Telecom Deregulation Gets Extreme (VZ, XOHO)

| About: Verizon Communications (VZ)

The Telecom Act of 1996 is rapidly being dismantled. Verizon (VZ) asked for, and received, regulatory relief on leased lines provided to businesses.

Background: Covad and Earthlink were shattered by rulings ending their right to lease back physical connections into residences. This was first challenged and won by the cable industry in the Supreme Court Brand X decision, and DSL was reclassified as an information service by the FCC shortly afterwards. So at this point, the companies that own the physical infrastructure that connects your residence to the Internet do not need to share that connection with another carrier or ISP. Verizon no longer is legally obligated to lease its copper pairs to Covad or AOL at prices dictated by the FCC.

In December 2004, Verizon petitioned the FCC to handle business connections in the same manner. The FCC commision (two Republicans and two Democrats) voted 2-2, and the lack of any conclusion on their part automatically forced the petition to be granted. FCC Chairman Kevin Martin put his stamp of approval on the outcome yesterday.

This is very radical stuff. The MCI/Verizon merger united a company with the access lines with a company that derives its most profitable business from connecting businesses. A major condition of this merger was that the companies unbundle the access lines to MCI competitors - the exact regulation that was just removed by the FCC.

The ruling is likely to face significant court challenges from companies like XO Communications (OTC:XOHO), who provide enterprise connectivity. They are analogous to Covad in the residential market, and such a ruling is a large strategic threat to their business.

Deregulation is now driving innovation in how broadband connections are made to the home. After the FCC indicated that new investments to the home would not need to be shared, Verizon and AT&T have aggresively started deploying new infrastrucutre.

Most businesses today use 20 year old T1 or T3 technology to connect to the internet or provide intranet connectivity between their sites. Now that the carriers can set pricing on their infrastructure, and set pricing on new, more advanced infrastructure, we should see these lines finally start to be replaced.

Another observation is that a lot of duplicate last-mile infrastructure to the business will need to be built in order to navigate around the Verizon monopoly. The dark-fiber guys with connections to downtown buildings suddenly are going to have more customers like XO looking to use a new right of way.

Lot’s of thinking to still be done on this subject. It’s a very disruptive event.