BellSouth's Earth Is Flat

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Hurricane damage and fleeing customers cut BellSouth Corp.’s (NYSE: BLS) fourth-quarter profits by 40 percent from a year ago, the carrier reported today. But analysts say the carrier could make a cozy future for itself if it succeeds in offering video services.

But the real take-away from BellSouth's earnings call is that all is not cozy right now. After stripping away the one-time items in its report, growth for BellSouth’s core businesses has essentially remained flat over the last three years, which may be an early signal that competition from cable operators and CLECs is slowly starting to erode the RBOC's hold on its territories.

BellSouth earned $496 million, or 27 cents a share, on revenues of $5.15 billion, compared to income of $836 million, or 45 cents a share, on revenues of $5.11 billion in the fourth quarter of 2003. For the full year 2004, BellSouth reported a 1.4 percent drop in net income to $3.44 billion, or $1.87 a share, compared to $3.49 billion, or $1.88 a share, a year ago. Revenue remained flat at $20.3 billion.

BellSouth CFO Ron Dykes attributes the lack of growth to repair costs associated with the hurricanes that struck the Southeast last year, severance-related expenses, and a change in the calculation of the retiree medical benefit obligation.

Tavis McCourt, senior telecom analyst at Morgan Keegan & Company Inc., says BellSouth’s revenues are in line with what analysts had anticipated and that strong wireless growth had helped even out the flat wireline numbers. Fortunately for BellSouth, the company’s earnings were propped up by the sale of 10 of its Latin American properties, which added $915 million, or 53 cents a share, to its bottom line. Its Cingular Wireless division also helped carry the load with its 1.8 million new customers added in 2004, bringing its customer base to 49.1 million -- the largest in the nation.

Dykes also notes that Cingular’s revenue was affected by its acquisition of AT&T Wireless, lower service revenues, and customer addition and retention charges. He touts the fact that Cingular has integrated more than 1 million AT&T Wireless subscribers since the acquisition (see Cingular Buys AT&T Wireless).

McCourt says that in the short term BellSouth and other RBOCs have two diverging trends working in their favor. “Right now, with AT&T and MCI getting out of wireless, they’re benefitting from the increased wireless business. "But the increase in VOIP offerings hurts their wireline business, so the two balance each other out.” Longer term, analysts say the Bells will have to be successful in offering video services to compete. “They’re going to need between 15 to 20 percent video penetration, and I don’t think they’re going to get that with a bundled satellite deal,” McCourt says. BellSouth reported the addition of 224,000 DSL customers in the fourth quarter, bringing its DSL base to 2.1 million customers. The carrier says pricing pressure and weak demand for access lines caused a 2.6 percent drop in large business customers (see BellSouth Boasts DSL Growth). BellSouth's Dykes attributes the DSL growth to the continued success of its tiered priced service offerings.

Overall, the number of the company’s access lines dropped 4.1 percent to 21.4 million, but the number of UNE-P access lines resold by BellSouth competitors rose to 2.8 million from 2.4 million a year ago. A look at the financials reveals that even this may have been a blip, as UNE-P lines decreased by 165,000 over the second half of the year.

Dykes tries to soften the blow of access line losses by saying that company research indicates that a lot of them are switching to wireless options. “There’s not a lot of insight into what access line numbers are going to look like in the future,” he says.

While BellSouth offers triple-play services through its partnership with DirecTV Broadband Inc. and boasts more than 200,000 adds to its co-branded DirecTV service, Dykes concedes that nearly half of those were existing customers opting for a package discount. He says the company is continuing to evaluate Microsoft Corp.’s (Nasdaq: MSFT) TV technology but doesn’t give a timeframe for rollout of IPTV services (see BellSouth Trials Microsoft's IPTV and BellSouth: Access Will Rise Again). BellSouth predicts growth in the mid- to high-teens in 2005, from DSL and long-distance customers, not its core communications group, where it is forecasting flat results.

BellSouth’s stocks dropped 1.77 percent, or 47 cents, to $26.09 in trading today.

— Chris Somerville, Senior Editor, Next-Generation Services

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