Spinoff Embarq outshines parent

When cellphone giants Sprint and Nextel merged in 2005, investors had a lot of hope for the combined company.

Few paid attention to Embarq, which was spun off from Sprint after the Nextel merger closed. Its core asset was in the dowdy — and dying — local phone business.

They're paying attention now.

Since being freed from Sprint s 15 months ago, Embarq eq has emerged as a top performer among U.S. telecommunications companies, easily surpassing its former parent.

"Embarq has been one of the best performing stocks in the group," says Frank Louthan, a telecom analyst with Raymond James.

Embarq shares have shot up 36% since it started trading as a separate company on May 4, 2006. Only AT&T, t up 55% in the same period, has done better, Louthan notes.

And Sprint, which was eager to shuck Embarq so it could focus on the jazzy new wireless world? Since marrying Nextel, the company has struggled with a host of merger-related problems. The pain shows in Sprint's share price — down 19% since the merger closed and 15% since the post-merger spinoff of Embarq. (The spinoff was required to gain the blessing of regulators for the merger.)

"Everybody thought Sprint-Nextel was going to be the superstar, but it's been plagued with so many issues," says Roger Entner, senior vice president-communications sector for IAG Research. "Embarq has largely chugged along."

Sprint's troubles bring no joy to Embarq CEO Dan Hesse. A veteran of AT&T before its merger with Cingular, Hesse was recruited to Embarq by Sprint CEO Gary Forsee. But he also makes clear that Embarq has no significant ties to its troubled ex-parent.

Embarq now has a "Mobile Virtual Network Operator" (MVNO) relationship with Sprint, enabling it to resell wireless service on Sprint's network under its own name. It also buys long-distance minutes. But that's where the association stops. "Customers wouldn't know we have a relationship with Sprint."

As for losing the Sprint brand, Hesse suggests Embarq dodged a bullet. "Sprint did us a favor by taking the Sprint brand."

Innovation is key

Hesse, who was CEO of the old AT&T Wireless when it was part of the pre-merger AT&T, is a big believer in the power of innovation to move markets. That extends to Embarq's wireless business.

"We add a lot of features that focus on the integration of wireless and wireline," Hesse says. ("Wireline" is industry parlance for the traditional phone business.) "We would not be in the wireless business just to sell wireless to customers," he explains. "We are in the business because we think there is an untapped need to have wireless and wireline work together."

And therein, he says, is the secret of Embarq's success to date. "What makes us different (from other local phone companies) is our focus on innovation," he says. "That's not necessarily the first thing people think of when they think of a local phone company."

The local phone business dates to horse-and-buggy days and is shrinking rapidly, thanks to alternative technologies such as Internet and wireless phones. The number of U.S. local phone lines is shrinking about 6% annually — nearly 10% in some markets.

Embarq isn't immune. The carrier, which has about 6.8 million local lines, is losing about 6% each year. Revenue is down year-over-year.

Even so, Hesse thinks there's a lot of life left in the traditional phone business. The key, he says, is making the business relevant to modern-day consumers. "Common wisdom is that people like wireline or wireless. We think 80%-plus like to have both, because each has unique strengths."

Traditional phone service offers superior transmission quality, he notes. It's also cheap. Wireless offers unfettered mobility but costs more. By marrying the two, Hesse thinks he can shore up the local phone business and create new service categories.

Blending services

One outgrowth of his thinking is a new line of services called "Integrated Calling Features."

The first, introduced last June, was an integrated mailbox for wireless and land-line phones. Missed calls to a home land-line or cellphone trigger message indicators on both devices. The service is marketed as a convenience because, "You only have to check one voice mailbox as opposed to two."

Another new feature allows customers to take wireless calls on their home land line, and vice versa. Customers can have them ring simultaneously or set which phone rings first — wireless or land line — and in what sequence, for up to three phones.

In development: a wired/wireless integrated directory like the popular address book on cellphones. When a contact number is entered on a cellphone (or a PC), it is stored on Embarq's network and can be accessed from cell and home phones.

While these features might save customers wireless minutes, they have strategic purpose: breaking customers' habit of using wireless phones at home.

"This takes away the lazy factor," Hesse says, referring to the consumer habit of using cellphone address books to place calls instead of dialing digits on their home phone.

It's an uphill battle. More than half of wireless calls originate at home, and the share is escalating. It's another reason the traditional phone business is dying.

Hesse acknowledges the problem. "When you come home at the end of the day, we want you to turn off your cellphone," he says flatly.

If he can get Embarq back on a growth trajectory, Hesse says, he'd like to take it to the next level.

How? Mergers. With more than 800 local phone companies, Hesse notes, the time is ripe for consolidation. "We'd like to play an important role in that."

In the meantime, Hesse says he'll stay focused — and maybe find a sexier names for his "Integrated Calling Features."

The services are cool but the label isn't, he admits. "I've asked our marketing people to come up with something new."