For whom the bell tolls

Established in 1877 as American Bell, AT&T enjoyed the largest share of the industry pie for nearly a century, thanks to the government's belief that the utility constituted a "natural" monopoly. That monopoly crumbled in 1969, when the Federal Communications Commission (FCC) allowed other companies to play in Ma Bell's sandbox. Companies like MCI were quick to get in the game. But monopolies don't disappear overnight -- to encourage competition in the long-distance market, the Department of Justice followed up with an antitrust suit against AT&T in 1974, resulting in the division of AT&T into a long-distance retailer and seven regional Bell operating companies (RBOCs), which would compete in the local call market as independent local exchange carriers (LECs). The final breakup took place in 1984. The industry thrived under the breakup, exploding into hundreds of smaller competitors, lowering the cost of long-distance calling dramatically. While AT&T held about 70 percent of the market in 1984, it holds about a third today, according to Hoover's. Still, it's these so-called "Tier 1" carriers -- AT&T, Sprint, and WorldCom -- that make up the bulk of the long-distance market.

Untangling the wires

As the long distance market diversified, the local exchange market remained relatively homogenous. The Telecommunications Act of 1996 aimed to change that, deregulating entry into local markets and requiring that the so-called Baby Bells, or incumbent local phone companies (ILECs), retail their network elements to smaller competitors. The incumbents were required to unbundle their networks for reasonable prices, with the goal of decentralization of the system into a "network of networks." The act also temporarily blocked an RBOC from entering the long-distance market until it could prove that there was sufficient competition in its local territory.

Another provision of the Telecom Act, allowing RBOCs the right to sell cable television services and phone equipment, proved to be a boon for the strongest RBOCs. Thanks to those services and the entry of the Babies into long distance, the Telecom Act actually had the opposite of its intended effect, allowing a few RBOCs to solidify their positions and dominate the market through mergers and acquisitions. Today, there are just four RBOCs -- Verizon Communications, BellSouth, SBC Communications, and Qwest Communications International -- dominating both local phone service access and the burgeoning DSL (digital subscriber line) markets.

Still, sniping among the RBOCs and long distance giants like MCI and AT&T over network-access rights continues. As late as May 2004, the FCC was engaged in a dispute between the Baby Bells and the long distance carriers, as the LD companies argued for increased access to local calling networks.

Merger mania

The Telecom Act ushered in an era of merger fever among telecom companies. In 1997, Bell Atlantic purchased little sib NYNEX for $25.6 billion, and SBC bought Pacific Telesis. The following year, SBC acquired local and long-distance provider Southern New England Telecommunications, entering the LD market through this Telecom Act loophole. SBC also acquired Baby Bell Ameritech for $68.8 billion, and Bell Atlantic merged with GTE to form Verizon. Also in 1998, Qwest Communications International bought long-distance company LCI International, entering the struggle between the big three of long distance, AT&T, Sprint, and MCI. The next year, Qwest's bid to acquire US West (the smallest of the Baby Bells) defeated that of fiber optics leader Global Crossing of Bermuda. Also in 1999, AT&T acquired cable operator Tele-Communications, Inc. and merged with MediaOne Group in a $44-billion deal. Meanwhile, MCI was folded into WorldCom for $47 billion, (more on this later) becoming the world's leading Internet carrier and a full-fledged global telecom company, boasting a 25 percent share of the U.S. long-distance market after the deal.

The activity wasn't limited to America's shores. Telecom became truly global in 1997, when 70 members of the World Trade Organization agreed to open up their telecom markets to each other at the start of the following year. Those 70 countries control 90 percent of worldwide telecom sales. Nearly all telecom companies around the world had privatized in anticipation of this expanded level of competition. The accord led to a rush of international deals, especially in the world's second-largest telecom market, Japan. In 1999, British Telecommunications and AT&T partnered to acquire a 30 percent stake in LD operator Japan Telecom, combining their Japanese ventures under JT. Britain's Cable & Wireless bought Japan's No. 6 carrier, IDC, a few months later. Also in 1999, Global Crossing teamed up with Marubeni to build an entirely new network, called Global Access, to service Japan.

Wall Street highs and lows

As M&A activity heated up, Wall Street took notice -- investors poured $1.3 trillion into telecom industry companies in the five years following the Telecom Act's passage, according to Forbes magazine. But with this activity came increased scrutiny and risk. Ultimately, the industry was subject to the same meltdown that hit the rest of the tech sector beginning in late 2000. According to Forbes, the industry's market value plummeted by $1 trillion after the Dow Jones took its dive. Mergers also fell by the wayside. In July 2000, a proposed deal between Sprint and WorldCom fell through when the Justice Department filed a lawsuit that attempted to block the deal. The prospect of a lengthy DOJ suit effectively killed the merger, and it may similarly discourage future unions.

Compounding the gloom in the industry, some major telecoms had high-profile problems in their accounting departments. The two biggest offenders were WorldCom and Global Crossing, both of which ran afoul of the feds in 2002. WorldCom filed for the largest bankruptcy in U.S. history in July 2002, racking up $41 billion in debts and an estimated $11 billion in fraudulent expenses -- leading to a $100 billion loss to shareholders. Even as the company attempted a rebound, emerging from bankruptcy in April 2004 with a lighter debt load, a moderately healthy outlook, and a less tarnished name (the company reverted to the MCI brand), it had to contend with scores of class action lawsuits; former chief executive Bernard J. Ebbers also faced a growing list of federal fraud and conspiracy charges as late as Spring 2004. Accounting firm Citigroup announced in May 2004 that it would pay $2.65 billion to investors for its role in the scandal. The turmoil has led some industry analysts to speculate about a possible sale of MCI to one of its Baby Bell competitors.

A debt burden of $12.4 billion, along with an oversupply of high-speed network capacity, led to Global Crossing's Chapter 11 filing in January 2002. The outcome was predictable in this era of accounting scandals, including a Justice Department probe into the company's accounting practices, and lawyers rounding up plaintiffs. In April 2004, investors again had reason to worry as Global Crossing announced it would need to review and restate its financial statements for all of 2002 and 2003 thanks to a $50 million to $80 million understatement of liability costs.

In addition to WorldCom and Global Crossing, about a half-dozen other providers of telecom services began Chapter 11 bankruptcy proceedings in 2002, dumping customers and employees as they went. In September 2003, Sprint reported a reorganization into business and consumer lines in an effort to save $1 billion.

Wireless wins the day

Thanks to the booming wireless market, however, Sprint, which offers wireless service under the Sprint PCS name, faces less market risk, analysts say. The same holds true for other major telecoms that have devoted resources to wireless services. In fact, the wireless market, with $89 billion in spending in 2003, outpaced long distance for the first time that year, according to TIA research (LD posted $78 billion in spending). The number of wireless users was estimated at above 1 billion in 2003.