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WEATHERING THE TELECOM CRISIS
Wanda Avila is a business writer based in Washington, DC.
Utilities and other energy companies who entered telecom in the past five years are confident that when the storm blows over, they will be among the survivors.
After the Telecommunications Act of 1996 deregulated the industry, hundreds of new companies sprang up, offering fiber-optic networks, switching equipment, and internet access. They had no trouble finding capital. Investment bankers and venture capitalists chased after them, "eager to fund anyone who could spell 'telecom'," as one industry executive put it.
Then around the end of 2000, customer spending began to slow. Telecoms could not make up for falling revenues by raising prices because so many other companies were competing for the same customers. Seeing no profits on the horizon, investment bankers tightened credit requirements, and shareholders pulled out.
By mid-2000, euphoric plans for initial public offerings and stock options had turned to reports of revenue losses, job cuts, and falling stock prices. Many telecom companies—like Winstar and NorthPoint Communications—went bankrupt. Others—like Nortel and Lucent Technologies, once industry giants—suffered gigantic losses.
Not surprisingly, the telecom downturn has also affected electric utilities and other energy companies who ventured into telecom in the late 1990s. (See Table 1 for a list of companies in telecom at the beginning of the year.) However, analysts generally agree that utility telecoms are better able to withstand the tempest.
"Unlike many newcomers, energy companies did not enter into the telecommunications arena from scratch," said Jack Richards, a partner in the law firm of Keller and Heckman. "They already had a list of valuable assets that could be useful in many telecommunications projects: poles, towers, conduits, rights-of-way, and the like." He pointed out that many already had fiber in the ground, communications support systems, and even radio licenses from the Federal Communications Commission (FCC). "They also had the right package of 'soft' assets," he said. "Well established relationships with their consumers, reputations for service and reliability in their local communities, marketable brand names, and a perception that they would not be here today and gone tomorrow."
But some see the supreme advantage of utility telecoms to be their access to capital. "Utility companies are sitting on cash reserves," said Beth Griffiths, director of research for the United Telecom Council (UTC). "As a result, many utility telecoms are in good financial shape, and their backers are not pulling out." She cited Florida Power & Light (FPL) Fibernet as an example of the utility telecoms—what she calls "Utelecos"—that are cash-flow positive and actually generating profits after only two or three years of operations, in spite of the economy. "Utelecos are in a position to grow as the demand for telecommunications services grows," she added.
Analysts differ in their predictions as to when the crisis will blow over. Susan Kalla, senior telecom analyst with Friedman, Billings & Company, is one of those who believe that the market will not recover until sometime in 2003. "Cycles are very long in telecom," she explains, pointing out that the current cycle began in 1997, and ended with the crash in 2000.
Convergence Plans On Hold
At the beginning of the year, some analysts were predicting that the telecom crisis would present an excellent opportunity for utilities to go into telecom or expand their operations by acquiring other companies. But utilities were making no move in that direction by mid-year.
An April survey conducted at KPMG's Energy and Telecommunications Convergence 2001 Conference revealed that many companies expected an alliance or merger within one to three years. However, William F. Kimble, KPMG's national industry director of energy and natural resources, later said that he suspected that, if the survey had been issued in July, that number would have gone down dramatically.
"Everybody was pretty fired up about convergence last spring," Kimble said. "Since then not a whole lot has happened, and a big piece of that is the economy. My guess is the telecom industry will have to have some dramatic upturn before we see any more convergence activities between the two industries."
David Cordeiro, vice president of strategy and communications at AFN Communications, agreed. "It is difficult to justify capital expenditures right now for assets because no one knows how low the prices of some of these struggling companies might go." AFN Communications, a carrier's carrier formerly called America's Fiber Network, is jointly owned by four utilities: Allegheny Energy, American Electric Power, GPU, and FirstEnergy.
"It is becoming a buyer's market," Cordeiro said. "With the chaos in the industry, nobody knows what the bottom of the market might be. Prices might get cheaper in the future so people are waiting until they have a sense that the bottom has been reached."
Surveying the Damage
Some utilities had reported major losses from their telecom ventures by late summer 2001. Two utilities had exited telecommunications altogether. Conectiv sold its communications subsidiary to Cavalier Telephone of Richmond, VA, in June.
A month later, Conectiv itself had merged with PEPCO. Reliant Resources announced in August that it intended to divest itself of its subsidiary, Reliant Energy Communications, which provided Internet, data, and voice transport services to business customers in Houston, Austin, San Antonio, and Dallas.
Energy companies that went into bandwidth trading a few years age—like Aquila Energy Services, Dynegy, El Paso Energy, and Enron—have also been badly burned. Enron Broadband Services was at the forefront of those who believed bandwidth could be traded like any other commodity. In April, Enron announced that it was laying off 250 broadband positions. In July, after Enron's broadband business had reported a $102 million operating loss for the second quarter, Enron eliminated an additional 100 jobs and closed its broadband office in Portland, OR. In August, Enron was rumored to be shopping around its broadband assets.
In addition, economic conditions were slowing down Montana Power's transition to TouchAmerica, the first telecommunications subsidiary to spin off its utility parent company. By the first week of August, Montana Power still had not sold the utility, a sale it had expected to complete by the end of the second quarter, and had postponed the sale to sometime in the fourth quarter.
Also, at the end of the second quarter, Montana Power lowered its projected year-end revenues for the TouchAmerica unit from $590 million (a 25-percent growth rate) to $286.4 million (a 10-percent rate). Montana Power attributed the modified forecast to present economic conditions and the additional time needed to refocus TouchAmerica.
For most utility-affiliated telecoms, it is business as usual, though they have been keeping a low profile, issuing few press releases or other public announcements. Few had made any significant course changes in the first half of 2001. Though most utilities had shelved plans for expanding their telecommunications activities, they were not cutting back on their commitments either—whether those commitments were as providers of long-haul fiber, as carrier's carriers, integrated communications providers, or wireless providers. They were hunkering down, waiting for the storm to blow over.
What Fiber Glut?
Excess capacity of high-speed, long-haul information pipelines underlies much of the malaise in the telecom sector, according to many analysts. By the end of 2000, almost 39 million miles of optic fiber have been laid, but less than 3 percent of the capacity is actually being used, according to Merrill Lynch estimates.
Utility telecoms, many of which entered telecommunications as long-haul fiber providers and as carriers' carriers, scoff at the idea of a fiber glut. "It's simply not accurate to add up dark fiber in the ground and then say there is too much capacity. It takes a great deal of time and capital to 'light' dark fiber," said Howard Janzen, Williams Communications' chairman and CEO, in a speech at the Goldman Sachs Emerging Telco and Internet Infrastructure Conference in June. Janzen added that Williams' network was fully lit and operational, ready to meet the developing demand for such broadband applications as wireless web, video-on-demand, and e-cinema.
"It is ironic that the market meltdown has actually created a bigger opportunity for us," Janzen said. "Even the largest players in telecom don't want to spend capital in this environment, and yet they need network capacity to meet the surging growth in voice, data, and Internet traffic. We are perfectly positioned to meet that need by providing a network outsourcing solution today, and with funding that carries us into 2003 when we expect to be free cash flow positive." By August, Janzen had extended the carry-through date to 2004.
Beth Griffiths also debunked the idea of a fiber glut. It is not lack of demand for telecommunications services but lack of capital that has caused the telecom downturn, Griffiths said. "A lot of people are saying the market is falling apart because the demand isn't there, but that's not really true. The telecom market is in a downturn because the capital hasn't been there, and backers are pulling out. And that's largely due to activities on Wall Street."
Griffiths admitted that fewer carriers were buying from wholesale networks because many of them were folding. "But the fact of the matter is, U.S. enterprises are not cutting back on the amount of bandwidth that they use. They are demanding more, more, and more—not less, less, and less. And it's true on the consumer side as well. Once you have a cable modem, you're not going to say, 'Oh, I don't think I need cable modem anymore. I think I'll go back to dial-up'," Griffiths said.
Networks Between
Second- and Third-Tier Cities
Most utility telecoms laying new fiber-optic networks are now focusing on the Tier 2 and Tier 3 cities (population under 500,000), where the demand is greatest and the competition least. Sempra Communications, for example, is laying a fiber-optic telecommunications link from San Diego through northern Mexico to Phoenix, with completion slated for the end of 2002.
Also building a network to serve Tier 2 and Tier 3 cities is Dominion's telecommunications affiliate, Dominion Telecom. In August, Dominion Telecom completed a fiber network linking Providence (RI), Springfield (MA), and Hartford, New Haven, and Stamford (CT) with Boston and New York City. Also, Dominion Telecom bought more than 2,760 fiber miles of dark fiber around Albany, Buffalo, and Syracuse (NY) from Telergy in June, so that it can provide services to its wholesale customers in upstate New York.
"Second- and third-tier cities are underserved, based on our research," said Tom Wohlfarth, Dominion Telecom's director of investor relations. "Also, as we are building out a fiber network now, it's actually a good time to be a buyer (which we are)—as the old adage says 'buy low and sell high.' Our expectations would be to take advantage of the current depressed price environment and build out a low-cost network. Then we sell later when the market recovers in 18 to 36 months."
AFN Communications is also adding 6,000 miles to its fiber network connecting second- and third-tier cities in the eastern and midwestern United States, slated to be lit and operational by the second quarter of 2002. AFN recently completed the first phase of the build out—a network connecting Cleveland, Akron, Canton, and Columbus (OH), Wheeling (WV), and Pittsburgh and Johnstown (PA).
Like many utility-affiliated telecoms, AFN Communications expects to weather the storm. "Clearly the capital markets are in dire straits," Cordeiro said, "but one positive impact of the downturn is that under better market conditions a lot of carriers who have access in Tier 1 cities might have built out to second- and third-tier cities. Because of market conditions, they are now more likely to buy services from AFN than to compete with us in Tier 2 and 3 cities."
Last-Mile Connections
Other fiber providers are focusing on "last mile" connections within major cities. Utilities' ability to provide these connections makes this service a natural niche for them, according to Terry Barnich, president of the New Paradigm Resources Group, a research and consulting firm serving the investment community. "While last-mile connectivity is the Achilles heel in most telecom networks, the last mile is the utilities' stock in trade," Barnich said. He added, "It makes sense for the utilities already enjoying this last-mile access to participate in the market."
In the second quarter of 2001, Sempra Communications created a new subsidiary, called Sempra Fiber Links, to market its technology to place fiber-optic cables into existing natural gas pipelines. Sempra said that this process offers a solution to the last-mile telecommunications problem because it allows providers to bypass expensive and disruptive trenching of city streets to reach buildings and end users.
"Demand for broadband service in metropolitan areas is greater than ever," said Donald E. Felsinger, group president of Sempra Energy, in a July statement. "The most significant obstacle to meeting that demand is the laying of fiber-optic cable under city streets—traditionally a slow, costly, and disruptive process. With our cleaner, quicker, and less expensive process, enhanced services and new revenue streams will flourish."
Also, Telergy, a telecommunications company jointly owned by Niagara Mohawk, GPU, El Paso, and others, specializes in providing last-mile connections in the northeastern United States. Since 1995, Telergy has obtained right-of-way (ROW) agreements with several utilities and (until the World Trade Center attack) was expected to complete its New York City network (using Con Edison's ROWs) this year.
Competitive Telephony
The Telecommunications Act of 1996 was supposed to facilitate competition between competitive local exchange carriers (CLECs) and the regional giants that dominate local telephone service, such as Verizon and Bell South. Theoretically, the Baby Bells were to allow the new companies to compete in the local market in exchange for being allowed to compete in the long distance market. However, it never quite worked. In spite of tens of billions of dollars that have been invested in the upstart carriers, they have been able to capture only 8 percent of the nation's local telephone lines. Now, many CLECs are going bankrupt because Wall Street investment bankers are in no mood to pour new money into them.
Many electric utilities—like Avista, Montana Power, PEPCO, Xcel Energy, and TXU—entered telecommunications by acquiring or partnering with telephone companies. Though they have all been affected by the telecom downturn, analysts say, they are likely to be among the survivors because of their access to capital and because of the reputation for reliability and customer service that their parent companies offer.
In 1999, Avista bought Spokane-based One-Eighty Communications (a CLEC) and renamed it Avista Communications. In 2001, it became an integrated communications provider offering local voice, data transport, and Internet access over a fiber-optic network to small-business customers in several Tier 2 and 3 cities in Montana, Idaho, and Washington.
Greg Green, president and CEO of Avista Communications, said that as a result of the telecom downturn, Avista Communications is simply weathering the storm. "We are not doing any market development," Green said. "We are simply operating the markets we have today. We have 12,000 access lines and a million dollars a month in revenue, and we are continuing to grow our revenue stream. We are focusing on the only things we can control, which is turning up new customers and increasing revenue and margin."
Green expressed optimism, though, about Avista Communication's eventual triumph. "The companies that survive this downturn will be much stronger when the financial markets turn around. They will have less competition and will have better brand loyalty because they have demonstrated their reliability through the downturn. Clearly, the weaker companies are being weeded out. We can't forget that there is a $100-million-per-year market here, so there is still a land of opportunity."
All the CLECs combined own less than 10 percent of the marketplace, Green said, adding that "monopoly in telecommunications is still as ubiquitous as water."
Herb Zuerich, president of TXU Communications, said that the downturn has had little impact on the company. "On the contrary," he said, "the downturn has presented some opportunities for us to expand our customer base and acquire other companies. We are actively looking at other development opportunities as we go forward." TXU Communications is the largest utility-affiliated telephone company, as well as the fifth largest telephone company in Texas and the sixteenth-largest in the United States.
Zuerich said that as a utility-affiliated CLEC, TXU Communications had major advantages over other CLECs, the most important of which was its access to capital. He said that TXU sold 50 percent of its equity in TXU Communications this year to provide the company with capital to grow. As a result, Zuerich said, it is fully funded for the next five years.
John Ng, vice president of PEPCO Communications, admitted that the telecom downturn has had a big impact on Starpower, a joint venture between his company and RCN Corporation. Starpower is an integrated service provider that provides local and long-distance telephone, high-speed Internet, and cable television to residents in the Washington, DC, metropolitan area. For the second quarter of this year, PEPCO had a loss of $4.2 million from its Starpower operations.
Nevertheless, Ng said, Starpower was continuing to honor most of its commitments. In April, though, Starpower canceled its plans to join with American Broadband of Massachusetts to invest a combined $365 million in lines and other equipment to compete with Baltimore County's monopoly cable provider. Citing concerns about the potential risks of rapid expansion in today's capital-constrained markets, Starpower suspended its application for a franchise agreement in the county.
"We're going to weather this storm," Ng said. "We may even benefit from the downturn, because a lot of DSL providers have gone bankrupt. There were probably too many players in this space prior to the downturn, and I think what you're going to see here is the survival of the fittest. We are the only provider in this market that can offer all three services."
Wireless Communications
How the downturn in the economy has affected wireless communications was dramatically demonstrated by the second quarter earnings statement of Nextel Communications, the largest wireless carrier in the United States. Nextel had losses of $369 million, or 56 cents per share, for the second quarter of 2001, compared with losses of $241 million (38 cents per share) for the second quarter of 2000.
American Electric Power, Exelon, GPU, SCANA, Southern Company, and other utilities that have gone into wireless have been buffeted by the same economic winds as Nextel. However, utility wireless companies seem to be holding up better than companies not affiliated with utilities, if Southern Company subsidiary Southern LINC is any measure.
Southern LINC—long-range integrated network communications—dominates the retail utility wireless services market. According to Julie Pigott, vice president of marketing, Southern LINC has been little affected by the downturn. She attributed this stability to the way Southern Company entered the wireless market. Before Southern LINC existed, Pigott said, the utilities that make up Southern Company were all operating around different radio systems, some of which were outdated and needed to be replaced.
"We built our system to satisfy all our utilities' needs," Pigott said. She explained that the utilities needed to cover rural areas as well as metropolitan ones, and relied heavily on telecommunications in restoration efforts. They also needed a network that could withstand severe weather conditions. After investigating several technologies, Pigott said, Southern Company decided upon Motorola's iDEN technology, which combines four communication services into one handset or installed device: phone service, two-way radio, numeric and text paging, and wireless data and Internet services. "This technology not only allowed Southern Company to meet its own needs," Pigott said, "but also provided excess capacity, which we could market to our business and government customers."
Pigott also said that Southern LINC had no expansion plans at mid year but was focusing on maintaining a high level of service to its current customers. However, she predicted that the company would expand in the near future, along with the wireless business in general. According to the Strategist Group, the 107.8 million users of mobile wireless services today is expected to grow to 154.7 million by 2003.
The future of fixed wireless is also bright, according to Robert Veltman, chief industry analyst with Wireless Communications Association International, an association for fixed wireless providers. He said that attendance at the association's annual conference in Boston in June had increased 65 percent over last year's conference. "More and more companies are thinking of going into wireless," Veltman reported.
"There's a huge market in the underserved and unserved areas of the country, especially in Tier 2 and Tier 3 cities," Veltman said. "And since utilities already service those areas, it is a lot easier for them to go into these markets—if they have the right people with telecom savvy—than it would be for other companies. Electric utilities own the towers, poles, and substructures that they can put antennas on. They're also used to billing mass customers, and they're sitting on a pile of cash that they can use to get them going."
Rainbow's End
The telecom downturn is likely to continue for some time. At the beginning of the year, most analysts were predicting an upswing by the end of the year. By mid-year, they had pushed up the turnaround to 2003. When the market does come back, many telecoms will no longer exist, but utility telecoms will be the ones most likely to survive.
"Utelecos have never been at the beck and call of the public financial markets," said UTC's Beth Griffiths. "They were funded internally by utility companies, who made them prove that they could meet their revenue goals."
"Access to capital is absolutely critical in this market," Susan Kalla agreed, adding that the successful companies will be investing in new technologies and product development. "So that when the market turns around, as it always does, these companies will not only have fewer competitors than they had in 2000, but they will also be in a stronger position to compete against the other companies that survive," Kalla said.
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