SBC does triage on Ameritech

At the Finishing Touch flower shop in the little town of Fishers, Ind., Karen McDonald has been battling her local phone company for six months, and still her business lines dont work. Customers trying to place orders hear the phone ring a dozen times or more before McDonalds employees — those who havent yet been laid off — hear ring No. 1 on their end.

"I guess [callers] think the shop has closed," McDonald said. "They give up and go on to the next listing in the yellow pages. Ive complained to Ameritech every day."

She is angry, frustrated and afraid. Orders have dropped 40 percent since June. Her life savings, retirement, loans against life insurance and a second mortgage on her home are all on the line. She is losing hope.

"This is going to put us out of business," she said. "And I dont know what to do about it. They cant seem to get it fixed."

McDonalds circumstance may be unique, but her experience with the phone company is not. Complaints about Ameritechs service reached epidemic proportions in the last 12 months, starting shortly after merger-hungry SBC Communications shelled out about $74 billion — 250 percent of Ameritechs book value — to gobble up the Midwestern regional Bell.

The big winners in the deal, merger documents show, were Ameritechs former top executives, who walked away with millions of dollars. Losers included SBCs stockholders and, more ominously for McDonald and thousands of others, Ameritechs customers.

While company officials said the service crisis is easing, regulators werent so sure. Some are investigating whether Ameritech neglected its phone systems for years so it could make itself a more appealing takeover target, and whether SBC failed to determine Ameritechs condition before paying a premium price.

Ameritech is not the only regional Bell accused of ignoring desperately needed upgrades for the basic phone services those companies still provide as virtual monopolies for residential customers. U S West, now Qwest, recently settled a complaint over poor phone service quality, for example. As the Bells have moved toward more lucrative Internet services, complaints around the nation over poor phone service have grown.

Now, Ameritech and SBC are mounting public relations and lobbying campaigns in all five of the Great Lake states in the Ameritech region, designed, critics said, to blunt regulators concerns about the drawn-out service crisis.

Trouble surfaced soon after SBC took over Ameritech in late 1999. Tens of thousands of customers in Illinois, Indiana, Michigan, Ohio and Wisconsin watched helplessly as wet spring weather led to a rash of service failures. Some neighborhoods went weeks without repairs.

Understaffed offices across Ameritech territory were overwhelmed. Workers found cracked and rotted cables that failed in the wet ground or on terminal boxes overhead. New customers could not get through to service representatives, so installations were backed up for weeks. Customers complained to state regulators of being left on hold for an hour or more — and of often being cut off after that.

In August and September, state utility regulators were overwhelmed by complaints of outages and delays.

"We had never seen so many complaints at once on our hotlines," said Beth Gianforcaro, a spokeswoman at the Ohio Public Utilities Commission, which in September got more than 1,500 customer complaints. "It was off the scale."

The story was the same across the region. In mid-October, alarmed regulators from the five states called an emergency summit in Chicago to confront SBC Chief Executive Edward Whitacre Jr.

Whitacre told regulators he was "embarrassed" by the breakdown, and he promised a fast fix.

Indeed, service complaints have fallen significantly since that meeting — but only as a result of a crisis-management decision that cost SBC untold millions of dollars for such measures as dispatching crews and trucks from as far away as the East Coast to rescue Ameritechs customers. Whats more, critics said, the problems are deeply rooted.

In dozens of interviews and in regulatory and corporate documents examined by Interactive Week, a picture emerged that contradicts company claims that the massive service problems were isolated events brought on solely by bad weather, surging demand for services and an unanticipated spike in the number of employee retirements.

In fact, Ameritechs service problems were long in the making, systemic and well-documented, leading some critics to question whether SBC overlooked — or at least neglected to tell its stockholders — that Ameritech was a troubled company with an infrastructure in advanced decay.

Merger documents filed with the Securities and Exchange Commission included opinions by major investment banking firms Salomon Smith Barney and The Goldman Sachs Group supporting the valuation stockholders paid for Ameritech. Each confirmed the target deal price, based on its own investigation, reviews of financial statements and representations by the two companies management. In May 1998, Ameritech and SBC stockholders approved an exchange of stock pending regulatory approval.

Neither Salomon Smith Barney nor Goldman Sachs returned calls seeking comment in the preparation of this article.

The companies began combining operations in October 1999, after the Illinois Commerce Commission, the states utility regulator, voted 3 to 2 to approve the merger and the Federal Communications Commission and Justice Department concluded their reviews. Because of state laws, regulators in Indiana and Wisconsin had no merger oversight.

Now, in the wake of the service crisis, some regulators have joined consumer groups in questioning whether SBC paid a Rolls Royce price for a Yugo, without ever kicking the tires or looking under the hood.

In a curt letter in November 2000 to Whitacre and SBC/Ameritech CEO Edward Mueller, Illinois Commerce Commission Chairman Richard Mathias raised pointed questions about how thoroughly SBC investigated Ameritech.

He quoted comments that Ruth Kretschmer, longtime Illinois utility commissioner and a dissenter in the merger vote in Illinois, made during a recent open commission hearing: "SBC did not know what it was buying." Kretschmer characterized Ameritech as "on the verge of collapse" when it was purchased by SBC.

Now, Kretschmer said, she has had to put those issues behind her and is focused on making sure SBC brings service complaints under control — whatever the cost.

Mathias said he has not formed an opinion on the quality of SBCs due diligence, but he acknowledged in his letter that due diligence over "the status of the Ameritech infrastructure and many other matters . . . raises serious concern."

Selim Bingol, corporate communications spokesman at SBC, insisted the company has had no reservations, then or now, about its due diligence on behalf of its stockholders. "There were no issues there for us," Bingol said. "These problems were the result of reductions in manpower, and that is not something you could discover through any amount of due diligence."

He and Ameritech spokesman David Pacholczyk said the problem lay with an unexpected increase in retirements of experienced service technicians, brought on by favorable federal pension rules. "We had no way of knowing that retirements would increase at the rate they did, from about 1 percent per year to 10 percent last year," Pacholczyk said.

Yet, Mathias said, the company continued to offer lucrative buyouts, promoting early retirement even as understaffing reached crisis levels. Late last month, SBC acknowledged in a statement that service problems at Ameritch could disrupt anticipated revenue streams for the company in 2001.

Documents obtained by Interactive Week and discussions with regulators throughout the region also suggest that staffing problems, and a resulting inattention to maintenance of wiring and equipment, were nothing new.

Seth Rosen, a spokesman at the Communications Workers of America in Cleveland, said the union warned state regulators in late 1995 that a pattern of understaffing had already put Ameritech on a perilous path. In a report that year to a committee of state regulators, the union documented thousands of problems with Ameritechs equipment, offering photos and statistical reports showing growing infrastructure deterioration.

In Dayton, Ohio, alone, deteriorated outside plant facilities like switching boxes could take 10 years to rehabilitate, union analysts estimated in their report.

"I cant speak to problems prior to when we announced the merger in 98," Bingol said. "So whatever happened in 95, I dont know about. It had nothing to do with the merger."

Consumer advocates in Indiana and regulators in Illinois, Ohio and Wisconsin told a different story. Many trace service problems to a well-financed push by Ameritech in the mid-1990s for changes in the way rates were determined. The company dumped historical calculations based on a reasonable return from investment in favor of a rate cap that allowed the company more flexibility in how and where it spent its revenue, especially in capital investment in equipment and infrastructure.

The company pressured regulators through public relations campaigns, in committee rooms of state legislatures and through political action committees that raised money for favored candidates. In the end, Ameritech won less restrictive rate regulation from public utility commissions throughout its region.

In Wisconsin, the effort went further. Ann Marie Newman, a spokeswoman at that states utility commission, said Ameritech and other telecommunications companies pushed in 1994 for telecom "reform" that, among other things, did away with Wisconsins authority to regulate mergers.

Regulators, she said, "joked afterward that we had been telecoed. "

Mike Mullett, special counsel at the Citizens Action Coalition of Indiana, said the consumer group initially supported Ameritechs alternative rate structure, based on the companys promises of rate reductions for consumers and investment in infrastructure to bring high-speed Internet access to schools, libraries and government offices.

"That never quite happened," Mullet said.

Later, Indiana regulators identified excessive profits and tried to force the company to rebate some $40 million to customers. But Ameritech went to court and persuaded judges to suspend the orders on procedural grounds. The issue is still pending.

"We have come to see those rate changes as a root cause of where we are today, a way for Ameritech to make itself look more attractive for takeover," Mullett said. "And that was exactly what happened. They passed through their cost savings to the bottom line, which made them look very, very profitable."

Mullet and other consumer advocates are asking Indianas utility commission to try to force Ameritech and SBC to open corporate records for an audit of investments and other closely held company information. They filed a new service complaint last month on behalf of some 70 business and residential consumers, and have plans to add a thousand or more names to it.

Company officials said they have continued to invest in Ameritechs system to the tune of $2 billion per year across the five states. But critics questioned how much of that went to rehabilitate an aging system and how much went into new technology that enables the company to capitalize on higher-priced Internet services. Whitacre also pledged increased rehabilitation spending in the region, including commitments of $3 billion per year in Illinois alone.

Meanwhile, Ameritech is facing investigations of the changed rate structure, with audits either under way or planned in Michigan, Ohio and Wisconsin.

Regulators also seemed increasingly suspicious of what they are hearing.

In Illinois, Mathias said the agency plans to consult with climatologists to test the veracity of Ameritech claims that certain severe service outages were the result of weather events.

SBC, criticized for reacting slowly to the growing number of service complaints, has treated the outages as a crisis in the wake of Octobers regulatory summit. Efforts to shuffle repair and installation crews around the country have left consumers surprised to see trucks from far-flung parts of the country outside their homes and businesses. That has been an expensive proposition — one that SBC clearly didnt foresee — but both companies said the strategy has paid off, bringing the backlog of repairs and installations up to date.

Consumer complaints, they noted, have dropped dramatically throughout the region. But the glass is also half empty. In Ohio, there were still more than 340 complaints in November, and while those are down from the more than 1,500 in September, the level is still well above comparable periods last year.

Regulators in all five states, and many others familiar with the history of Ameritech, remained skeptical.

Robert Johnson, a member of a prominent Indianapolis law firm and former state consumer counselor for utility issues, said the two companies have done little more than "put a Band-Aid" on the crumbling infrastructure.

"These problems didnt occur overnight, and they wont be fixed overnight," said Johnson, who represents clients of Ameritech. "They are the result of years of underinvestment. Local loops were not maintained. Here and in other states, they have a problem with old copper wire in the ground, which cracks and erodes, and when it rains, it shorts out," he said.

Those problems are no longer of concern to the former Ameritech executives who came up big winners in the deal. In what Mullett described as a "platinum parachute," former CEO Richard Notebaert walked away with a compensation package worth $21 million, SEC filings show. Other top executives got packages that totaled tens of millions of dollars.

As for the cost of the crisis to SBC, Bingol said the company had not yet calculated how much it has shelled out for personnel, equipment and lost revenue.

"Its kind of the cost of doing business," he said.

No matter what the tally might finally reach, the service disasters have already cost the company tens of millions of dollars just in regulatory fines, penalties or settlements. SBC/Ameritech agreed to a $10 million settlement with Wisconsin in October. In July and again later in the year, Ohio levied two penalties totaling some $11 million. And if service doesnt improve significantly, regulators have threatened penalties totaling $122 million more.

In third-quarter financial statements, SBC acknowledged it could face additional payments in Illinois of tens of millions of dollars, over quality-of-service stipulations the companies made to win merger approval there.

Ohio may prove the toughest overseer. Gianforcaro said the commission will launch an independent audit of the service problems this year and will keep an investigation open well into 2002.

While Bingol said nothing related to the merger or the subsequent service problems had prompted complaints by shareholders, Ohio regulators have enforced provisions of a 1953 law to prevent payment of dividends to Ameritech stockholders until the company meets minimum service standards, an action the company opposed. The cost to stockholders is not yet known, but Gianforcaro said the action did not go unnoticed.

"There were letters to the editor from stockholders in the local papers," she said. The commission is reviewing that enforcement action this month following a hearing with Ameritech.

But whatever the cost to shareholders, consumer advocates said the biggest losers in the merger were ordinary customers, including some who found themselves in life-threatening situations after telephone service tanked.

In one highly publicized case in Ohio that symbolized the worst of the problems, an elderly woman could not call 911 when her husband suffered a stroke. Neighbors heard her screams for help and summoned an ambulance in time. Elsewhere, when entire neighborhoods lost their dial tone, cell phones were shared to maintain lifelines to emergency services.

Outages and installation service delays affected thousands of customers throughout the region, but complaints to regulatory agencies seemed to be only the tip of iceberg, said regulators and consumer advocates. Regulators throughout the region also said, however, they have had no way of knowing what percentage of angry customers eventually filed complaints with them — or even whether consumers knew they could complain to public utilities commissions.

Among those who did not know of their consumer rights was Karen McDonald, who discussed her phone plight while trying to run her Indiana flower shop from home while her two young sons were housebound with the flu.

"There is a place to complain besides Ameritech?" she said. "I never knew that. Whats the number?"