A broad warning issued last week by credit rating service Standard & Poor’s has cast a lingering dark cloud over regional Bell companies (RBOCs). It's also raised new questions about VOIP regulation.

S&P says RBOCs stand to lose about $5 billion in annual revenues if regulators make voice-over-IP providers exempt from federal and state access fees. RBOCs currently rely on carrier access fees for about 22 percent of their total operating revenues, or about $20 billion.

In its estimate, S&P assumed RBOCs will lose about 15 percent of residential access lines with average monthly bills of $24 each to cable companies, independent carriers, and long-haul carriers that offer VOIP service. Loss of local lines would account for about four-fifths of the $5 billion shortfall, and loss of access fees would make up the rest.

The overall loss could be mitigated by VOIP providers’ recurring payments to RBOCs for local connectivity services such as ISDN primary rate interface or toll-free 800 service. On the other hand, the loss could soar beyond $5 billion if VOIP providers use leased facilities to terminate large volumes of long-distance calls.

The issue hinges partly on whether the Federal Communications Commission (FCC), states, and courts require VOIP carriers to pay access fees to RBOCs for VOIP traffic transmitted over, or terminated on, the RBOCs’ networks.

Current regulation of VOIP service is murky at best. VOIP providers like Vonage Holdings Corp. and AT&T Corp. (NYSE: T) have claimed that they are information services and should not be treated as telecommunication services, which are required to pay access fees. Some state regulators, such as the Minnesota Public Service Commission, have challenged those claims. But in October, a U.S. District Court overruled Minnesota’s decision to regulate Vonage as a telecom carrier.

The FCC is reviewing VOIP regulation but has no deadline for a definitive decision. Whatever it decides, the threat of VOIP to the RBOCs may be unavoidable. “Regardless of what happens with regulation, I think you’ll see the competition [from VOIP providers] move forward,” says Catherine Cosentino, the credit analyst at S& P who wrote the report.

S&P currently has a credit watch on all three investment-grade RBOCs: SBC Communications Inc. (NYSE: SBC), BellSouth Corp. (NYSE: BLS), and Verizon Communications Inc. (NYSE: VZ). But Cosentino stresses that the threat from VOIP providers is only one of several reasons for the rating service’s concern. Substitution of cell phones for wire lines also puts RBOCs’ revenues at risk, as does the loss of retail lines to unbundled network element platform (UNE-P) competitors.

Some RBOCs, such as Verizon, have been battling S&P's negative view. When S&P put Verizon on credit-watch negative, Verizon fought back with a strongly worded press release (see Verizon Scuffles With S&P and Verizon Hits Back at S&P).

But VOIP is poised to grow quickly, especially as cable companies roll out the service. Last year, Cablevision Systems Corp. (NYSE: CVC) rolled out VOIP service and had 29,000 subscribers by Dec. 31, 2003. Cox Communications Inc. (NYSE: COX), Time Warner Cable, and Comcast Corp. (Nasdaq: CMCSA, CMCSK) have introduced similar offerings.

In response, some RBOCs have started deploying VOIP service themselves. Qwest Communications International Inc. (NYSE: Q) provides the service to consumers in Minnesota, and SBC offers VOIP to business customers as part of an Internet services package.

VOIP systems can be as much as 50 percent less expensive for RBOCs to maintain than circuit-switched systems. Nevertheless, RBOCs may still have to cut prices for VOIP services to compete with CLECs, which have lower overall cost structures.

— Justin Hibbard, Senior Editor, Light Reading