The nation’s smallest telephone companies saw their operating margins increase by 5.3% in 2011 to an average of 10.3%, reversing a downward trend they experienced in 2009 and 2010, according to a comprehensive financial study of the small telco industry completed recently by the Telergee Alliance. The alliance, comprised of several accounting firms with a specialty in small telcos, has been conducting the study, known as the Telergee Benchmarking Study, for several years. After sharing the report previously with Connected Planet, a telecom news website that ceased operation at the end of 2011, the Telergee Alliance shared this year’s results with Telecompetitor.

In last year’s report and in the report from one year earlier, small telcos saw their margins increase on the non-regulated side, but not enough to make up for declining margins on the regulated side, where telcos have experienced erosion of their traditional voice business. But this year small telcos saw margins increase on both the regulated and non-regulated side.

On the non-regulated side, small telco operating margins increased 13% after increasing 4.9% the previous year. On the regulated side, operating margins were up 1.3% after dropping 15.4% the previous year. The reversal on the regulated side was particularly surprising considering that telcos continued to see declines in voice lines, which decreased an average of 3.7% and in inter-carrier compensation (ICC), where minutes declined an average of 8.9% on the interstate side and 12.1% on the intrastate side.

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This year’s Telergee Report was based on responses from more than 200 small telcos, representing at least one quarter of the nation’s small telephone companies.

The regulated side
There is no simple answer to why small telcos saw the increase in operating margins on the regulated side. But Chris Skidmore, assurance manager for the telecom practice at Moss-Adams, the Telergee member firm that coordinates the Telergee report, offered a few ideas.

One factor is that administrators are getting better at predicting the decrease in ICC minutes. For the first time in several years per-minute rates were set high enough to ensure that sufficient revenues were collected, he said – although the full impact won’t be known for two more years because of the way ICC is accounted for.

In addition, he said, “We saw quite a bit of cost saving initiatives throughout all of the companies. They’re trying to keep corporate, marketing and customer service expenses down and were a lot more careful about those expenses.”

Although there were some headcount reductions, Skidmore said there was a bigger emphasis on reducing overtime hours, travel expenses, fringe benefits and non-essential expenses.

The non-regulated side
The increase in operating margins on the non-regulated side appears to be the result of several positive trends.

“Companies are trying very hard to be more than traditional rural ILECs,” said Skidmore. Small telco managers, he said, are asking themselves, “What else can we do – video, Internet, reselling wireless, CLEC, dedicated circuits, Internet backbone?”

Those small telcos with wireless businesses saw an average 17.8% increase in operating income, and that’s a significant improvement over other recent years. Skidmore cautioned, however, that margins in the wireless business are quite narrow; consequently, any improvement in margins as a result of increased revenues or decreased expenses results in a large percentage increase overall.

In 2011, wireless operating expenses represented 93.7% of wireless revenues.

The reason wireless margins improved at all, Skidmore said, is the result of several factors.

“2010 was a bad roaming year,” said Skidmore. In that year, national carriers acquired various Alltel assets, and as a result, a few smaller wireless carriers found themselves without appropriate roaming agreements, he said. But that issue was largely resolved by 2011.

Another factor is that smaller wireless carriers may be sharing some of the good fortune of larger national carriers. “Roaming is up on data devices,” noted Skidmore.

Skidmore also noted that he has seen an increase in small telcos offering wireless through resale agreements with larger carriers – and although those margins are not wide, they have the advantage of being predictable.

The small telcos “get a cut of two to five percent,” Skidmore said.

Small telcos with CLEC business units also saw a big performance improvement in 2011, when margins jumped 27.6%, following a jump of 29.3% in 2010. Skidmore didn’t have any particular insight on this result, but it may represent a continuation of trends from the previous year, when small telco CLEC units focused on getting higher value customers and saw some improvements in per-megabit backbone costs.

Skidmore also noted another important growth area for small telcos—providing backhaul connectivity to cell towers for wireless carriers, who are aggressively expanding their networks to support the wireless data boom.

“Those orders are going through the roof,” he said.

He cautioned, however, that “as demand goes up, supply will go up and prices will come down.”

The bad news
Despite some good news, there was also some bad news for small telcos in this year’s Telergee report.

One area where small telcos continue to struggle to make a profit is video. Margins in that line of business dropped 6.8% in 2011.

“Content costs are constantly getting higher,” commented Skidmore.

Small telcos also appear reluctant to borrow – a trend noted in last year’s Telergee report that was repeated this year. After declining 4.6% between 2009 and 2010, small telcos’ interest expense declined an average of 6.4% between 2010 and 2011.

“Companies don’t have confidence yet in future revenues,” said Skidmore. “They’re reluctant to borrow or build facilities if the FCC is going to say ‘We will no longer pay you based on those facilities.’ Lenders and borrowers have been stepping back for another year to let things shake out.”

What isn’t clear is how long small telcos can continue to put off investment in their network infrastructure.

 

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