TC2's David Rohde on Telecom

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News and Analysis From the Enterprise User Viewpoint

Moody’s downgrade reflects Sprint’s sinking morass of issues

By Posted December 18, 2014

Three years ago I said that “For Sprint, now everything has to go right.” I’m not sure much of anything has gone right for Sprint since then.

Yesterday Moody’s lowered Sprint’s credit rating to “B1 with a negative outlook.” Here’s a handy guide to translation from credit-speak. B1 is four notches into junk bond territory. “Negative outlook” means Moody’s is signaling that the next move is likely to be the fifth notch down rather than a move back up.

The practical financial meaning is that Sprint is basically where bad CLECs were 10 years ago.

Moody’s credit downgrade comes on the heels of a proposed $105 million fine from the FCC for “cramming” unauthorized charges onto wireless bills. Sprint is hardly alone in cramming. But the fine would be a record among U.S. wireless carriers.

Sprint also has to face the ominous spike in spectrum costs signaled by the more than $40 billion in current auction bids for what was expected to be a relatively sedate AWS-3 auction. It’s not that Sprint doesn’t already have a great deal of spectrum on its hands – it certainly does via Clearwire. Organizing that spectrum into geographically consistent broadband service with additional investments has been their issue. And nobody wants to be financially hindered from getting some of the coveted low-band, high-propagation spectrum that the government is prying out of the hands of UHF television stations to auction off in early 2016.

The rising cost of capital implied by a crumbling credit rating does not bode well in this environment. At the marketplace level, it’s hard to see where Sprint is able to go on offense. Sprint has basically forfeited its place in the wireline business, and in enterprise wireless it’s principally relevant in terms of defending incumbent positions in individual accounts more than being able to blow people away with aggressive bids for new business.

In the consumer wireless market Sprint is certainly trying to look menacingly aggressive with its half-off offer. But I think it’s kind of a phony aggression that doesn’t come off cleanly. Certainly the offer is going to get people onto the showroom floor, to borrow a car-dealer image. But the whole promotion is based on waving its arms to say “me too” on whatever Verizon and AT&T is offering, because you have to bring in or send in your bills from those guys to try to get the deal.

Is this kind of me-too-ism a classic marketing mistake, as some marketing gurus would declare? Earlier this week T-Mobile introduced “Data Stash,” a plan to let customers carry over unused data allowances for up to a year, replete with shots at specific Verizon and AT&T practices from T-Mobile’s perpetual funnyman John Legere. I think that approach hits a nerve while “half off” is just whiny. Besides, everyone knows it isn’t really half off.

Remember something in all this that people may have already forgotten since midyear 2014. When SoftBank and Sprint were thinking they had a shot of buying T-Mobile from Deutsche Telekom and getting the U.S. government to approve the deal, they were clearly thinking of changing their name to T-Mobile and installing Legere as CEO. You don’t recover easily from this downgrade of your own brand value and self-esteem, even if it was never officially announced.

Of course SoftBank itself brings financial resources to the table. But some of their moves, like repurposing SoftBank engineers for Sprint work and clearing out Sprint employees under actual new CEO Marcelo Claure, look a lot messier in real-life human terms than they do on org charts.

One thing that’s always been implicit, and concerning, in the SoftBank/Sprint saga is that the main focus has never been on enterprise, as was clear two years ago even when the $22 billion takeover was just being discussed, and as was illustrated in the sad tale of the Nextel migration. I doubt that Claure’s understanding of how hard it is to appeal to enterprise customers when the whole focus is on cutting and chopping has advanced very far at all.

And there’s some concern about SoftBank’s staying power as its easy analogies to winning as a No. 3 carrier in markets like Japan and South Korea have proven exceptionally difficult to execute in the U.S. market. Sprint does now have 260 million LTE POPs and yesterday it boasted about its new network organization under SoftBank leadership. As a cross-cultural company SoftBank/Sprint is another test case in these global mergers, which overwhelmingly have proven difficult, as many large enterprise managers themselves have experienced.

That brings us to the other, aggressive players in all of these markets. T-Mobile’s potential in enterprise (which is still far more potential than actual) and the welcoming and varied approaches to enterprise wireline from Level 3, CenturyLink, Zayo and others are clearly starting to fill the gap. At this point does Sprint magically turn it around and effectively get back in the game for new business? Under current ownership and management, the answer in this corner has to be: It’s increasingly hard to see how.

BT jumps back into wireless by leapfrogging its old wireless business

By Posted December 17, 2014

A major global carrier having no play in wireless seems like an oxymoron at the dawn of 2015. And yet BT (known then as “British Telecom”) divested its wireless business in 2002 in an effort to pay down debt.

Now BT is going to jump back into the UK wireless market, and by jump I mean really leap. Skipping over a relatively simple opportunity offered by Telefonica to buy O2’s UK network, which has legacy ties back to the original BT wireless business, BT is negotiating with two other European national carriers to buy out their UK joint venture instead.

The carrier to be acquired is EE, an abbreviation for what itself was the 2009 merger of UK wireless carriers owned by Orange (of France) and Deutsche Telekom (of Germany). That merger resulted in “Everything Everywhere,” a mouthful that eventually became simply “EE.” More importantly, EE has risen to the top of the British market with a 34% market share and the most LTE coverage in the UK. Vodafone and O2 are tied for second with 26% each.

BT chose to say that the deal to purchase EE gives them the ability to offer their domestic customers “fixed-mobile convergence,” a term that may not have exactly the same play as it used to in the U.S., where it meant literally seamless landline and mobile handoffs.

I sense that BT simply means the opportunity to sell both fixed-line and mobile services to the same customers, most especially enterprises – something that Verizon and AT&T obviously revel in in the U.S. Since it originally spun out O2 and then sold it for good to Telefonica in 2006, BT has offered wireless services to enterprise customers as an MVNO. But interest from large companies has been limited at best. Acquiring EE will completely change the game for BT in the UK mobile market.

BT often struggles to offer bespoke deals (attractive, customer-specific deals) to enterprise customers that bundle multiple UK wireline products. So it will be fascinating to see how BT will approach enterprise customers with combined mobile/wireline deals, which is what enterprise customers will expect.

Not only is this acquisition important for any business customers, including U.S.-based multinational corporations, with substantial UK traffic and expenditures, but it also kicks off a round of transactions among a larger circle of world telecom players.

Telefonica itself is now struggling with debt as it tries to really refocus as a major player in the combined European and Latin American Hispanic-centric market. It was fairly desperately angling to get BT to buy O2 back instead of going for EE, pitching the idea that O2 would be a simpler transaction between one buyer and one seller. But with BT now opting for the greater market share and 4G coverage of EE – even at the price of paying both cash and BT stock to both Orange and Deutsche Telekom – Telefonica has to look elsewhere for financial relief.

Fortunately for them, they may have another candidate to buy O2 in Hutchinson Whampoa Ltd., an Asian diversified conglomerate with interests ranging from real estate to telecom – and the current owner of yet another UK wireless player called Three (ironically the No. 4 player in the UK with 12% market share). The financial implications of any Telefonica sale of O2 would go well beyond the UK, as Telefonica and Telmex (which now operates under América Móvil in its corporate structure) go toe-to-toe for Latin American regional enterprise business, much as SingTel rides the cresting wave of Asia-Pacific Rim enterprise business.

I’ll have more to say about Telefonica’s financial status soon. Suffice it to say that offloading O2 to somebody for some material amount of benefit is a huge priority for Telefonica.

If you’re following the players here, notice that for all the UK deal-making, the likely transactions don’t pose quite the same level of government “antitrust” or competition concerns as they have in the U.S. Quite simply, BT not being in the wireless business during mobile’s period of explosive growth means that there’s no explicit concern of competition reduction by its jumping back in with an acquisition. That said, BT is a unique beast whose dealings with enterprises should be comprehensively understood as business customers contract with EE (or whatever it will be called) going forward. We have our eyes eagerly trained on it.

Cable makes its first apparent foray into Ethernet Everywhere

By Posted December 16, 2014

Let’s say you compile a rigorous demand set of hundreds or thousands of U.S. network locations with all of their bandwidth requirements. Would you think of sending the spreadsheet to a cable company and expect a complete bid response back?

Probably not. For all of their local infrastructure, cablecos love to play in their own sandboxes and not in anybody else’s. In fact, when I go to Time Warner Cable’s website, it immediately informs me that services may not be available in my area (because I’m based in Fairfax County, Virginia, served by Cox Communications) and tries to shove me off to to find my own provider. Talk about turning away business.

And yet, Time Warner Cable apparently now IS interested in seeing these national enterprise network inventories. Tucked into a recent interview with TWC’s top business services executive at Telecom Ramblings was the revelation that the company launched a national Ethernet service a couple of months ago.

I’m not quite sure what TWC’s Philip Meeks means by “launched” a service. If there’s a press release or other announcement heralding this move, I can’t find it. But if he means that TWC business account executives are prepared to talk to you about providing Ethernet access even where TWC is not the local cable provider, that’s an important step forward for the cable industry’s participation in the enterprise market.

Now let’s talk about the caveats. I’m only bringing these up because I expect this to be a developing story over time.

First, Meeks says that lot of this service would be Type 2. Well yes, that’s what it would be. And on the surface, that’s a good thing. Type 2 – getting the underlying local loop infrastructure from somebody else – is exactly what cable companies have been allergic to up until now. Presumably a bid response would combine Type 1 and Type 2 connections into hopefully a very economical national proposal.

But note that Meeks puts all this into the context of what of course is TWC’s strongest desire right now, which I’m sure is even stronger than the desire to win your business – the proposal to merge with Comcast. With those two together, the combined company would service part of 20 of the largest 25 metropolitan areas. This seems to give Meeks the confidence to say that once the nirvana of a combined TWC-Comcast were achieved, the company would probably not have to continue to build out local infrastructure to expand their Type 1 footprint.

That’s dicey. Compare it to the approach of Level 3 and the unrelated TW Telecom, which recently merged. They have local presence in about 85 markets and, far from causing them to pull back on further buildouts and building entrances, the merger is causing them to accelerate that investment, or so they promise.

Why? Because much as I’m pleased that a cable company is finally willing to serve locations outside its footprint in order to complete proposals, that doesn’t mean that renting the incumbent last mile is the best way to go about things in all cases. If you can run fiber to a building (and effectively deal with any in-building remediation issues), then 10M Ethernet – or 50M, or 100M, or more – becomes a much more straightforward proposition.

Just think about the issue of Ethernet over copper. There are great developments in this area, especially with the recent ITU approval of the standard which theoretically boosts EoC speeds up to 10G. But that’s largely a consumer development. This technology is very-high-speed DSL technology and, similar to DSL, can’t really be qualified as to its actual speed and transfer rate until time of order. And to achieve anything like even 100M speeds, the distance has to be extremely short and the quantity and quality of copper pairs has to be high and available.

Even in non-managed, transport-services corporate RFPs, we’re rarely dealing with a true best-efforts scenario. There are invariably SLA and end-to-end network-visibility requirements from the customer or promises from the provider.

Bottom line message to Time Warner Cable: Kudos for breaking the taboo against cable companies going out of territory. But don’t be naïve about how easy it is to grab local loops wherever you want them and meet all of the pricing and quality requirements of rigorous enterprise RFPs. Comcast merger or not – and I’m not sure that this pitch for national Ethernet either justifies or fails to justify the merger – both willingness and effort are required to compete nationally in the emerging new Ethernet-centric enterprise WAN market. There’s a place at the table for you, or any other major cableco, if you really want it and prove you deserve it.

Day-old wireless, half off: The meaning of Sprint’s gambit

By Posted December 3, 2014

Great, so is Sprint going to take half off your company’s AT&T or Verizon bill?

Just kidding. But you gotta admit that Sprint’s announcement that you can bring your own personal Verizon or AT&T bill to them and get the same service for half the amount starting Friday got your attention. It got mine.

What do you make of it? Well, this is what CEO Marcelo Claure was brought in to do. No chief executive from within the carrier industry would have come up with this. Not even John Legere. Claure’s background as a trader of used handsets obviously teaches him to treat minutes and megabits as straight commodities.

I’m sure he’d deny that’s literally true and recite the lines that any national wireless CEO must recite about critical investments and network quality. But his actual actions since taking over Sprint have been primarily to chop and cut his way through the company’s cost base (mostly by firing people). He was brought in by SoftBank to get more subscribers and, by golly, he’s gonna get some.

But it’s that commodity outlook that’s sticking in my craw. On the surface, cutting the other guy’s price in half sounds like a very simple offer. Actually, it’s potentially very complicated. It’s the other guy’s bill he’s chopping, not Sprint’s. Wow, carriers and billing systems – they can hardly manage their own. Now here’s a carrier saying they’re going to work off of what somebody else is billing you.

How likely is that to work out perfectly? I almost want to offer up TC2’s Contract Compliance and Optimization experts, Julie Gardner and Theresa Knutson, on standby for the flood of billing complaints I foresee three months down the road from new Sprint customers.

I realize there’s a certain commonality among carrier retail offers which almost certainly will cause Sprint to at least try to pour new customers into a particular template. If it’s 20G these days for four lines and unlimited talk and text for $160, well then, 80 bucks it is. (Of course the family price point has moved down to $100 anyway in Sprint and other quarters, so this may not be quite that big of a concession.)

But why is Sprint letting someone else set the terms here? It’s one thing for a competitor in any field to take aim at a detested feature of another player’s offer (like ETFs in wireless). But for Sprint to say that it’s taking half off of all of whatever it is AT&T and Verizon are offering is telegraphing that it’s those two companies that set the standard. And the bit about this offer only being available to new customers screams “existing customers pay twice as much” (although it isn’t really that much, but the messaging counts). What’s that going to do to Sprint’s loyalty scores, churn rate, and brand value?

Here’s the takeaway, I think, for enterprise customers. Already Sprint has lower gross margins, higher churn rates, and no profits compared to the other carriers. Now it looks like it will settle for no margins and the hell with the income statement for a while (unless Claure just wants to finish emptying out the buildings in Overland Park, Kansas). Why is this rational in at least SoftBank and Sprint’s mind? Because right now what counts in wireless is postpaid subscribers, period. It’s the measuring stick of health on the assumption that wireless subscribers (even those without formal two-year contracts) are today’s version of yesterday’s ILEC telco phone lines – a near-guaranteed annuity because customers can’t do without the service in question.

If all that is the case, then there’s no reason for the thousands of subscribers that you offer up to these carriers to be sitting at premium margins. The game in enterprise may not be a question of looking for “half off” or of treating networks as commodities, which they most certainly are not. It’s more interesting than that.

If you do not know the actual best practices in enterprise wireless deals – not just leading-edge “discounts” but the good stuff that makes a real difference in the bottom line – then you’re just subsidizing the so-called price war in consumer wireless. As hints, these best practices involve things like commitments for at least one model of handset available free throughout your contract, quarterly rate optimization, ETF waivers that actually act as upgrade mechanisms, data pooling, no-, low-, and seasonal-usage mechanisms for given end-users, and much more. This really just scratches the surface and, along with the spectrum arms race that leads to clear distinctions among carrier coverage and capabilities, shows why “we’re just like the other guy, only less” doesn’t have any clean application in enterprise.

All that Sprint has revealed here with its 50% off consumer play is that there is a LOT of margin in the wireless business that is excessive compared to how wireless carriers are really being valued in the financial marketplace. Make sure that this extra margin is not coming out of your company’s pocket, and that you know to achieve this.

Funding for in-building mobile coverage is as big a part of an RFP as any other

By Posted December 2, 2014

The following is a guest post by TC2 UK managing director Mark Sheard.

Complaints about mobile coverage are not just a matter of big maps with colors. Coverage problems can happen within local areas, parts of cities, or individual buildings. End-users – your internal customers – are a great early warning system to these issues. Even if you haven’t had any complaints or these were “resolved” (or ignored) in the past, you cannot assume that coverage isn’t going to be a problem going forward.

If coverage in any of your buildings is poor, one way towards improvement is through in-building cellular enhancement with a distributed antenna system provided by your supplier. Who pays for this? Such coverage enhancement (and others) can be built into the deal, but you need to make sure the associated terms and conditions are fair and reasonable.

The investment funding required for coverage improvements is there to be negotiated just like any other aspect of the deal. You might also want to look more closely at your Wi-Fi infrastructure, so that data traffic can be more effectively delivered – just like many of us do at home. Of course, you may not want to or, in the short term, be able to upgrade this infrastructure to meet the social media demand of employees’ BYOD devices! But you may also soon realize that you do not have Wi-Fi access for visiting business partners or customers who are expecting it. You can quickly come around to wanting to make sure your in-building mobile network coverage is as good as possible.

As part of your next prospective deal – i.e., a structured extension negotiation or, better still, an RFP – you can get bidders to undertake coverage assessments to give you comfort or identify the need at your key locations. That’s the first step in obtaining improvements as cost-effectively as possible. When your leverage is at its peak before you commit to the next 2-year deal is the time to make sure your coverage needs are addressed.

Interestingly, once you have negotiated and seen your in-building cellular enhancement implemented, this can become a barrier to future change that you must consider in any RFP and potential transition to a new supplier. After all, now that you have provided the coverage, which executive is going to want to lose the signal in the underground parking garage that she has gotten so used to?

So how far do you go to lock in to a carrier? In order to assess this, it’s a question of looking at your total enterprise relationship with the suppliers in your market. But the mere fact that you will wrap this question into the context of a fully competitive RFP helps set the tone at the outset.

Soaring price for spectrum adds to carrier investment needs

By Posted December 1, 2014

Usually the nation’s wireline carriers have reason to look with envy at the wireless market and the overwhelming attention the four national wireless carriers get from customers and the media. But right about now perhaps every wireline carrier ought to be grateful it doesn’t have a wireless network to continually upgrade.

Bids for what had been thought to be a relatively marginal spectrum auction – the Advanced Wireless Service No. 3 auction – topped $37 billion as of last Wednesday, more than double original forecast.

That figure for the AWS-3 spectrum auction is portentous for a more highly anticipated auction of TV airwaves, now scheduled for early 2016. Lining up the money for the coveted low-band, high-propagation spectrum in that so-called “incentive auction” is no longer just a question of raising capital. It also means another possible run at restructuring the wireless industry.

Everyone’s assumption is that Verizon and AT&T can find a way to handle the money needs, and that AT&T will keep its nose to the grindstone this time rather than make a failed political issue of it. But the huge dollars that are going to be involved put Sprint and T-Mobile on the hot seat in various ways.

In a flurry of pre-Thanksgiving notes from Wall Street analysts and traders’ almanacs like Investors Business Daily, three basic themes emerge.

Sprint is running short. In a note from Evercore Partners, analysts calculate that Sprint needs a minimum $3 billion more beyond its current equity and debt plans to make a credible play in the incentive auction and take care of its own operating needs next year. This isn’t just a balance sheet or academic exercise. It’s simply a by-product of the fact that Sprint has little or no momentum in the marketplace. Eventually in the wireless market it’s a question of quality postpaid subscribers to generate positive cash flow (of which Sprint is expected to have a negative $3 billion this year). It turns out CEO Marcelo Claure can’t just cut his way to a “relevant” price point – Sprint has to find a successful positioning to generate funding from its own business. And we’re seeing the first fruits of Softbank’s distance from the U.S. market – it won’t raise the money by selling more stock because it doesn’t want to dilute its ownership position.

T-Mobile may have to buy, sell, or something. Deutsche Telekom has done a great job of holding out in the marketplace after AT&T and Sprint made their failed runs at buying the company. My read continues to be that DT won’t sell T-Mobile US for less than $40 a share, which equates to at least the $32 billion that AT&T offered in 2011 before T-Mobile appeared to sink into irrelevance and then zoomed all the way back since mid-2013 under John Legere. But all of this has been based on the presumed future value their having added 5 million subscribers. The 2016 incentive auction funding needs cut short the amount of time T-Mobile can hold out independently with virtually no net profits even as it beats Sprint to new customers. Dish Network is very much in the mix here. Reports are all over the place – Dish could buy T-Mobile from DT. Or DT (or some consortium involving it), reenergized by the possibilities in US wireless, could approach Dish to merge with T-Mobile. Off the table: Unserious proposals from cut-rate players like France’s Iliad.

Verizon is to blame for all this. For all its success in the wireless marketplace, Verizon actually is second banana to AT&T in terms of the amount of spectrum it has on hand. To ensure its premium position in U.S. wireless, Verizon will do almost anything to grab as much new spectrum as it can. And its perceived unlimited fundraising abilities – witness the $49 billion it raised in a heartbeat to buy out Vodafone – is making its “pay any price” spectrum strategy stick (even as it means that customers are noticing Verizon’s strong preference to play ball on certain services rather than others).

Of course there’s always the quarter trillion dollars in cash on the sidelines on the books of the top half dozen U.S. tech companies. Some of them may now have wireless handset businesses, but they don’t have carrier networks (except in the limited, head-fake sort of way Google Fiber has played so far). The bottom line: The next merger proposal in the U.S. wireless industry – now that it’s proven impossible for any of the four to merge with any of the others – is likely to be taken seriously. The funding costs of ever-expanding spectrum demand is driving that reality.

Memo to carriers: You can’t use network investment as a political football any more

By Posted November 28, 2014

In 2011, AT&T found out that it couldn’t use promises to hire people as a wedge to eliminate a competitor through merger. The FCC rejected AT&T’s acquisition of T-Mobile even though AT&T was promising to hire 5,000 new employees if the deal were approved. Already one of the great growth industries in the country, wireless telecom hardly needed a political quid pro quo to ensure its vitality. Just imagine where the consumer wireless market would be today without T-Mobile, even as T-Mobile’s impact in enterprise is still a work in progress.

Here in 2014, AT&T has learned another such lesson: It can’t trade network investment promises for political goodies any more. In a classic “news dump” on Wednesday afternoon (the Thanksgiving version of Washington’s traditional late-Friday news dump of bad news and policy retreats), AT&T said that it was not going to halt fiber buildout plans while the contentious net neutrality issue was pending.

In doing so, AT&T walked back CEO Randall Stephenson’s controversial statement at a Wells Fargo investment conference two weeks ago that AT&T could no longer hold to a previous commitment to build lots of new fiber while the net neutrality rules were up in the air. Stephenson’s statement seemed to boomerang for two related reasons:

  • It was understood as a wedge against the kind of Title II regulation (essentially reclassifying ISPs as public utility telcos – well, sort of) that President Obama had endorsed two days earlier.
  • It stood in contrast to the decision of Verizon (no friend of Title II either) not to make any such threat, even when Verizon CFO Fran Shammo was explicitly invited to do so by a Wells Fargo analyst at the same New York conference on the same day.

The issue here is fairly narrowly drawn for enterprises. In public the entire network investment / net neutrality contretemps of the last two weeks played out against a much broader canvas than the metro fiber stakes that is now driving consolidation of the second-tier wireline industry.

AT&T’s original promise in question was largely framed against its attempt to acquire DirecTV in the face of a consolidating cable industry. It appeared to be a step beyond the purported 2 million homes it says it will connect in exchange for the DirecTV approval (because after all, one has some reason to doubt that AT&T will feel the need to do any more residential builds once it can offer satellite broadband).

In Washington even that angle was murky. Two days after Stephenson blabbed his threat, the FCC sent a pointed letter to AT&T’s Washington office asking what exact promise Stephenson was referring to. As I mentioned when this originally happened, AT&T’s slippery language throughout this growing controversy reflects “game-playing” – essentially skepticism on their part – of how much threat Google Fiber or anyone else really is in the residential wireline sweepstakes.

But the big picture here is that AT&T has discovered that its capital expenditures are no longer an easy bargaining chip like they used to be, no matter what market segment the specific announcements and promises are referencing. Why not? Just look around you. Verizon’s early and sustained charge on 4G LTE is giving them what they think is justification for premium pricing. The fact that cable and ostensibly residential telco fiber buildouts now pass business locations is affecting enterprise procurement at many companies. The Level 3 / TW Telecom merger is entirely driven by the pace of metro network buildouts and “capillarity.”

And enterprises are starting down the road of abandoning T1s for Ethernet access, in the face of possible loss of the entire TDM protocol ecosystem for voice and data by the end of the decade.

In short, carriers have found that capex or network investment is too important to be left to the lobbyists. The net neutrality issue has to play out on the merits, which LB3’s regulatory practice is bird-dogging from an enterprise standpoint on a daily basis. And market pressures mean that wireless and wireline capex have to follow a business case, which corporate users are helping to drive by realizing they can compete their increased end-to-end bandwidth needs among prepared and competent carriers in IP transformation projects.

Thus the days when network investments can be used as a political football appear to be drawing to a close. It’s not the first time AT&T has reached into the same bag of political tricks one time too many to try to get what it wants. Let’s see if it’s the last.

Who else is prepared to spend the money to build out to you?

By Posted November 28, 2014

I’ve made much of the fact that Level 3 is promising to adopt TW Telecom’s pace of 2,000 or more added on-net buildings per year now that their merger is complete. But part of the impact here is not just on Level 3 itself in its run at AT&T and Verizon.

It’s on whether other so-called “second tier” wireline carriers are going to be forced to copy Level 3’s move to stay competitive. It’s actually basically a simple proposition in two ways.

First, we naturally say that Level 3 bought another carrier, but in reality what they bought were those buildings. That’s why the purchase price was nearly $6 billion while the still-larger revenue base of Sprint wireline is worth less than $4 billion in the early rumor-reports, and perhaps as little as zero. It’s the buildings, not the revenue stream, that Level 3 is paying for and the market is valuing at this point. The TWT customers are basically a free gift.

Second, the ultimate effect here is on the ability to price access down. To make it simple, if the enterprise of the (not-too-distant) future puts out a demand set of 250 locations – 125 of them at 5M Ethernet and 125 at 10M – then who else can compete with AT&T and Verizon on this bid? After all, the Big 2 each has 35%-40% of the country in incumbent territory.

Well, let’s look. There’s CenturyLink. They have the old USWest ILEC territory that came with the Qwest acquisition, plus their own legacy telco business in various places. But are they a facilities-based CLEC elsewhere? To some limited extent. And they’re certainly part of most people’s bid list.

But I would argue that their “ILEC-ness” has hampered them in this arena. Just as AT&T and Verizon are not entirely prepared to provide facilities-based, end-to-end on-net connections in each other’s territories – and their heavy focus has been on 4G investments – CenturyLink is not nearly top dog in Ethernet access and on-net buildings.

There’s Windstream. Now here’s a really interesting case. Like CenturyLink, Windstream is a combination of a significant ILEC (just not a legacy RBOC ILEC) plus acquisitions of independent “telephone companies” and remote territories that RBOCs lost interest in. And the overall map of Windstream away from major metros has kept them relatively free of the “SIP Trunking Hesitation to Cannibalize Revenues” syndrome that plagued AT&T and Verizon – AT&T especially – in the early days of IP transformation. We’ve seen good bids from Windstream on specialized products like SIP Trunking.

Here’s the problem: This nice niche business does not seem to rise up to the level of senior management attention to keep them from possibly sabotaging their future enterprise prospects with poorly thought-through network investment plans.

Last summer Windstream announced that it plans to spin off its wireline network assets into a real estate investment trust that will separately trade on the stock market. When this happened, jazzed-up Wall Street analysts, who love a good financial engineering story, started asking all the other companies – including Verizon and AT&T – whether they’d do the same. Of course no one has gone for it.

Why? Because REITs have to give 90%+ of their operating income to shareholders in dividends. What kind of network investment plan is that? There is no way that AT&T or Verizon is going to handicap itself on necessary mobile broadband investments (including future auctions) with that call on their money.

You could start to argue that Windstream is just transferring money from one pocket to the other, but it doesn’t appear that the spinoff works that way. Instead a given shareholder will hold two companies instead of one. The company that holds the REIT assets will have to pay out 90% of the money to avoid taxes and maintain REIT status. Whatever dividend payout ratio the parallel non-REIT (not a parent) company has, to the extent it’s below 90% (and at all viable telecom carriers it’s well below that, and at growth companies like Level 3 it’s zero) it conserves money for capital investment a lot better than the REIT.

Windstream did argue in its original announcement that the move will boost money available for broadband investment. Theoretically they’re right to the extent that new investors initially come into the “real estate stock” who would never buy a “telecom stock.” But that’s a one-time gain when the stock is issued – after that it’s just a traded stock among investors. And the announcement made it clear “broadband” was in the consumer ILEC sense where none of the nation’s ILECs (RBOC or otherwise) have done as well as Verizon’s FiOS so they need to catch up.

How about aggregators like Virtela? Actually this is interesting in that the company itself may not be making fiber-to-the-premise investments, but their proposals are based on exactly this idea. If cable companies do run broadband to business locations, and they pile into Virtela bids, then in effect they’ve trumped everyone except a Level 3 which can employ its current footprint plus “success-based capex” (my favorite carrier euphemism for “special construction”) to propose a clean slate of good-looking access prices as bandwidth needs move dramatically up from the old T-1.

Let’s not give Level 3 a complete pass. Recently, CTO Jack Waters reiterated a promise that it will maintain TWT’s, not Level 3’s own, level of building additions. (TWT was moving 4 times as fast.) In doing so Waters claimed that Level 3’s combined new metro network, with much better “capillarity” than before, could build out each building at much lower costs than before. And that’s true as far as it goes – to the building entrance.

The asterisk is that many people have issues with in-building remediation to accommodate end-to-end Ethernet. That’s not nothing – the worst scenario is when the new customer, the selected carrier, and the building management are all looking at each other expecting the other one to take responsibility. Nothing’s worse than failing to establish in advance how this will all work and who will pay for it – remember that’s one big reason for RFPs, not just the pricing proposal. And we don’t really know yet how accommodating Level 3 will be in including these requirements as in-scope to financial pools, incentives or credits to make special-construction promises pay off on time and within budget.

But let’s face it – every carrier faces the same issue if they’re at all serious about Ethernet access and know they have to price very competitively to win business vs. the incumbents. If Level 3 has to make accommodations in negotiations for the extra complexity of upgrades away from the dying T1/T3 paradigm, then so does everyone else if they want a piece of the business.

And at least they’re talking about it. Get on any conference call with Level 3 or read any interview and what are the top executives talking about? Building connections, fiber, Ethernet, dynamic bandwidth allocation, network management – your world and mine. What is Windstream talking about? Real estate investment trusts. Oh and Verizon? Streaming NFL games over “XLTE” so they can maintain their enormous wireless margins. That may be the most telling gauge of all.