Results tagged “reclassification”

September 2, 2014 3:50 PM

Free Press's Mistaken (and Misleading) Theory on Title II and Investment (Pt. 1)

It's no secret that Net Neutrality pressure group Free Press would like the FCC to revisit the 2002 Cable Modem Order, in which the FCC classified broadband Internet service over cable as an "information service."  Nor is it a secret that the largest broadband ISPs oppose such a reclassification.  

The ISPs often contend that a reclassification of broadband Internet service as a Title II, or "common carrier" service, would open the door to a range of regulations that could dampen or distort their incentives to invest in network improvements.  But, in its comments on the FCC's Net Neutrality NPRM, Free Press intends to conclusively vanquish the "investment fear" arguments of the ISPs once and for all.  

Free Press believes it can "debunk" the "myth" that Title II discourages regulated firms from investing in their networks if it can show that the broadband ISPs invested heavily in their networks at a time when the ISPs' broadband services were (pretty much) subject to Title II classification.  Free Press relies on revenue and capital expenditures from the annual reports of a cross-section of large, publicly-traded, telecom and cable companies to tell the Commission a fairy tale.

Perhaps everything that could be wrong with Free Press's facts and theory about ISP network investment over the last 20 years is wrong--starting with the theory itself.  This blog will focus on the problems with Free Press's theory, and its limited set of "facts" in support of its theory.  Tomorrow, we'll explain what really happened (using Free Press's data, along with other relevant historical facts), and why Free Press's narrative is so misleading.
 
Investment Itself Is Never an Appropriate Regulatory Goal

Free Press seems to equate periods of rising capital investment as a "good" outcome, and periods of falling investments as a "bad" outcome.  However, regardless of whether the investment was efficient or not (it isn't), the FCC should never try to assume the role of central economic planner.  The FCC's only interest in investment should be to make sure that consumer interests are served in the manner that least distorts company investment incentives.

CapEx from Financial Statements Doesn't Show What Free Press Thinks It Does

Even if stimulating investment was the right focus for the Commission, the capex information Free Press presents does not prove that Title II is the answer.  If Free Press is trying to show that the regulatory classification of consumer broadband service affects how much a firm invests in that service, then aggregate, firm-wide network investment wildly overstates mass-market broadband investment in any period.  

In Fig. 1 (Comments p.100), Free Press tracks capex for a number of telecom carriers over time.  But, by using aggregate enterprise capex, Free Press is primarily tracking capex for Title II services in all relevant periods.  Notwithstanding the regulatory classification of one residential service, the majority of the revenue produced by these firms' networks still comes from Title II services (e.g., both AT&T and CenturyLink reported record numbers of residential broadband customers in 2Q 2014, but this service only comprised ~16.5% of total firm revenues for both firms). 

A more accurate estimate of the capex devoted to the Title I service would focus on correlations between significant broadband subscriber growth and increased (decreased) capital investment over the same period of time.  For example, CenturyLink has tripled its broadband subscribers (from ~2m to ~6m) over the last 5 years; during this same period, capex has grown at a CAGR of over 60%. See here (figures are from 2013 Annual Report, and the 2Q 2014 Earnings Supp. spreadsheet).  A more careful review of the companies' data, however, may not support the story that Free Press wants to tell.

Investment and Revenue Figures from the Late '90s Are Not Entirely Accurate

Even if we accept that "investment" is a worthy regulatory goal, Free Press paints a misleadingly "rosy" picture of the era.  Free Press concludes its recasting of the "golden age of investment under Title II" by simply stating that, "the 2001 recession and the economic impact of the September 11th attacks took their toll on the U.S. economy, and the telecom sector wasn't spared." (Comments at 101) 

Free Press neglects to mention the devastating accounting scandals that would surface right after 9/11, or the massive layoffs, bankruptcies, and distress sales that would follow, and cascade through the industry over the next two years.

On October 16, 2001, Enron announced it would have to restate its earnings for the prior 2 years.  This statement, and the subsequent SEC investigation, would uncover widespread accounting fraud throughout America's largest companies.

When you look at this list of the accounting scandals that were exposed in the 11 months after 9/11, don't focus solely on the telecom and cable companies.  Keep in mind that every energy company on this list also owned significant telecom network assets.  (See this 2002 study at p. 21/38).

Bandwidth trading.  If you're wondering why most of the accounting scandals involved telecom or energy firms, that's because they had a common thread.  Most of the telecom-related accounting fraud was related to "bandwidth trading."  If you don't know what bandwidth trading is, just listen to Enron explain it. 



The idea of bandwidth trading was just a few years ahead of its time.  In practice, it would take BitTorrent and The Pirate Bay to make using someone else's capacity while they were sleeping a reality. 

Early bandwidth traders, like the modern P2P thieves users, did not actually exchange money.  Rather, if you had bandwidth on one route, and another company had capacity on a route you wanted, you could just swap capacity--but that's boring.  Instead, each party would "pretend pay" the other for the prevailing value of the capacity (which still seems kind of dull). 

The real fun came with the accounting.  Both parties could record each other's pretend payment as real revenue, and record the capacity they were giving up as a capital expenditure; winning!  For more, see this 2002 Wall Street Journal article.  Oh, and when I say "could record," I mean literally; not legally.

As you can see, Free Press makes a number of mistakes in its attempt to prove that their Net Neutrality opponents could never justifiably fear Title II regulation--from trying to prove that a fear of undefined future regulations is unwarranted, to a misunderstanding of what their data actually show.  Tomorrow, we'll explain what actually happened in the golden age of Title II and why Free Press's narrative is so deceptively misleading.