Nearly 21 percent of the U.S. population, or over 60 million Americans, live in rural areas that are either un-served or under-served by broadband services, according to Computerworld (as of August 2007).
Incumbent local exchange carriers (ILECs) prefer to focus on the more densely clustered urban and suburban demographics, where copper/fiber broadband is most profitable. While advanced fiber broadband growth is projected beyond 2008, the urban market is quickly nearing saturation.
Some ILECs such as Windstream, CenturyTel, Qwest and rural cable companies have rolled out DSL and cable broadband in rural markets. These ILECs still see attractive returns from extending their existing loop lengths with additional copper/fiber-based DSL deployments. Yet these business models can only stretch so far, as physical and economic constraints prohibit service to the most rural customers far from ILECs’ central offices.
Historically, demand for broadband in rural markets lagged the rest of the country; today, however, broadband service is increasingly considered a basic need among rural Americans — a massive audience of telecommuters and customers with increased buying power. When ILECs reach the DSL saturation level (which should happen in the next one to two years), focus will undoubtedly turn to other technologies intended to capture the massive yet relatively untapped rural market share.
Wireless broadband services, such as WiMAX or satellite, are logical ways to extend the network. Some small ILECs have already made the leap (i.e. Evertek, CTC Telecom, 3 Rivers Communication) and several larger providers have deployed wireless broadband services on a limited scale, but we expect a surge in interest leading into 2009. Many ILECs will look to develop wireless broadband services organically; still more will see the benefits of purchasing existing wireless broadband service providers with a built-in customer base and wireless technology backbone. With this in mind, current wireless broadband providers should be enhancing their product to prove more attractive when buyers approach.
Wireless broadband providers create competition
Wireless broadband technologies have lower entry barriers relative to other broadband technologies, thereby inviting more entrepreneurs into the market to offer services in direct competition with ILECs that have invested millions if not billions of dollars in their respective network infrastructure. WiMAX, and particularly mobile WiMAX technologies offer enhanced revenue opportunities for wireless broadband providers; these technologies prove not only competitive, but in many areas they are the only broadband alternative.
Fast-moving wireless Internet service providers are diving into the industry — thousands of small, highly focused geographic providers are offering services today. Many have begun building out their own end-to- end wireless broadband networks, from access equipment to backhaul, that terminate directly on the Internet backbone. Today, wireless broadband service providers like Clearwire, Sprint and Towerstream have established broadband wireless networks in ILECs’ backyards and they are courting ILEC subscribers without broadband access. (See: There's no business like small business for Towerstream)
Spectrum has been an important consideration for deploying wireless broadband services and many providers are quickly improving their spectrum position. Sprint has amassed one of the largest WiMAX- appropriate spectrum portfolios. Clearwire’s spectrum position is estimated to be worth more than US$1.6 billion including the $300 million purchase of spectrum divested by AT&T. The 700MHz spectrum auctions beginning in January 2008 are expected to be potentially transformational events for the telecommunications industry as existing service providers, new entrants and hardware providers strategize and prepare for what is expected to be one of the most significant spectrum auctions in U.S. history. Even some ILECs are potentially lining up to participate in these auctions.
Buy versus build dilemma
Incumbent carriers won’t cede ground in the access-services business easily. Forward-looking ILECs are acquiring fast growing wireless broadband service providers or extending their existing footprints with advanced wireless technologies. This proves to be the logical next step in the ILECs’ evolution to reach the remaining rural-focused growth market.
Once an ILEC decides it needs to get into the space, it must take into consideration the age-old dilemma of buy versus build. According to some estimates, many ILECs and other operators are each expected to spend $10-100 million rolling out WiMAX in the next 2-4 years, to a collective North American subscriber base of nearly 8 million by 2011 (Source: Yankee Group).
The benefits of WiMAX market entry are numerous: 1) communications demands in rural areas are rising, predominately backed by homeowners’ increased spending power and the rise of telecommuting, 2) these un- served or underserved areas by definition have limited competition, 3) wireless broadband technologies offer some potential cost advantages over copper/fiber in very rural areas, and 4) there is increasing political pressure to close the “digital divide” of broadband service in rural areas, which may lead to increased government subsidies.
Some ILECs will build, like Qwest Communications, which recently claimed that 78 percent of its households have broadband availability. At around 80 percent penetration level, Qwest intends to look at WiMAX as a means of further extending its coverage. The activity is occurring throughout the industry with BellSouth, AT&T and others conducting WiMAX trials. Other ILECs, attracted to WiMAX companies with strong subscriber bases, great rollouts of products/services and top equipment/technologies, will inevitably favor buying. There are likely to be significant synergies between the ILECs and wireless broadband operators, further increasing the buy incentive — and there will be plenty of acquisition candidates available.
Broadband wireless access operators have proliferated in recent years, yet, to date, few have reached the kind of scale that would make them a serious threat to their wireline competitors. Rather, they have been viewed by ILECs as niche players, who are willing to work the stony soil of the marginal areas where others are unwilling to venture. Smaller WiMAX vendors should move to gain scale, while simultaneously differentiate themselves through regional or vertical market efforts, which could yield much-needed momentum. If nothing else, this momentum could make smaller vendors more attractive as acquisition targets when consolidation does begin.
As ILECs begin to reach maximum broadband penetration of their traditional networks, we expect a large subscriber base to remain underserved. Satellite and increasingly WIMAX are expected to be potential ways for ILECs to extend into this target rich area in a cost effective way. When this begins to happen, the scale of existing WiMAX service providers will have a big impact on the likelihood of whether ILECs decide to grow organically into these markets or acquire existing service providers.
Kenny Gunderman, Chad Crank and Ross Rucker are members of Stephens Inc.’s Telecommunications & Media Investment Banking division. For further information, contact Mr. Gunderman at 501-377- 2216 or via e-mail at kenneth.gunderman@stephens.com.