CARRIER CHANNEL: Can Carrier’s Carriers Survive Over Long Haul?

Posted: 04/2002

Can Carrier’s Carriers Survive Over Long Haul?

By Josh Long

First came the downward spiral of Vancouver-based 360networks, a latecomer to the let’s-build-fiber-everywhere game.

Then Global Crossing Holdings Ltd. boasted to money managers about its fantastic worldwide network weaving in and out of golden capitals like Hong Kong, London and New York.

But it was not long before the Bermuda-based behemoth’s earnings disappointed Wall Street. Bankrupt and berated by the hand that fed it — the common stockholders — Global Crossing showed corporate America early this year the so-called long-haul carrier’s carrier market is a perilous game to play.

So dangerous, in fact, that Level 3
Communications Inc. and Williams Communications Group Inc. were fighting for their freedom during the first quarter, struggling to avoid the fate of some of their peers: the once-promising optical stars that went belly up.

Level 3 and Williams Communications say they are a special breed among the long-haul wholesale pack and are destined to outrun the Grim Reaper.

Two weeks after insisting it would not seek to restructure its balance sheet under a Chapter 11 bankruptcy petition nor advocate an alternative that would eradicate shareholders’ equity, Williams Communications said in late February it was considering such options, sending its shares plunging.

Meanwhile, Level 3 hoped to avoid a potential gutter by signing a definitive agreement to purchase Norwood, Mass.-based CorpSoft Inc., a global reseller of software. In its 2002 guidance, Level 3 had told Wall Street one quarter of its recurring revenue base was at risk and noted it could violate a revenue-based covenant as early as the second quarter. But Level 3 execs say the software acquisition would eliminate such a possibility.

Analysts predict the U.S. economy will start to rebound during the second half of the year. By then, they predict Internet service providers and other communications companies marketing to American families and businesses will demand additional IP transit and other forms of wholesale capacity to support growth.

In the meantime, though, investors are running out of patience.

Among the damages threatening to force more network service providers into the bankruptcy courts: a recession; a slew of federal investigations into the accounting practices of carriers that swapped capacity on each others’ networks, bludgeoning the reputation of the wholesale sector; industrywide covenant violations; rock-bottom transport prices and financing woes battering telecom giants such as Qwest Communications International Inc. and WorldCom Inc.

Carrier’s carriers such as Williams
Communications and Level 3 say they will not compete with their wholesale customers. Level 3 has reiterated its commitment to generating business through the top 300 bandwidth consumers around the world, including some financial institutions.

The agreement to acquire CorpSoft does not mean Level 3 would begin to directly market its network services to enterprises, says Level 3 spokesman Paul Lonnegren. “Level 3’s core strategic focus is to enable our (wholesale) customers, not compete with them and that is not going to change,” he says.

Still, with mighty corporations like Broadwing Communications Inc. and Qwest focusing on seizing market share in the enterprise space, will there be a point in which long-haul carrier’s carriers begin directly targeting large corporations to meet revenue guidance? Williams Communications inked network services agreements with Boeing and Yahoo, leaving Frost & Sullivan wholesale analyst Rod Woodward wondering whether the company is considering opportunities “just outside of the pure carrier’s carrier space.”

Industry observers say long-haul carriers burned through billions of dollars installing way too many fiber strands under the streets and seas on practically the same routes around the world, resulting in capacity gluts and subsequent price erosion.

Yet, even late last year many telecom analysts insisted carriers building networks within U.S. cities would be in a better position than their long-haul peers because there is not enough capacity surrounding the skyscrapers and small office buildings of corporate America.

Despite all the hype over the so-called “bottleneck” solution, metro carriers have put up their “For Sale” signs. Though they piled up hundreds of millions of dollars in debt — comparatively less than their long-haul brethren — some metropolitan carriers such as privately-held network operator Sigma Networks have closed shop while others such as Sphera Optical Networks have filed Chapter 11 bankruptcy petitions, spawning consolidation.

Tom Brown, vice president of carrier sales at optical metro carrier FiberNet, says wholesale customers are signing month-to-month and one-year agreements. New York-based FiberNet, which operates the meet-me-room at 60 Hudson St., achieved EBITDA (earnings before interest, taxes, depreciation and amortization) positive in December.

Brown adds, “It’s still a challenge (selling). Don’t get me wrong.”

The regional carrier’s carriers that sell bandwidth services to Internet service providers, inter-exchange carriers, regional bell operating companies and other providers in regions encompassing smaller cities like Dayton, Ohio; Worcester, Mass.; and Portland, Maine, are bleeding as well.

Northeast-based carrier NEON
Communications missed an interest payment it owed Nortel Networks early this year and was in discussions with Credit Suisse First Boston to restructure its debt. The company owes $180 million in long-term debt and $42 million in vendor financing.

NEON spokesman Fred Kocher says secondary markets still are “crying for bandwidth.” But there are far fewer wholesale bidders than a year ago.

Regional carriers backed by multibillion-dollar utilities appear to be in a better position to ride the dark economy. A spokesman for American Electric Power, a stakeholder in Tulsa-based AFN Communications and Houston-based C3Netw-orks, said in late February the company has not put the assets belonging to the telecommunications wholesale providers up for sale.

AFN is “definitely more conservative with our growth plan,” a spokeswoman says. “We are waiting more on people being able to come to us.”

However, some telecom providers backed by utilities say they are committed to expansion. Dominion Telecom, a subsidiary of gas and electric company Dominion, plans to light an additional 10,000 route miles, ultimately penetrating 47 new markets east of the Mississippi.

Telecom analysts say there is no doubt about it: Wholesale telecommunications is and will continue to be big business.

Qwest, WorldCom Inc. and AT&T all declined interviews to discuss their wholesale strategy in 2002 and disclose exactly how much money their network services operations comprise out of total revenue.

But annual figures released by Boston-based research and consulting firm Atlantic-ACM reveal network services comprise a hefty portion of the companies’ U.S. toll-based operations. Among their findings for 2000:

  • Qwest, excluding its local US West operations, grossed a little more than $1 billion in U.S. and international outbound wholesale toll-based services, comprising roughly a third of $3.044 billion.

  • AT&T Corp. generated $6.6 billion in U.S. wholesale revenue, representing less than one-sixth of its $38.1 billion in toll-based revenue. The figures do not include the company’s local, cable or wireless services.

  • WorldCom posted $6.1 billion in wholesale revenue, representing 27 percent of the company’s $22.55 billion in toll-based revenue.

Using figures through the end of the third quarter last year, Atlantic-ACM predicted Qwest’s wholesale long-distance revenue in 2001 would comprise 36 percent of its total US toll-based revenue (excluding US West). The consulting firm predicted AT&T’s wholesale long-distance revenue would comprise 19 percent of toll-based revenue while WorldCom’s wholesale operations would make up 29 percent of its toll-based revenue.

So what do all the numbers mean? Wholesale remains an important revenue source for U.S. carriers and allows AT&T and Sprint to realize efficiencies in their higher-growth retail businesses, say analysts.

AT&T, Qwest and WorldCom own some of the best networks in the world, says Atlantic-ACM analyst Taher Bouzayen. They are not about to de-emphasize their wholesale operations, he says. “I think we will always need a wholesale market,” Bouzayen says, but “there isn’t any market for newcomers.”

Or a market for all the wholesale carriers that remain, say analysts. Probe Research analyst Lynda Starr says the story hasn’t changed much for quite some time. “It is the same story it has always been,” Starr says. “People built the capacity without the thought of how much traffic, how much revenue there was going to be over their pipes and, unfortunately, we have been talking about this for a while now.”

But the story is changing. Communications companies have begun to sell their wholesale assets at bargain-basement prices. One early example: Hong Kong-based Reach, the joint venture between Australian carrier Telstra Corp. Ltd. and Hong Kong-based Internet service provider Pacific Century CyberWorks, inked an agreement last December to acquire capacity and network infrastructure from Level 3 in northern Asia for a fraction of the development cost. Merrill Lynch valued the assets Reach is acquiring at $436 million.

“We believe there are too many long-haul pure-play wholesale firms,” says The Yankee Group analyst Seth Libby one week before Williams Communications announced that it was considering filing Chapter 11. That doesn’t necessarily mean there is not a need for all that fiber; however, there simply are too many long-haul providers chasing too few companies, Libby says. “You are going to see consolidation.”

Who has the money to buy networks these days? Analysts say the Baby Bells, entering long-distance markets across the country, would consider picking up select network assets, and interexchange carriers like AT&T Corp. and Sprint Corp. might acquire infrastructure on the cheap.

Such a cherry-picking strategy would not be unprecedented. Last year AT&T bought DSL infrastructure from bankrupt operator NorthPoint Communications Inc. for $135 million as part of its strategy to offer consumer broadband services.

Operators servicing high debt are likely to acquire parts of networks as an alternative to building infrastructure, but it unlikely they would assume a lot of debt, says Jay
Pultz, vice president and research director of networking at Gartner. “They are only going to buy someone like a large carrier’s carrier in the event they can get a very low price for it,” he says.



360 Networks

AFN Communications

American Electric Power


AT&T Corp.

Broadwing Communications

C3 Networks

Corporate Software

Credit Suisse First
Boston Corp.

Dominion Telecom

Fibernet Corp.

Frost & Sullivan

Gartner Inc.

Global Crossing Holdings

Merrill Lynch

Neon Communications


Probe Research

Qwest Communications
International Inc.

Reach Global Services

Sigma Networks

Sphera Networks

Sprint Corp.

Testra Corp.

Universal Access

Worldcom Inc.

Yahoo Inc.

Yankee Group

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