Subject: [NEXTEL-1] Competition & Wireless

From: Marcel <[email-masked]>
Date: Fri, 13 Dec 2002 18:35:01 -0500

BW)(NY-FITCH-RATINGS/TELECOM) Competition & Wireless
Performance Risk Could Hamper Credit Profile Improvements - Fitch US
Telecom '03 Outlook

Business Editors

CHICAGO--(BUSINESS WIRE)--Dec. 13, 2002--The events of 2002 clearly changed the U.S.
telecom competitive landscape including the strategic focus of many participants. While
weakness still
exists in the various telecom sectors predominantly due to competitive pressures, some
stabilization of
credit quality is also present going into 2003. All operators are focused more than ever
on improving
financial flexibility through growth in free cash flow and reducing debt in their balance
sheets. The
greatest tool for improving free cash flow remains reduction in capital expenditures and a
focus on
improving efficiency. Capital spending for the telecom sector will generally remain low in
2003, which
will allow for a maximization of free cash flow. Event risk still exists in the telecom
sector with
particular examples around consolidation in the wireless sector, wireless churn risk
associated with
the introduction of local number portability and the conclusion of the FCC's review of
local phone
network unbundling policies and how this might affect the Unbundled Network Element
Platform
(UNE-P). While economic improvements could spur demand for telecom services, particularly
related to data, this is not expected to be a source of wide spread strength for the
industry in 2003.

Looking Back at 2002

While high-yield telecom credits bore the brunt of credit erosion in 2001, this trend
shifted to the
investment grade telecom companies in 2002, particularly as it related to operating
performance and
market access. Further reductions in IT spending by end-users has negatively pressured
both voice
and data revenues. Additionally, significant capital spending and merger and acquisition
activity of the
last few years leading up to 2002 left many companies will little financial flexibility
and large debt
burdens. Numerous SEC investigations and questions surrounding accounting of WorldCom and
others hurt the level of confidence associated with the integrity of financial filings. As
a result many
telecom participants had little accessibility to the capital and bank markets particularly
when needed
the most. More than 35 telecom companies experienced significant downgrades of their
credit ratings
in 2002.
From a positive perspective, companies have responded to dramatic credit profile pressures
by
taking steps to enhance financial flexibility. Non-core operations and investments have
been
monetized with proceeds being used in part to reduce debt. Cost reduction programs that
many
carriers implemented near the end of 2001 and continued to expand in 2002, helped to
support
operating cash flow. Capital spending by the telecom industry in 2002 is estimated to be
approximately 35% lower than 2001 and nearly 50% lower than in 2000. It is likely that
this level of
spending will increase with increased revenues, but that this will not occur before 2004.

Looking Forward into 2003

Local Exchange Carriers

In 2003, Fitch believes Local Exchange Carriers (LECs) will continue to reduce debt in an
effort
to mitigate the effect of weakening operating performance on their overall risk profiles.
The lower
wireline capital spending programs of 2002 are expected to continue -- and in some
instances be
further lowered -- due to reduced demand for services. Debt levels could further decline
through the
completion of additional non-core asset sales. A note of caution, however, would be the
potential for
carriers to use proceeds from non-core asset sales to expand in certain businesses,
primarily wireless.
There is a lack of clarity with regard to the revenue and EBITDA growth prospects for the
RBOCs in 2003. Even if there is a moderate recovery in the demand for services,
competitive effects
will lead to little or no growth. Fitch believes prospects are relatively better for
Verizon
Communications given the relatively greater proportion of revenues and EBITDA provided by
Verizon Wireless in its consolidated financials compared the contribution of Cingular
Wireless to
SBC Communications and BellSouth. On the positive side, the RBOCs should experience
continued
revenue growth from long distance services, with the carriers likely to attain approval in
their
remaining states in 2003. In addition to aiding the carriers in reducing residential churn
to long
distance carriers' bundled offerings, the RBOCs will begin to expand in certain enterprise
market
segments.
In 2003, competition will continue to be the primary concern of the RBOCs. Modified
regulations
to be issued by the FCC in early 2003 will likely ameliorate some of the effects of
competition from
long distance carriers using UNE-P platforms and Fitch expects transition mechanisms to
guide users
of UNE-Ps toward increased use of and investment in alternative facilities. Longer-term
competitive
concerns center around further wireless substitution and cable operators' wireline
telephony and
high-speed cable modem offerings. To counteract competition from all providers, the RBOCs
are
expected to be more aggressive in marketing bundles of service that include local, long
distance,
wireless, and high-speed data services.

Wireless

Fitch holds a guarded view on the wireless industry outlook in 2003 due to fundamental
issues
including the uncertain ability of operators to generate positive free cash flow, the
growth in net
additions due to penetration rates in excess of 50% and the continued pressure on ARPU due
to
pricing decisions.
While average revenue per user (ARPU) was flat to slightly negative for a majority of the
nationwide operators in 2002, pricing decisions initiated during the year could lead to
increased
pressure on ARPU in 2003 particularly if operators fail to see anticipated growth in data
revenues.
After the completion of large investments associated with the GSM/GPRS and CDMA 1XRTT data

networks, carriers must successfully execute their wireless data strategies for consumer
and enterprise
customers in 2003 to drive rapid growth of data revenue. Carriers have indicated a focus
on positive
return for invested capital. In order to achieve this objective, companies will need to
take actions that
lead to profitable customer growth, which is measured by stable ARPU, lower acquisition
costs, high
retention and control of credit risk.
Due to the continued pricing pressures combined with slower growth, operators must
implement
rigorous cost containment as a key to maintaining reasonable margins and ability to meet
free cash
flow objectives in 2003. During 2002, operators consolidated call centers and billing
systems,
outsourced costs, reduced employee headcount, entered into network sharing agreements and
deployed networks that were more efficient. In 2003, benefits should be derived from the
improved
scale of operations and cost efficiencies associated with the GSM and CDMA networks.
Additionally through judicious capital spending, modest stability for ARPU and churn, the
majority of
nationwide operators should become free cash flow positive in 2003.
The picture for wireless industry consolidation is no clearer than in 2002 with several
barriers such
as regulatory hurdles, non-customary ownership structures and the different technology
platforms
encumbering operators from completing any agreements. Fitch believes during 2003, industry

competitive forces will dictate two of the three GSM providers to merge operations. In
addition, if the
FCC adopts Nextel's spectrum proposal along with the continued improvement to its credit
profile,
Nextel could become an attractive acquisition candidate.

Long Distance

Long distance carriers will continue to be negatively impacted by competition in 2003
especially
related to service substitution. Consumer voice long distance continues to operate in a
deteriorating
revenue environment for all the established carriers. This will likely continue in spite
of recent price
increases implemented in 2002. Carriers will continue to emphasize profits in this segment
by
maintaining a cost structure that varies directly with traffic volume and minimizes
expense. It is
expected that the RBOCs will continue to have success in penetrating the consumer retail
market
segment as they complete their section 271 approvals to offer long distance service.
Competition in
the business voice and data markets should continue to be fierce with the RBOC entry, but
Fitch
expects that it will take the RBOCs far longer to penetrate this segment then consumer
retail. It is
likely that stronger data service growth will not occur until an economic recovery is well
in place and
end-users increase their IT spending, which is not expected in 2003.
Long distance carriers such as AT&T and Sprint have benefited from the industry turmoil
experienced in this sector in 2002 as customers have migrated to these relatively more
stable
operators. The financial impact of these customer migrations should begin to be felt in
early 2003.
Fitch recognizes that risk exists that carriers with newly restructured balance sheets
could introduce
irrational pricing to the market to gain market share. While this risk exists, it is
unlikely that carriers
will revert wholly to this strategy considering past results and the current investor
focus on profits.

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