WSJ(6/18): How Fiber Barons -3: A Clash Of Two Billionaires
From The Wall Street Journal
"Qwest is a fine company and I like Joe. However, we have a big
disagreement," says Mr. Crowe. "Our goal is not simply to deploy one
generation but to build an entirely new model that assumes technology will
change quickly, and at times, unpredictably."
Mr. Crowe quickly attracted an almost cult-like following with his theories
of how the Internet would revolutionize the stodgy world of communications.
One of his best-known principles, and one of the main reasons he built such
a large network, was known as disruptive pricing - using low prices to
stimulate Internet demand. "For every one percent you drop price, you get a
greater than one percent increase in demand," Mr. Crowe said again and
again.
He also had little patience for vertically integrated companies that try to
do it all. Instead, he argued, communications would eventually drift toward
a high-tech model, where each of the most successful companies carves out
its own niche.
Investors ate it up, especially in Omaha, where the Peter Kiewit name was
legend. Generations of engineers had already become wealthy through an
employee stock ownership plan, and when Level 3 was spun off, the workers'
paper profits soared. The fact that Mr. Scott sits on the board of Berkshire
Hathaway Inc., and Berkshire's legendary leader, Mr. Buffett, keeps his
offices on the 14th floor of Kiewit Plaza, only added to the allure. "A lot
of people thought this was the next coming, the next Berkshire Hathaway.
They loaded all their assets in," says Marc LeFebvre, a stock broker in the
Omaha office of Dain Rauscher Inc. who, along with his father, once worked
at Kiewit.
By February 2001, Level 3 had managed to raise $13 billion, enough to
finance building its entire network and - according to its plans - keep it
going until it achieved profitability. Derek Scarth, an equity analyst with
Berger Funds, remembers Mr. Crowe's pitch boiled down to this: "If you build
it, they will come."
But it wasn't customers who came so much as it was competitors, lured by the
easy availability of funding. J.P. Morgan and McKinsey & Co. figure at least
50 companies, offering a range of Internet backbone services, joined the
gold rush by the end of 2000.
"There was a time in 1998 and 1999 where we were getting five offerings a
week, just in telecom," says Brian Hayward, head of telecom investing for
Invesco Capital Management Inc. The pile of prospectuses on his floor was
two feet high.
Mr. Nacchio marvels at how easily the money flowed. In the fall of 1998, he
remembers coming up with a second round of financing in a 10-minute call
with bankers while driving to his son's soccer game. "Before the game was
over, we had subscribed for a billion bucks at 8.9% interest," says Mr.
Nacchio. "To me, we had arrived."
Once the big dig was set in motion, it was hard for any one player to scale
back. Each had raised money by promising investors a new fiber-optic
network, and each felt compelled to forge ahead to get revenue flowing as
soon as possible. Mr. Crowe, who watched competitors creep up behind him
much as he had crept up on Qwest, consoled himself with the conviction that
his network would be superior. And he and all the others stood firm in the
belief that Internet traffic - whether e-mail, or pay-per-view movies or the
frenetic transactions of day traders - would soon be gushing so fast that it
would engulf all their pipelines and more.
In retrospect, the executives - and Wall Street - made some major
miscalculations. Too many companies focused on the easy part of building a
network: the long-distance loops that cut mostly through rural areas. Too
little money went into widening the pipes that run into homes and offices,
an extremely expensive undertaking complicated by the fact that the Baby
Bells already own such "last-mile" connections. With high-speed access slow
to reach businesses and consumers, development of the sort of "killer
applications" that might spur new usage dwindled.
Some analysts tried to sound a warning. In October 1998, an Internet
researcher at AT&T Labs named Andrew M. Odlyzko published a paper debunking
the widely held view that Internet traffic was doubling every three months.
Mr. Odlyzko laid out an argument that in fact Internet use was doubling only
once a year. "It was an extremely convenient myth," says Mr. Odlyzko. "Every
entrepreneur who was getting financing could quote it."
With the flood of investment money continuing unabated, few in the business
paid him any heed. But Mr. Nacchio was starting to get rattled. With so many
new entrants, he figured, life as a carrier's carrier might get tough. The
entire wholesale market, Mr. Nacchio calculated, was roughly $9 billion a
year. "There wasn't enough revenue to go around," he says. So Mr. Nacchio
began converting Qwest into a retail company instead, acquiring LCI
Communications, which made Qwest into the nation's fourth-largest
long-distance company.
In June 1999, he dropped a bombshell by making a bid for U S West, the
Denver-based Baby Bell. Coming as it did in the midst of America's Internet
euphoria, the move stunned investors, who wondered why Qwest would buy such
a traditional, slow-growing company. Mr. Nacchio even had trouble persuading
Mr. Anschutz that the move was justified. "All I knew is that we were not
going to succeed by being a one-trick pony," says Mr. Nacchio.
Whatever the justification, the stock market wasn't buying it. Qwest's
shares plunged, but the $35 billion deal still went through. Mr. Crowe, for
the time being, was looking brilliant. Level 3 stock surpassed $130 per
share in March 2000. Dangling fat stock options, Level 3 poached Qwest
employees, sometimes driving Mr. Nacchio to distraction.
Even though Level 3 was still more than a year away from completing its
network, it managed to grab headlines. In October 1999, the company snagged
a key piece of America Online's business from WorldCom. Analysts estimated
that Level 3 undercut WorldCom's price by 50%. Mr. Crowe's theory of
disruptive pricing was having an impact.
But Mr. Nacchio had some disruptions of his own in mind. Angered by the
defections and worried about market share, the executive ordered his sales
teams not to lose any contracts to competitors. The project, code-named
"Operation Clean Sweep," turned the tide back in Qwest's favor.
It also kicked off a deflationary spiral the likes of which few industries
have ever seen. In the wholesale market - the business of selling network
space to other phone and Internet companies - prices are expected to plunge
at least 60% this year.
It's even worse for so-called "dark fiber," which hasn't yet been connected
to the expensive electronic equipment needed to make it usable. A major
brokerage house, say, that wanted to purchase its own strand of fiber could
pick it up for $1,200 a mile, down from as much as $5,000 in 1997, according
to Qwest.
Such sales are becoming increasingly rare, however, because few companies
are in a position to invest in the equipment needed to connect the fiber
into a network. That equipment, including the ultra-fast switches called
routers, costs many times more than the fiber itself.
The pricing collapse, combined with the bursting of the Internet bubble, has
left the fiber industry gasping for air - and Mr. Nacchio looking like a
genius.
Thanks to the constant trickle of money from plain-vanilla local phone
service, Qwest is projecting revenue of as much as $21.7 billion this year,
up from $19 billion in 2000. It lost $81 million last year and won't be
profitable anytime soon, but its stock price has been holding steady lately
at around $33 on the New York Stock Exchange. That's down 48% from its high
but still well above the initial offering price, adjusted for a split, of
$5.50.
Life isn't so easy for Mr. Crowe. After trading as high as $130 in March of
last year, the company's stock closed Friday on the Nasdaq Stock Market at
$7.62, off 34 cents, or 4.3%. By some estimates, investors in the Omaha area
alone have suffered paper losses of as much as $20 billion, leading to
plenty of grumbling around town.
Tom Dowd, an Omaha attorney, is kicking himself for not selling his Level 3
shares earlier, but he still has faith the situation will improve. "Walter
Scott has his reputation on the line with all these people getting it in the
teeth," he says. "He doesn't want his legacy to be a foul ball."
It will take some doing to turn Level 3 back into a hit. Due to some
environmental problems in California - the digging was disrupted temporarily
by regulators when a trout turned up dead near the route - the network isn't
quite finished. Of the 96 fibers in Level 3's first conduit, only two are
currently lit.
And, despite winning high-profile customers such as Yahoo Inc. and XO
Communications Inc., Level 3 recently lowered its projection of
communications revenue for this year to as little as $1.4 billion from $1.7
billion. In 2000, the company reported a net loss of $1.45 billion on
revenue of $1.18 billion, including $200 million in revenue from mining
operations.
Some acquaintances have noticed that Mr. Crowe seems more subdued these
days. But in public the executive remains the picture of confidence. He
stresses that the company still has $4 billion in cash and says it will
emerge from the shakeout.
"A year ago we were in a hothouse environment where every plant, regardless
of its strength, prospered," he says. "Now, we are outside in the cold
world. It is a better environment, as painful as it is."
(END) DOW JONES NEWS 06-18-01
12:37 AM
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