Embarq (NYSE: EQ) emerged following the spin-off of Sprint's Local Telephone business that became effective on May 17, 2006. Investors who held Sprint Nextel common stock on May 8, 2006, received one share of EQ stock for every 20 shares of Sprint Nextel common stock they owned. Until then, EQ was a wholly-owned subsidiary of Sprint Nextel. EQ's assets and business now consist largely of those that comprised Sprint Nextel's former Local Telecommunications Division and Sprint North Supply operations. EQ, headquartered in Overland Park, Kansas, is now the fourth largest local communications company in the United States, (based on access lines) and provides services in 18 states which include many major metropolitan areas and rural markets. The customer base, market reach, competitors, network infrastructure and economics of the business vary widely among geographies. The total access lines are split even by between metropolitan and rural markets.
EQ reports its operating results in two segments Telecommunications (92% of 2006 revenues) and Logistics (8%). The Telecommunications segment provides regulated local communications services as an incumbent local exchange carrier, or ILEC, to approximately 5% of U.S. households, with approximately 6.9 million access lines as of December 31, 2006. Florida, North Carolina, Nevada, and Ohio territories represent approximately 66% of EQ's access lines. This segment provides local voice and data, high-speed Internet, nationwide long distance, wireless, satellite video and other services to customers within EQ's local service territories. Additionally, the company also provides access to Embarq's local network and other wholesale communication services for other carriers. The company offers wireless services to large and medium customers through a mobile virtual network operator (MVNO) arrangement with Sprint Nextel. The Logistics segment engages in procuring, configuring, and distributing equipment, materials, and supplies to the communications industry. This segment offers outside plant business communication systems, telephones and accessories, and network access equipment from manufacturers.
Erosion in access lines persists as the company continues to face stiff competition from wireless operators and cable companies with recent triple-play (voice, video, and data) offering to the consumer. Switched access lines declined 6.1% in 2006 and the percentage of access line losses will accelerate in 2007 as cable companies offering Voice over Internet Protocol (VoIP) services continue to add coverage in the company's territories. The challenge for the company will be to retain its subscriber level and grow revenue with new services and expansion of its geographical reach. One initiative that will attempt to offset existing service challenges is the delivery of new video services to compete against cable operators offering voice service in its local markets. However, EQ will face a difficult deployment process as municipality approval is required in each intended local jurisdiction before offering video to subscribers. Similar regulatory hurdles have already hindered other telephone companies, including Verizon and AT&T, deploying video broadcast services.
In June 2006, the company also started offering wireless services. However, EQ's wireless operation is leveraged from Sprint Nextel, and not organically owned by the company, which may limit overall financial return on its third party services. EQ plans to integrate its wireline voice and data services with the wireless service in order to complement and enhance the value of its core offerings. We believe that the non-exclusive wireless wholesale arrangement with Sprint Nextel will facilitate improved bundled services and more attractive pricing to customers. Unfortunately, Sprint Nextel is also consummating similar arrangements with competitors, including cable operators, so the outcome may not be as significant moving forward.
Although the divestiture of Sprint Nextel's local telephone business (EQ) unlocked value for Sprint shareholders and the company's aggressive dividend policy (the $2.50 dividend payout equates to a 5.0% yield) will entice investors to hold shares, much of the burden is now placed on EQ in terms of financial debt and the need to turn a mature operating business into one that becomes more robust. The highly leveraged balanced sheet is an issue that should be considered as the company had $5.87 billion of total long term debt and only $10 million of cash and equivalents as of September 30, 2007.
Earlier in the year, management's outlook for 2007 guided us to lower revenue and earnings levels than previously forecasted. The company estimated that year-over-year access lines will decline at a mid to upper 6% rate due to increasing competition from cable and wireless providers. Revenues are expected to grow modestly while operating income is estimated to decline. Management expects that the launch of its wireless service in 2006 will be dilutive to financial results in 2007 as a result of up-front customer acquisition costs as well as the absence of a substantial customer base generating a level of recurring revenue sufficient to cover these initial investments.
As a result of these challenges, we believe EQ's cash generation and earnings power will be offset by the company's limited growth prospects and the regulatory challenges, which we believe are negative factors that may impede higher valuations.