kimmelman to the United States Senate Judiciary Committee, April 19, 2005.
[10] Wall Street Journal, p.B1, February 4, 2005.
[11] www.allianceforcompetition.com/newsroom/release/050525.php
[12] Wall Street Journal, “Don’t Create a Duopoly” by Dick Notebaert, February 28, 2005.
[13] Internetnews.com, “SBC, AT&T Seen as Prototype for Telecom’s Future”, January 31, 2005.
[14] Fortune, “AT&T’s CEO Speaks Out on the SBC Deal”, February 7, 2005.
