Executive Summary:
Competitive Carrier Report 2007

This is not your father's competitive telecom industry. It is leaner, meaner and battle tested. Five years after the great telecom nuclear winter, only the shrewd and adaptable competitive carriers remain. Hard won gains have begun to form the basis for new growth.

by New Paradigm Resources Group [April 2, 2007]

That 2006 was a pivotal year will be more apparent in retrospect. Outwardly, the changes and trends of recent years seemed to be continuing incrementally through the year, but underneath, profound developments were underway. While total industry revenue seemed mired in a no-growth or slow-growth scenario, this masked a reality of dynamic cross currents among specific services. Traditional telecommunications services were in decline as markets moved to wireless, broadband, IP and integrated services.

Changes in network architecture were even more profound than changes in service offerings as the migration to advanced fiber and IP technologies accelerated. The prospect for early obsolescence of embedded network equipment increased sharply. Handling this network rotation became a major task for all carriers and worked to the disadvantage of some established players large and small.

The need for scale and for service differentiation became crystal clear.

Reflecting on 2006
Competitive carriers, like incumbent telephone companies, responded to the need for scale with a year of unprecedented mergers and acquisitions. Indeed, 2006 was a busy year for the Competitive Carrier industry. Consolidation throughout the telecom industry was the headline story of the year, but the continued rollout of softswitches and the Ethernet future were subtexts.

Clearly, the industry is healthier than it has been in the recent past. The last major competitive carrier to enter bankruptcy, for example, was McLeodUSA, which entered bankruptcy in October 2005 and emerged rather quickly in January 2006.

Since then, mergers and acquisitions have ruled the day. Level 3 went on a buying spree, acquiring Progress Telecom, ICG, TelCove, Looking Glass Networks, and Broadwing to extend its network deeper into metro areas and broaden its product offerings.

Some competitive carriers combined to add markets to their national footprints. Qwest's OnFiber acquisition and Time Warner Telecom's Xspedius acquisition reflected this trend, adding strong metro fiber networks in new cities to two existing national competitive carriers.

Other competitive carriers were busy shoring up their regional footprints. Eschelon Telecom sought to add adjacent carriers in 2006 to broaden its regional reach. Eschelon's acquisitions of Oregon Telecom, OneEighty Communications, and Mountain Telecommunications accomplished that. PAETEC and US LEC, meanwhile, announced a similar planned merger on a larger scale. The two carriers' service areas are geographically adjacent along the east coast with only a little overlap. Three adjacent regional carriers with a bit more overlap—Choice One, CTC, and Conversent—formed One Communications in 2006, broadening the participants' geographic reach while deepening market penetration in overlapping markets.

Still other competitive carriers explored alternative technologies to grow their businesses. Covad glimpsed the wireless future and dived in with its acquisition of NextWeb and pending acquisition of DataFlo Communications.

As noted, for a variety of mostly-sound fiscal and competitive reasons, competitive carriers merged and acquired in 2006, a notable improvement over years gone by.

Looking Ahead
The future is looking better for competitive carriers. Today, competitive carriers are stronger than ever, with most of the stronger competitors remaining, while a handful of troubled service providers continue to hobble along. Growth opportunities abound amid the challenges. New transport technologies such as Metro Ethernet offer competitive carriers the chance to compete on level footing. Less expensive switching technologies—softswitches—have reduced the barrier to competitive entry. And the acquisition of the two largest competitive carriers—AT&T and MCI—by RBOCs has offered an opportunity for the rest of the field to offer non-RBOC alternatives to the new AT&T and Verizon, both inside and outside the incumbents' service areas.

If size is an important factor in viability, the competitive carriers are increasingly capable of facing off against new and existing challengers. The acquisitions in 2006 have swelled the number of billion dollar competitive carriers to six. We expect the newly merged PAETEC-US LEC to join this list, as the two carriers' combined 2006 revenue falls just below $1 billion.

Challenges in the coming years may include price pressure as customers expect discounts from TDM-based technologies to IP-based technologies. Cable companies are also beginning to venture more into traditional CLEC businesses, strengthening metro fiber

networks to offer carrier-grade connectivity within their cable service metro areas. And the RBOCs, whose acquisitions of AT&T and MCI may have opened up some "carrier diversity" contracts to the other competitive carriers, are marketing their converged in-region/out-of-region services as unified, bundled offerings under a unified sales force. In many instances, this will result in stronger—not weaker—RBOC competitors. Another challenge competitive carriers will face in the coming years is the need to decide the extent to which they will embrace wireless alternatives. As we noted earlier, Covad is already hedging its bets, with its NextWeb and DataFlo acquisitions. XO Communications has reinvested in its fixed wireless capabilities to avoid being passed by. The extent and format of wireless integration into competitive carrier networks are still being determined—microwave and millimeter wave fixed wireless, broadband wireless, cellular partnerships, and fixed-mobile convergence, but in what proportions and using which technologies?—but wireless is part of the competitive carriers' futures in some form and fashion.

The challenges faced by competitive carriers are formidable, but the carriers as a group are a stronger, leaner, and smarter group, and the future for this group looks brighter than it has in quite some time. With a shift from switched local and long distance voice traffic toward private line and data traffic, the components of the carriers' revenue may evolve over time, but for the rest of this decade, NPRG expects a slow, steady four-to-five percent revenue growth rate. Cast in the light of recent history, that's not too bad!

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Competitive Carrier Report 2007™ ©2007, New Paradigm Resources Group, Inc.