Federal Ruling Should Be A Boon To Junk Issuers

In a move toward creating a more open and competitive marketplace among Internet service providers, the Federal Communications Commission issued a directive last week ordering local telephone companies to allow Internet and other data service providers access to their lines.

According to sell-side players and high yield telecom analysts, digital subscriber line (DSL) providers and residential consumers stand to benefit significantly from the ruling. Among the biggest winners might be names like Covad Inc., NorthPoint and Rhythms NetConnections.

Trading on Rhythms' bonds, for example, experienced an uptick immediately following the news. They moved from the 90-91 level up four to five points to the 94-95 range. Bond spreads for high yield competitive local exchange carriers (CLECs) are improving slightly, according to Gus Okwu, telecom analyst at Fitch IBCA. Still, he added, the decision "puts CLECs in a much more positive light and makes the sector much stronger."

"The FCC has obviously taken an interest in ensuring that competition comes into the local exchange market and is actively exploring ways to do this," said Robert Stewart, senior vice president of high yield issuer Teligent Inc.

Still, DSL and ISP players are confident the federal announcement will ultimately improve their revenues and stimulate demand from the residential consumer market. Currently, these companies have to lease lines from the Bells, paying approximately $20 to $40 per subscriber. Some sell-siders estimate the cost per customer in providing DSL lines consequently will drop up to 50%, making the lines a cost-effective alternative to dial-up high speed Internet access.

"The FCC ruling is the single most important step in terms of deploying broadband services to consumers," said Jim Monroe, vice president of NorthPoint, a DSL provider. "Line-sharing is the key ingredient to aggressively expanding into the consumer market. It opens a new market to companies like NorthPoint, and with line-sharing, we have greater parity with incumbents."

Covad Inc. also will reap the benefits of the ruling, according to industry observers. "It's a big win for Covad and consumers because it provides choice in the marketplace," said Martha Sessums, a spokesperson for DSL and ISP provider Covad. Currently, only 15% of Covad's customers are residential DSL subscribers. With the FCC ruling however, Covad, like many DSL providers, is looking to rapidly expand that customer base.

Most CLECs have developed business plans centered on small to mid-sized business customers. Not only will this order lower the overhead for companies hoping to break into the residential marketplace, but it also might make DSL an affordable option to individual consumers. Currently, most residential DSL subscribers are those who operate small businesses out of their homes.

Monroe estimated that consumer spending for Internet access would reach $20 billion by 2003. Of that, approximately 50% would be for broadband services like DSL.

"With the lower cost, it should help [the CLECs] expand their business plans beyond the business market and into the residential market. There's potential for pretty large demand, and right now the cable guys have a lock on that market," said Senecal. "It could mean more investment up front and then higher cash flows on the back end."

The ruling could take up to a year before it really takes effect. It could be tied up in the courts for months.

"The FCC has said 180 days, but we don't expect to see anything for the next six to nine months... we won't see any benefits of the [residential consumer] market until well into 2000 - by the third or fourth quarter," said Sessums.