Kevin: NOT A BULLISH ARTICLE..............
From SSB's Grubman:
Sunday New York Times Article Dovetails With Many of Our Views
Monday, July 12, 1999
--SUMMARY:----Telecommunications Services
*This Sunday's NY Times wrote an article on long distance bandwidth which
made several key points.
*First takeaway is that bandwidth may be a commodity but no capacity glut
exists.
*Article stressed the need for applications to fill networks.
*Clear takeaway from article is that local bandwidth assets will increase
in value.
*Article made it clear that WCOM's set of assets and capabilities positions
it best within this industry and local bandwidth assets will increase in
value.
--OPINION:------------------------------------------------------------------
The Sunday NY Times wrote an article which if one just read the headlines
one would think that it was yet another typical oversupply of capacity
argument. Actually, the point of the article, which we believe was an
important distinction and reasonably well stated--is that while bandwidth
may be a commodity at the most elementary level, the fact is there is not
a capacity glut. This is an argument we have put forth many times as we
have always argued that bandwidth may be a commodity but what you do with
it is not. In other words, as we mentioned in our WCOM note of a couple
of weeks ago, in the long distance industry as capacity continues to come
on those entities that develop applications to fill that capacity will be
able to offer high value proposition services. The deployment of new
capacity clearly does further commoditize the low end of the food chain.
Thus, the NY Times article which pointed out backroom trading of minutes
on networks, clearly focused on the very bottom of the food chain, but at
the same time, the Times' article pointed out something which we have
stressed for a long time--that new applications continue to be developed
that use up the bandwidth created.
The takeaway from this article consists of several points:
1) The distinction between bandwidth as a commodity versus a glut. This
was perhaps the most important point of the article and a point that we
have stressed for some time. Those companies that drive enhanced
applications over their networks will be in the position to use up the
capacity being deployed. In particular, companies such as WCOM which has
customers, products, applications, as well as global network assets, are
in the best position to drive higher value from the deployment of
capacity on a global basis.
2) Local bandwidth remains scarce. The fact is that the ability to drive
high speed broadband connectivity into as many customers as possible at
the local level remains the gating factor towards the full delivery of
enhanced applications to as many end-users as possible. In this vein, com
panies such as MFN, which are building dense fiber networks in several
dozen cities around the world, WinStar, Teligent and NEXTLINK which have
fixed wireless networks capable of delivering broadband access to a large
part of the business market and the DSL players such as Rhythms--all have
assets that will increase in value over time.
3) The third takeaway from this article is not so much something the
article said but rather something they did not say about long distance
pricing. Included in this article was a chart which showed that long
distance rate per minute has declined about 25% cumulatively since 1984
while the US Consumer Price Index has risen about 60-70% during that time.
However, what the article failed to explain was that 80% of the drop in
the long distance rate was a flowthrough of lower access charges. Thus,
the impression that long distance prices have dropped roughly 80%, in
real terms is not quite right since it was driven by lower access
charges. However, even taking the numbers at face value the reality is
despite this drop in rate per minute, long distance revenues grew 7% per
year and long distance margins almost tripled during this time. This
occurred despite a doubling of capacity in the long distance industry ev
ery two years since divestiture. The reason for revenue growth and margin
expansion in the face of falling rate per minute and increasing capacity
is the development of new applications which go up the value chain and
use the capacity that is being deployed.
4) Players that just focus on the bandwidth layer, such as Level 3, have
a tougher long-term value proposition. While we agree that bandwidth is a
commodity, we do not view what Level 3 is doing as building a "state of
the art" network simply to sell commodity minutes or commodity packets.
Rather, we view Level 3's business plan as, in fact, selling high-end
bandwidth-consuming services but simply on a wholesale or enabling basis
as opposed to on a commercial basis. This subtlety was not necessarily
articulated in the article. The fact is that there will be companies that
have customers who do not have the capabilities to deliver "state of the
art"-managed bandwidth services on a national or global basis which is
the application layer that Level 3 is striving for.
The bottom line is we think this article quite nicely articulated the
difference between the notion of bandwidth as a commodity versus the
concept of a capacity glut or lack thereof. As we said, this is a concept
we have been talking about for a long time and we think this article did
a good job in pointing out the distinctions between the two. It is clear
that companies which develop value-added applications which use the
capacity being deployed, are going to drive huge value-creation while at
the same time, the most mundane uses of bandwidth will continue to be
commoditized. Thus, what seems like a paradox really isn't. A basic
element of bandwidth has always been and will continue to be a
commodity. What you do with it isn't--which is why we never have and
continue not to worry about the notion of a capacity glut given the level
of activity surrounding the development of applications to use the
bandwidth being deployed.
NET/NET: We believe this article clearly pointed to why WCOM is the best
positioned telecom company in the world and why it remains our favorite
name. In addition, companies at the local level that are deploying
high-capacity networks like fiber, fixed wireless or DSL, will continue
to increase in value. We remain very bullish on the prospects of
bandwidth increasing in value as a function of new applications being
developed even in the face of the continued commoditization of the low
end of the food chain.
[*OT* how 'BOUT that China.com! (NASD:CHINA)]
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