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Telecom Services Equity ResearchTelecom Services Equity ResearchBroadband, Economic Growth and the Financial Crisis

January 30th, 2009

Christopher C. King

443-224-1329

ccking@stifel.com

Current Broadband Statistics

Broadband currently available to 85%-90% of homes nationwide

95% of cable plant has access to broadband

According to latest Pew Internet & American Life Survey, only 55% of households subscribe to broadband

Thus, approximately 30% of households have access and choose not to pay for broadband

According to the survey, 33% of those that do not have broadband access say they are simply not interested

Only 12% of those that do not use the Internet at all say it is because they don’t have access

Broadband Subscriber Growth Slowing

Source: Company data, Stifel Nicolaus estimates

Total Subscribers

.02.55.07.5

10.012.515.017.520.022.525.027.530.032.5

3Q03 3Q04 3Q05 3Q06 3Q07 3Q08

Su

bsc

rib

ers

in m

illi

on

s

1.00x1.10x1.20x1.30x1.40x1.50x1.60x1.70x1.80x1.90x2.00x2.10x2.20x2.30x2.40x

Cab

le/D

SL

rat

io

DSL Cable Cable/DSL ratio Cable/RBOC ratio

Net Additions

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

3Q03 3Q04 3Q05 3Q06 3Q07 3Q08

Su

bscri

bers

in

th

ou

san

ds

30%

40%

50%

60%

70%

80%

90%M

SO

sh

are

ILEC MSO MSO/Total MSO/(Bell+MSO)

Year-over-year High Speed Net Adds Growth

0.0%

5.0%10.0%

15.0%20.0%

25.0%

30.0%35.0%

40.0%45.0%

50.0%

3Q03 3Q04 3Q05 3Q06 3Q07 3Q08

Grants in “Unserved Areas”

More coordinated stimulus likely requiredShould include both tax credits and ongoing support mechanisms

Why??

Case Studies—CenturyTel October 2007 FCC Ex Parte Filing

Rosendale, Missouri

Gorin, Missouri

Rosendale, Missouri

288 Access Lines (88% residential; 12% small business)10 miles of fiber will have to be trenched, attached to poles ($330,000); DSLAM ($6,000) and additional electronics ($14,000) purchasedTransport costs of $1,200 per month will be incurred for T-1’s to backhaul traffic to Internet nodeBuild will not cover everyone in the exchange because slightly less than half of households live well beyond 18,000 feet from central officeAssuming a 40% take rate over 5 years—yields 40 DSL customers at end of year 5DSL priced at $35 declining to $28 per month over 5 yearsRetail revenues from DSL would be $48,000 over 5 years while recurring operating expenses would be $93,300 (excluding the $350,000 in capital costs)Broadband rates would have to average $90 per month just for the carrier to break-even on operating expenses—not allowing for any return and ignoring capital commitments

Gorin, Missouri

149 access lines (77% residential and 23% small business)

A new $6,000 DSLAM would need to be deployed

No additional fiber transport required, but 2 T-1’s would need to be purchased from RBOC at a cost of $1,640 per month to backhaul data traffic to Internet node

Initial build will cover 76% of the market or 113 access lines

Over five years, assume 36 DSL customers and pricing declining from $35 to $28 per month

Broadband revenues of $43,400 over five years versus operating expenses of $117,600

Broadband rates would need to be priced at an average of $129 per month over the five-year period for company to break-even on an expense basis—ignoring capital outlays and not allowing for a return on investment

More RLEC Economics

A quick survey of 6 RLECs suggest an average cost of between $2,000 and $3,000 to provide DSL service to an unserved customerIncremental investment is required to upgrade existing infrastructure by extending fiber into access plant to reduce loop lengths and installing broadband-enabling electronics into the networkIncreasing downstream speeds to 6 Mbps appears to approximately double the per-home investment costs

RLEC Conclusion

Current plans unlikely to do much to stimulate private-sector investment in unserved areas

Comprehensive support structure neededCapital commitment support

Grants

Operational Expense supportTax credits to offset middle-mile investment

Potential re-regulation of special access

Tax Credits

ITIF (Information Technology and Innovation Foundation) has suggested tax credits of 60% in unserved areas and at least 35% to promote additional advanced broadband deployment

Capital spending for telecom is expected to fall between 10%-15% in 2009 versus 2008 levels

The CWA (Communications Workers of America) has recommended that tax credit programs assume that capital spending above 85% of 2008 levels be eligible for tax credits

Companies such as Clearwire and Qwest are unlikely to benefit at all from tax credits, given their current financial situations

Other Issues

Underserved AreasHigh-speed thresholds in current proposals (45/15 Mbps) will likely only benefit Verizon’s FiOS and possibly cable’s DOCSIS 3.0 platforms today

Wireless broadband plans could benefitClearwire-WiMax

Verizon/AT&T LTE

Two Significant Potential Issues in Senate Bill

Draft language appears to suggest restricting company participation to public-private partnerships

Significant complication which will likely disincent investment, in our view

Failed Municipal WiFi Model

Definition of “underserved area” to include areas with only one broadband provider

Would appear to artificially incent competition against incumbent broadband provider

Failed UNE-P Model

Conclusion

Solutions must address both the initial investment costs of the network and the ongoing operating deficits in “unserved” areas

Could include substantial tax credits for capital expenditures that would also include “middle mile” investment

USF-like Lifeline and Link-Up programs for advanced services that would aid low-income families by relieving them of monthly fees

Support mechanisms that not only include grants for broadband deployment in rural areas, but also ongoing support that would help offset material operating expenses

Conclusion

We believe significant tax credits for broadband deployment is likely the most effective stimulus tool at policymaker’s disposal

Tax incentives are available on day one after legislation is signed; easy for companies to implement and normally have a quick impact on investment decisions

Tax credits also leverage substantial private investment by companies that have the capability to deploy advanced networks and generally come with very few strings, giving companies ample flexibility—particularly important in a period of economic uncertainty

Conclusion

We are wary of plans that include artifically incenting competition in the broadband market

This includes both a strained definition of “underserved markets” as well as a mandate for public-private partnerships to be eligible to receive grant monies

Disclosures

Important Disclosures and Certifications I Christopher C. King, certify that the views expressed in this research report accurately reflect my personal views about the subject securities or issuers; and I Christopher C. King, certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation or views contained in this research report.