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Markets versus regulators: will there be a WorldCom effect?
A regular column on the information industries
Markets versus regulators: will there be a WorldCom effect?
By and large the financial markets much prefer monopoly structures to those that are highly competitive. This is understandable since monopolists can, if they so choose, usually extract excess or "supernormal" profits from their customers, whereas profitability should in principle be much lower in competition. This does not necessarily mean that monopolists' prices are higher since they may well have access to economies of scale that reduce their cost base, but against this must be set the possibility that they will have no interest in cost control since they have no competitors.
However, irrespective of the theoretical virtues of monopoly, governments have in practice invariably introduced regulatory controls designed to keep profitability within what they consider to be acceptable bounds. In the case of telecoms, this has almost invariably resulted in sector-specific regulation in addition to existing multi-sector anti-trust regimes. There is much disagreement about whether telecoms regulation has been successful, but one thing at least has always been explicitly or implicitly assumed, namely that in the absence of regulation the sector would be profitable.
During the 1990s that seemed a reasonable enough assumption to make, but since early 2000 the telecoms sector has been hit by an unprecedented downturn that has now gone well beyond mere conversion of profits into losses and has, for example, led both to the "junking" of bonds issued by former heavweights of the sector such as Alcatel, Qwest and Vivendi Universal and to widespread bankruptcies, including the largest ever in respect of WorldCom. Not surprisingly, the markets seek structural remedies, to be effected primarily via consolidation, with a view to reducing the forces of competition and raising profitability. The problem this presents is that it effectively constitutes a desire to overturn the traditional approach of regulators. The question, therefore, is whether the collapse of former giants such as WorldCom will finally force regulators to change tack.
Such a change could take two possible forms. On the one hand, regulators could capitulate and agree to stand aside from the telecommunications sector until such time as the restructuring is complete. On the other, they could agree to loosen existing rules while continuing to examine every case on its merits. On the face of it both approaches have severe drawbacks. While the first clearly looks to be overly radical and would arguably set an unacceptable precedent, the second runs up against the fact that mega-mergers have tended in recent times to take a year or so to be fully resolved – cf WorldCom and Sprint – and that is equally unacceptable during a period of rapid change accompanied by deteriorating finances. Watching regulators struggle to find the "middle way" should be an interesting experience. In all probability, the key decisions will be made in the USA and involve the Federal Communications Commission (FCC), but some will also stretch the imagination of the European Commission.
This assertion largely reflects the fact that the 1996 Telecommunications Act has yet to achieve its objectives. In particular, it may be observed that, as of July, the Baby Bells have been authorised to provide long-distance services in only 15 states with a further ten applications outstanding. Given such modest progress, it may seem heretical to many that the Baby Bells should be allowed to buy long-distance operators and hence circumvent in one fell swoop the underlying rationale of the 1996 Act. Yet that is precisely what is now being proposed since, in mid-July, the FCC announced that it would be willing to let a Baby Bell buy WorldCom, the second-largest long-distance carrier – subject of course to jumping unspecified "high hurdles". But how high can they be in practice given that WorldCom is in Chapter 11? Predictably, certain members of the Senate anti-trust committee immediately declared that the hurdles would be set very high – in fact, they would only authorise such a takeover as a last resort – and long experience of the 1996 Act does suggest that the American system of checks and balances is peculiarly unsuited to dealing with anything approaching a crisis of this kind. The trouble is that there are few non-US operators in a position – i.e. not heavily indebted – to take on the purchase of fallen mega-stars such as WorldCom. BT, Cable & Wireless and Telefónica might fit the bill in principle, but their shareholders are highly unlikely to welcome foreign adventures of this kind.
Because the demise of many other operators does not raise such obvious potential conflicts of interest in relation to the 1996 Act, it will be much easier for the regulatory bodies to turn a blind eye, and the structure of the industry in the USA may well look rather different in two years' time. However, it must also be borne in mind that this is far more likely to result from the simple disappearance of bankrupt companies than from explicit decisions about preferred structures – after all, even if they believe that too few operators are left in any particular market, regulators can do little other than implement price caps and their ilk, and even these may look like excessive interference when survivors are struggling to restore their finances as they emerge from recession.
The position in Europe is currently more concerned with residual state holdings and the potential for mergers between incumbents. It is of interest that the two most heavily indebted incumbents by far are Deutsche Telekom and France Télécom – both of which retain a large shareholding held by the state – in the latter case a majority – and hence it is generally felt that they will never be allowed to go bankrupt. Indeed, the French government recently announced – allegedly – that it would be prepared to renationalise France Télécom as a last resort. The other major incumbents are trading reasonably happily but have debts of their own, and it is certain that the merest rumour of a proposed takeover of another telco with substantial debts will suffice to devastate their share prices. Hence, for now, restructuring looks to involve only the minnows, particularly those in Scandinavia. So far, the European Commission has not needed to get overly involved since proposed mergers between smaller incumbents tend to self-implode before they can reach fruition, but it is of interest that the Commission was quick to authorise Telia's merger with Sonera without imposing much by way of forced sales.
Of course, this does not of itself guarantee a successful conclusion, and it will hardly result in a significant change to the competitive landscape. Hence, it seems logical to conclude that, as with the FCC, the Commission will in effect have to stand powerlessly to one side as CLECs, cable operators, ISPs and others go bankrupt, leaving the incumbents even more firmly entrenched than before. As for regulators in individual countries, these are trying hard to preserve their fiefdoms, but at what cost? In Germany, for example, the regulator is determinedly refusing to allow 3G licensees to trade their licences and is demanding that licences be handed back without recompense if licensees merge. This may well deter consolidation in 2002 given the cost of licences that would have to be written off, but will leave the weaker licensees vulnerable to adverse market conditions and damage their prospects of recovery. Indeed, the weakest, Group 3G, has just abandoned its network, so here again the markets appear to be resolving the problem by making surplus competitors disappear. This suggests that concessions will eventually need to be made.
What all the above indicates is that, in the end, the markets will generally get their way. Their power should never be underestimated when times are bad. If the financial markets, say, drop a credit rating below investment grade, the consequences are both severe and well beyond the control of anti-trust regulators. If you had to back one side in the battle to control the restructuring of the industry, I know which side my money would be on.