Considering Frontier Communications Corp. (NYSE: FTR) generated nearly $1.3 billion in revenues in the first quarter of 2012, why is it the first to take a new handout from the Federal Communications Commission (FCC) for the purpose of delivering broadband connectivity?

The answer is far from simple. In fact, it bears a striking resemblance to the raging battle over the tax versus penalty debate in U.S. health care.

On July 9, Frontier Communications announced that it is the first local exchange carrier (LEC) to take money -- to the tune of $71.9 million -- from the FCC’s Connect America Fund (CAF). Those not familiar with CAF are probably more familiar with the name by which it’s been known since it was established in 1934 -- the Universal Service Fund (USF). (See FCC Launches 'Connect America Fund'.)

USF originally was created at a time in which only 40 percent of America had landline phone service, and the idea was to create a fund (created by a tax or a penalty, depending on how it’s viewed) that would subsidize the cost of building out phone service to areas where it might not be considered economically feasible to do so by the phone company. (See Back to the Future on Unbundling.)

Fast-forward about 80 years, and USF’s noble beginnings mushroomed into an unwieldy mechanism that far outgrew its original intent, enabling telecommunications service providers to profit mightily at the cost of consumers, who pay USF fees (for a complete history of USF and its evolution, see Understanding The Universal Service Fund).

The answer to this problem, per the FCC’s ruling late last year, was the creation of CAF, a $300 million fund to be used to build out broadband to unserved -- generally rural -- areas of the country, as defined on the National Broadband Map. The telcos that are eligible for CAF funds have until July 24 to decide whether to accept the funding, which essentially provides them with $775 per household to build out broadband service in these rural areas.

Table 1: Connecting to the CAF

Double dipping
"The $300 million that funds CAF was created through savings made by reforming USF," according to FCC spokesman Mark Wigfield. What’s most interesting about these savings and the resulting reformation, however, is that now, these service providers continue to receive the USF fees they already were receiving, but they’re also eligible for a hefty chunk of CAF money, as well.

The justification here is that the FCC has capped USF at its 2011 rate for service providers (it’s interesting to note here that between 2002 and 2011, USF fees increased 272 percent, according to Broadband Reports). It’s also helpful to note that service providers are not required to collect USF from their customers; in fact, since the Telecom Act of 1996, they’ve had the distinct option of not charging customers for USF or doing so as a tax, an option for which they all opted (again, the penalty vs. tax analogy).

As of this week, Frontier is the only company to outright accept the FCC’s money. Steven C. Crosby, SVP of Government & Regulatory Affairs and Public Relations with Frontier Communications, said that between the CAF money and Frontier’s own investments, the company plans to deploy broadband to about 200,000 unserved locales. This fits nicely with the company’s need to meet its 2013 goal of achieving 85 percent broadband penetration as part of its 2010 acquisition of Verizon’s 4.8 million landlines, a deal valued at about $8.6 billion. Currently, Crosby says, Frontier is “at nearly 80 percent” of that goal.

The only other company to publicly acknowledge its intent toward the CAF money is CenturyLink. On June 26, CenturyLink filed a waiver with the FCC to ask that it be allowed to use the CAF money to build broadband into locations on the National Broadband Map that are already served by fixed wireless providers. However, CenturyLink contends that these fixed wireless providers do not provide adequate service to the areas. This is an important distinction. Instead of providing service to areas that have no service, CenturyLink has the potential here to use the funding to set itself up as a competitor in areas that already have service.

A CenturyLink company source, speaking under the condition of anonymity, said won't say whether CenturyLink plans to take the money regardless of whether the waiver is granted. “Under the waiver,” the source said, “CenturyLink expects to be able to use an additional $32 million to serve an additional 42,000 homes if the waiver is granted.”

FCC spokesman Wigfield said he was not certain whether CenturyLink’s waiver filing would open the door to other service providers attempting to circumvent the ruling that CAF fees be used to provide broadband to unserved areas, as opposed to those deemed “under served” by the service providers.

“The bottom line,” he said, “is that with CAF, the FCC tried to establish reasonable benchmarks on what the appropriate amount of support is for carriers. Some were found to be getting too much support, but others weren't getting what they deserved. So these changes make the system more fair overall.”

— Denise Culver, Special to Light Reading