AOL Overpays Again

Once upon a time, it was "The Phone Company." Got a problem? Call the phone company. Didn't have to identify which one because AT&T(NYSE: T) nearly served every home in America: service, equipment, local, long-distance. It didn't matter. We can fast-forward through the breakup of the long-distance and local companies, spawning giants like Verizon(NYSE: VZ) and SBC(NYSE: SBC), the spinoff of Lucent(NYSE: LU), and the rapid rise of a slew of competitors like MCI and Sprint(NYSE: FON).

This is a story the last generation would have largely bet would never happen. After the long-distance companies lost a recent regulatory battle with the Bell Operating Companies (BOCs) over access rates, AT&T announced that it would no longer offer new local or long-distance service in seven states. So someone needing service in Nashua, New Hampshire, or Fayetteville, Arkansas, or Columbus, Ohio, would be wasting his time calling AT&T for phone service. It won't sign him up. It doesn't want his business.

MCI likely isn't far behind. According to The Wall Street Journal, the company's considering exiting the consumer business in its entirety. AT&T said it stopped soliciting new customers in these particular states because it couldn't profit in those jurisdictions. The company simultaneously slashed its revenue expectations for 2004 from $32 billion to less than $30.

Last February, I selected AT&T as a candidate for shorting in the Hidden Gems predecessor Motley Fool Select. (See my review of these selections in The Long and Short of It.) With this most recent setback, the rationale for this decision comes sharply into focus. AT&T's basic phone service business is still being blasted on many fronts.

Earlier this month, long-distance companies suffered a setback when the FCC did not appeal a court decision that struck down its rules governing wholesale rates that the BOCs can charge for access. Several BOCs have complained that the rates they can charge are below their cost to provide the service to what are, essentially, rival companies. The battle isn't over, but what it still amounts to has less to do with competitive or anti-competitive practices than this simple fact: too many companies are competing for too few telecommunications dollars. This doesn't even include the Internet- and cable-based solutions eating even further into the market. Several telecommunications companies need to exit the business before the U.S. market will be anything other than a net destroyer of capital.

AT&T has the most to lose, since it is still the largest long-distance provider in the country and is still knee-deep in debt, even after its divestiture of cable and wireless assets. AT&T is a profitable company that creates substantial free cash flow and pays a dynamite dividend. These elements may make it attractive at some price. It may be attractive at the current price. But one needs to recognize that the environment where this and other long-distance companies works continues to deteriorate, and it won't stop until equilibrium is reached. With AT&T abandoning whole states rather than trying to compete, it's clear we're a long way from that point.

Bill Mann is wondering just why in the world people are excited about telecommunications these days, which reminds him more and more of the airline industry. He holds shares in none of the companies mentioned in this story.

Discussion Board of the Day: Will AT&T's Move Hurt States?

So AT&T stopped soliciting customers in seven of its least profitable states. Even though it will continue to offer phone services, what impact will its decision have on prices and the economy in those communities? Share your views on our AT&T discussion board.

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