Debt, dividends and the postbubble telecom universe

Over the years I’ve had many enlightening and entertaining exchanges with readers, who have inspired some of my favorite columns. Many thanks to reader Jeff Williams for raising some of the issues that appear in this column.

Readers might be wondering how MCI compares with its historical competitors (AT&T and Sprint) and with the incumbent local exchange carriers (ILEC) and the handful of thriving competitive local exchange carriers. More broadly, there’s the question of how the U.S. telecom market will shake out in the postbubble era.

It’s important to keep in mind the economic environment and technical and strategic moves. In particular, two economic factors will continue to affect the relative positioning of carriers in the mid- to long term.

The first is debt elimination via bankruptcy. Carriers such as MCI have undergone Chapter 11 restructuring to emerge virtually debt-free. That puts them in an outstanding position compared with their competition vis-à-vis capital investment and the ability to expand. Such carriers are better able to roll out next-generation infrastructure, solutions and services – a factor that MCI Chairman Michael Cappelas is counting on as part of his “go-forward” strategy.

At first glance this seems eminently unfair. Why should a company that – aside from its alleged “cooking of the books” – indisputably displayed outrageously poor management be rewarded for laying off employees, destroying service quality to customers and devastating shareholder value?

Quite simply, because that’s the American economic system. Our “get out of debt free” philosophy dates back to the American Revolution. Draconian English debt laws at the time punished failure to repay by imprisonment, deportation or both. The American view is that someone who’s banished or in jail has no way to contribute to economic growth.

The net effect of this approach is to reward companies that “push the envelope” in terms of risk assumption at the expense of those who play it safer. Thus, MCI is favorably positioned vis-à-vis its traditional competitors, assuming it can leverage this positioning via sound strategy and effective management. (The same will hold true for Global Crossing when it emerges from Chapter 11.)

The other economic factor to keep in mind is the current favorable taxation climate for dividends. The feds have just lowered the effective tax rate on dividends, which means that companies that pay them are more attractive investments than those that don’t. More investors means more available capital. That’s good news for traditional telephone companies – you’ll recall that companies such as SBC and AT&T historically have paid dividends (and continue to do so). Sprint’s case is a bit more complex (some parts of the company pay dividends, others don’t).

Ignoring all other factors, then, a rough ranking of the providers would be MCI first, AT&T and the ILECs second, and Sprint and everybody else third. Of course, “all other factors” includes size, services, strategy, customer satisfaction, and overall financial and operational performance – all the really important stuff.