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AT&T's call for relevance

This deal isn't about phones— it's about every other service that can be stuffed down a phone line.
This image obtained 05 March, 2006 shows
AT&T chief Edward E. Whitacre Jr. called the merger "a logical next step" in his company's growth.AFP - Getty Images
/ Source: Forbes

When AT&T Chief Executive Edward E. Whitacre Jr. announced Sunday that his company would acquire BellSouth in a deal worth $67 billion, it signaled a new era for big telephony as well as the near complete undoing of the 1984 breakup of Ma Bell, with four out of seven Baby Bells soon subsumed back into the company.

If approved by U.S. regulators and completed, the merger will create a telecom giant with a market capitalization of more than $150 billion, far greater than its $92 billion rival, Verizon Communications.

But AT&T's purchase of BellSouth isn't really about undoing regulatory action or increasing market cap. For that matter, it isn't even about phone service. This merger is about buying the lines that connect to the homes of BellSouth customers and selling them everything you can squeeze down a fiber-optic line, including television, Internet, movies and music.

In a statement announcing the merger, Whitacre outlined the company's strategy. "This merger is a logical next step," he said. "Together, we will lead the way into a new era of converged and bundled communications, video and entertainment services while also improving our ability to manage complex networks."

At the heart of things, the last few years' flurry of telecom merger activity — including AT&T's union with SBC Communications (which was completed just last November) and Verizon's buyout of MCI — was a response to the fact that the traditional telephone business is breathing its last, done in by cellular technology and, perhaps more pertinent, by the Internet. Consumers are rapidly realizing that voice is just another kind of data, and it can be cheaply and easily sent over an Internet connection. And why pay for both a phone line and a broadband Internet connection when you only need the latter?

To make up for the death of their oldest and historically most important business, the phone companies have had to scramble to find alternatives. Wireless telephony proved to be one great way to make cash — the burgeoning growth of No. 1 wireless vendor Cingular, co-owned by AT&T and BellSouth, was doubtless a major motivator for the two companies to merge.

But while cellular is still hugely important, it's rapidly becoming a mature market. More than 80 percent of adults in the U.S. already own a cell phone. Companies like AT&T know they have to compete directly with fast-growing Internet phone services and turn the tables on the cable companies that provide them.

"They are gearing up to fight new competitors, the cable-television industry, for the complete bundle of services, including telephone, television, wireless and Internet," said independent telecom analyst Jeff Kagan.

"AT&T is getting ready to roll out their television service on a nationwide basis. This is much more advanced than traditional television," Kagan continued. "Customers, for example, can watch four channels at one time. This is sending companies like Comcast and the other cable television companies back to the drawing board to offer a better combination of services."

What's this all got to do with Bell South? Simple. The company maintains 20 million access lines in service, has approximately 7.2 million long-distance customers and nearly 2.9 million digital-subscriber-line subscribers. It's the biggest telecom provider in the Southeastern U.S. And it was, until now, the biggest and best way for AT&T to quickly pick up giant handfuls of potential television and data customers.

With BellSouth off the table, the remaining lines out there become all the more valuable — and another regional phone company will probably soon take center stage. Qwest Communications International is the last of the seven Baby Bells, and the only one not re-absorbed by either Verizon or AT&T. Expect the company to attract its own takeover bids, perhaps from Verizon, which needs to bulk up to take on its now significantly larger rival.

Ultimately, it's likely the telecom industry will become something of a duopoly, with Verizon and AT&T competing head-to-head, and both companies squaring off against the cable industry.

"Telecommunications as an industry in the United States is going through massive changes," says Kagan. "We are in the middle of a major 20- to 30-year transformation. When we come out the other side, we'll have the choice of our telephone company versus our cable-television company for the same big bundle of services."