The "New" Regional Long DistanceCompanies

Posted: 11/1999

The "New" Regional Long Distance
Companies
By Ken Branson

In baseball, coaches call it staying within yourself–the art of hitting the ball hard
and consistently, but not necessarily far. It is advice several competitive local exchange
carriers (CLECs) seem to have taken to heart.

They have concluded–and their routes to this conclusion vary–that regional long
distance service is an essential part of the package they offer their customers. They may
not lead with it, but they wouldn’t be caught dead without it. They use their own
facilities whenever possible, and offer the service within a distinct geographic footprint
(see chart, below).

"We’re regional, as opposed to national," says Jere Thompson, CEO of CapRock
Communications Corp., Dallas. "We’re interested in serving Texas, Louisiana,
Arkansas, Oklahoma, New Mexico and Arizona. We’re focused on being as inclusive as
possible, tying customers onto the fiber backbone, offering voice and data services."

For some carriers, such as GST Telecommunications Inc., Vancouver, Wash., local service
came first. For others, such as ITC^DeltaCom Inc., West Point, Ga., long distance and
local service collided in mergers. Others, such as CapRock, began as long distance players
and now are building local networks. Whatever their history, the companies almost always
describe themselves as "integrated communications providers," or ICPs, and
bristle a little at being forced into a service cubbyhole.

"Basically, our plan has been to de-emphasize the long distance, and make it part
of the product bundle, especially as we focus on the data segment," says Kendall
Karle, director of long distance services at GST. "But long distance is still an
important part of that. We’re trying to get it into the bundle, make sure that pricing is
competitive, but our other products are what drive the sales opportunity."

GST started as a CLEC, and laid fiber between its local networks up and down the West
Coast from Seattle to San Diego. From the beginning, the fiber was a key part of the
carrier’s strategy, and GST started laying it in the ground before long distance service
became a commodity. But the point of the fiber, for GST and other carriers, was to offer
data services over GST’s own network to the business customers that are its bread and
butter.

"Long distance as a standalone is pretty short-lived," says Peter Kennedy,
vice president-equity research at Morgan Stanley Dean Witter Inc., New York. "We’re
seeing price declines, although it’s not a giveaway yet."

To Kennedy and other analysts, data is the driver, and data over one’s own facilities
is preferable to data over leased facilities. "Owning end-to-end services, that’s
what everybody is focused on," he says.

GST laid, and continues to lay, extra capacity in its fiber network to wholesale to
other carriers. Its network, called the VITA network, is supposed to have 6,600 miles of
operational fiber by the end of this year.

McLeodUSA Inc., Cedar Rapids, Iowa, began bundling local and long distance service to
business customers in parts of Iowa and Illinois in 1994. McLeod began with resale, and
has built its fiber optic network out from its base until it now serves 12 states in the
Midwest and Rocky Mountain regions. A spokeswoman says McLeod has 8,500 route miles of
fiber now, and is still building. The company uses long distance resale as a
stalking-horse in new markets, but is focused on providing integrated services on its own
facilities.

Where McLeod may differ somewhat from its counterparts is its deliberate foray into
residential service. The company offers integrated long distance and local service to
residential customers in Colorado, Michigan, Missouri, North Dakota, South Dakota and
Wyoming.

The idea of staying inside one’s geographic footprint isn’t merely homey. Carriers
offering regional long distance service have a clearly defined customer base. Although all
the carriers PHONE+ contacted refuse to say what percentage of their revenue or traffic is
attributable to long distance service, they can rest assured that most of the calls
originating in their regions also terminate there.

"In ITC^DeltaCom’s case, for instance, they serve the Southeast, and that’s a
region where about 70 percent of the originating calls also terminate there," Kennedy
says. "And GST has the West Coast; about 55 percent of the calls originating in
California terminate in California."

That’s how CapRock’s Thompson sees it, as well. "We’re going after companies who
have a significant portion of traffic originating and terminating within this
region," he says. "That means lots of smaller and medium-sized companies,
sometimes larger ones. But the extensiveness of our network makes us as competitive as
anybody out there in providing services to those target customers."

CapRock started as a regional long distance company and added local service as it grew.
Thompson, an investment banker by trade, had seen a demonstration of video on demand in
1989 and decided that broadband services were the wave of the future, if only he could
figure out a way to deliver them. He founded CapRock Fiber Network in 1992 to offer the
necessary connectivity to carriers and businesses in Texas, using optical fiber.

However, in the days before the Telecommunications Act of 1996, the merit of such a
strategy was not apparent to everyone. Thompson, who had quit his day job in investment
banking to devote himself to his new business, had lots of trouble getting it funded.

"People thought, if there was a need for fiber, AT&T [Corp.] would already
have put it in the ground," he says. "I was rejected by 20 different potential
investors."

Eventually, however, he talked to the Central and South West Corp., Dallas, an energy
company interested in finding an alternative to its microwave network. Thompson and his
colleagues convinced Central and South West that fiber was the answer. "Here’s the
design; here’s the engineering," he remembers telling the Central and South West
people. "All we need is the capital." That gave CapRock Fiber Network its start
in 1992. Mergers with another small carrier and a professional company created CapRock
Communications in 1998.

BTI Telecommunications, Raleigh, N.C., also started as a long distance company–a
reseller–back in 1983. The company has since laid down its own fiber optic network in the
Southeastern states–1,100 route miles of fiber as of July 15, according to documents
filed with the United States Securities and Exchange Commission (SEC)–and leveraged that
network to add new services. Its local service began in November 1997, and BTI had sold
75,000 access lines by the end of the second quarter this year.

BTI officials decline to discuss the place of regional long distance with PHONE+,
explaining that they are in the middle of their "quiet period" following their
registration with the SEC for an initial public offering (IPO) of stock. However, in that
filing, BTI affirms the importance of owning and operating its own facilities.

According to the registration statement, BTI will have 3,900 route miles of fiber
throughout the Southeastern states by the end of 2001, as 19 local and five long distance
switches. "Owning our own network allows us to offer higher-margin services, such as
data and private-line services, improve our margins by transitioning large portions of our
traffic onto our facilities-based network and control the quality of service and improve
the delivery of services to our customers," according to the statement.

ITC^DeltaCom, which covers much the same territory as BTI, is the product of a series
of mergers brought together long distance (DeltaCom), fiber optic network expertise
(Interstate FiberNet). The company began offering local service in July 1997 and went
public three months later.

ITC^DeltaCom’s long distance antecedents are oldest, originating in 1983 with DeltaCom,
a long distance reseller in Alabama. "In … early 1996, we were acquired by ITC
Holding Co., and merged with Interstate FiberNet, another sub of ITC Holding Co.,"
says Foster McDonald, ITC^DeltaCom’s president and a veteran of DeltaCom’s days as a
reseller. "Interstate FiberNet had started in 1993 as a builder of fiber optic
network capacity. They were building fiber net throughout the Southeast, not just in
Alabama."

ITC^DeltaCom now has 9,000 route miles of fiber in the Southeast–though, as McDonald
is quick to point out, much of that mileage actually belongs to utility companies.
ITC^DeltaCom manages its transmission networks in return for the right to use some of
their capacity.

The Telecommunications Act of 1996 provided the impetus ITC^DeltaCom needed to become a
LEC, but its strategy is built on integration of services–and bills–to its small and
medium-sized business customers.

"We rolled out our local services strategy in July 1997," McDonald recalls.
"So, at that point, we became a full-service provider, and added to that along the
way Internet access and data services, and have added to that the telecom equipment
business."

ITC^DeltaCom is a value-added reseller for Nippon Electric Corp. (NEC), Tokyo, and its
people sell and service that equipment throughout the Southeast, McDonald says. For
McDonald and his colleagues, the idea is to have ITC^DeltaCom’s customers associate the
company with everything, absolutely everything, having to do with communications. "If
you ask our customers what they like about doing business with us, they would tell you,
‘If I have a problem with my phone service, I know who to call,’" he says.

To paraphrase another baseball saying, if you build it for data, and they come, you
might as well sell them regional long distance.

Ken Branson is business and finance editor for PHONE+ magazine.