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MarketWatch
December 7, 2006 Thursday 5:03 PM EST
Jeffry Bartash, MarketWatch
From Lexis Nexis

WASHINGTON (MarketWatch) – Executives at the largest U.S. phone companies are predicting that after years of bleeding customers to cable and wireless rivals, their access-line loss rate could finally plateau in 2007.

In a series of presentations in New York this week, executives from AT&T Inc. (T) and Qwest Communications International Inc. told investors they expect the rate of access-line losses to either stabilize or taper off next year.

“Our expectation would be that in 2007 that we don’t see a worsening access-line loss situation,” Rick Lindner, AT&T’s chief financial officer, told clients of the investment bank UBS.

The statement, like similar comments this fall from Qwest (Q) and Verizon Communications Inc. (VZ) , signals a shift toward optimism among phone company executives, who until recently have declined to predict a deceleration in the rate of line losses.

Whether the comments turn out to be wishful thinking will depend in part on whether cable giants like Comcast Corp. can continue to snare phone customers at their current pace.

If the phone companies can succeed in slowing their losses, concerns about future profit and sales growth in the sustainability of their high dividend yields may dissipate.

Before investors are convinced, however, phone companies will have to show proof they can stanch their losses.

Accelerating losses

The increased optimism about line loss rates is noteworthy because they come as access-line losses have been proceeding at an inexorable pace – and even accelerating for the two largest phone service providers.

Verizon’s access lines fell 7.5% to 46 million in the third quarter, the fourth straight quarter the company saw its loss rate increase.

Verizon has seen its annual loss rate accelerate every year since 2002.

In the same quarter, AT&T access lines fell 6.2% to 47.1 million, the fastest loss rate this year. For all of 2005, its line-rate loss was 5.6%.

Still, phone executives say they are doing a better job of retaining existing customers with faster Internet speeds and discounted bundles of service that combine Internet access with local and long-distance calling. Verizon is also rolling out out its own pay-TV service, with AT&T following suit.

At the same time, executives assert, wireless substitution for regular phone plans is starting to slow while recent industry entrants such as cable companies will find it harder to attract customers to their new phone services.

Lindner of AT&T said cable companies have already introduced phone service in most of its territory and probably picked much of the low-hanging fruit — the customers most eager to switch.

“The first year into the market they obviously had the opportunity to make the most in terms of penetration gains,” Lindner said. “Then it becomes more difficult to further penetrate the market and it does start to level off a little bit. I think that is some of what we are seeing right now.”

Yet executives at Comcast Corp. (CMCSK), one of three large cable operators with a presence in AT&T’s territory, believe they can still make big inroads into the phone market until at least 2010.

John Alchin, co-CFO of Comcast, said his company could add as many as 10 million phone customers over the next few years. The cable operator already has 2.1 million phone customers, 1 million of whom have signed up in 2006, when Comcast made its primary push into the market.

Still, that represents just 4% of Comcast’s potential market. “Our penetration rates still leave us a huge upside,” Alchin said.

The real fight

The battle between big phone and cable companies is being closely watched by investors, some of whom worry that a price war could break out and damage both sides. Both industries, however, insist they won’t compete primarily on price but on quality of service.

That’s why both sides continue to increase the speeds of Internet access and take other measures to lure customers. Verizon is building a multi-billion-dollar fiber network not just to offer television service, but to deliver the fastest Internet connections in North America.

Indeed, the Internet represents the true frontline between cable and phone companies, Oren Shaffer, Qwest’s chief financial officer, told clients of the investment bank UBS.

For cable, offering phone service is a way to help attract customers to its video and high-speed Internet plans. And phone carriers believe upgrading their networks to offer video and faster Internet access will also lock in their phone customers.

“That battle that is going on in the marketplace is really focused around the broadband connection,” Shaffer said.

So far, cable is wining that battle and controls 55% of the market, though phone carriers are catching up. Cable was the first to jump into the market in a big way about five years ago and has held the lead ever since, aided in part by faster access speeds.

Comcast is the nation’s leader in broadband connections, serving 11 million high-speed Internet customers. AT&T is second with 8.2 million, but the carrier will leapfrog Comcast once it completes its pending acquisition of BellSouth Corp. (BLS) and adds that company’s 3.4 million broadband subscribers to its total.

Because of fast growth in broadband and wireless, phone companies have actually increased the number of so-called customer connections in the past few quarters, more than offsetting the decline in access lines.

Their hope is that the addition of video service as well as Internet speeds comparable or better than cable will prevent more phone customers from defecting. Local phone customers are particularly lucrative for the phone companies and costly to win back after they leave.

“I think that at some point in time, and probably not very far from now, access-line losses should start to decelerate, not only for ourselves but also for the other players,” Oren Shaffer, Qwest’s chief financial officer, told clients of the investment bank UBS.

Qwest lost 6% of its access lines in the third quarter, ending with 14 million lines.
 
What makes Shaffer’s comments noteworthy is that Qwest (Q) Chief Executive Richard Notebaert has repeatedly said he did not know when the decline in access lines would decelerate. Notebaert repeated that view as recently as Oct. 31 in an interview with MarketWatch.