Rich,
On the one hand the analysts say that the RBOCs have won. I've been reading this rationale for some time now, which suggests that now that they've won they should be given the opportunity to grow, unfettered. And then, the theory goes, they will be free to unleash innovations heretofore unseen for the betterment of end users, and they will be able to do this without being saddled by having to support their competitors through unbundling and resale. Makes sense on the surface.
On the other hand, the analysts see IP and Ethernet as the winner, and they conclude that SONET and ATM will wither.
What's wrong with this picture? I addressed this contradiction in terms yesterday in another post, here:
Message 17114036
"The problem with this, and I think that this is consistent with Verizon's backing of the report (and the author's own prior history as an economist at an incumbent) is that SONET and ATM are far more expensive to deploy than Ethernet and other so-called next gen architectures."
There are some analysts who don't give the gold ring to the ILECs as readily as the robiestephenses of the world, although robie still has plenty of company. The following is an executive summary from the April 2002 Cook Report on Internet, which you may find an interesting read, although it doesn't begin to do justice to the line-item-by-line-item interpretations of the ILECs' (and some of the fiber barons') 10Qs found that are found in the full report:
cookreport.com
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Part One:
THE FUTURE OF THE INDUSTRY
Why the ILECs Are in Trouble
New Technology Has Stood their Business Model on its Head and Is Beginning to Erode their Revenue Base
/snip
Googin Asserts that Caught in a Vice Between Shift to Unprofitable Data, Declining Use of Network and Long Depreciation Schedules for Heavy Debt ILECs Will Find Themselves Unable to Pay their Debt
--snip
February 18, 2002 -- In this issue we shift from technology to economics and business models. A year after folk could no longer ignore the bursting of the bubble, the industry is still headed downward. We seek to define the problem and the reasons why. The reasons of course are to be found in a mixture of technology and business models as constrained by the policy frameworks in which they must operate.
The most critical insight to result from our efforts at problem definition is Roxane Googin's assertion that there is a combination of economic and technology forces eating away at the ILECs that will bankrupt them. While the same combination of forces will play out differently with the old line IXCs, their future (especially that of AT&T and MCI WorldCom) is also grim. Between 1985 and 1995 the legacy telco networks were structured for the digital delivery of circuit-switched voice with the purchase of a very expensive SONET based infrastructure. With data representing a small but growing share of traffic their business model seemed to permit them adequate time to convert their networks and financing to cope with a data dominant future.
What their planners hadn't reckoned on was the impact of the internet and web driving data growth even more rapidly than they had projected between 1995 and 2000. At the same time, rapid improvements in optical network and gigabit Ethernet technology greatly reduced the costs for both capital expenditure and operating expenditure while at the same time providing a more data-appropriate infrastructure. As a result, almost overnight their new SONET networks were rendered obsolete. This flew in the face of the 20 or 25 year economic life cycles anticipated by the ILECs for their SONET gear, as exemplified by the 20-25 year amortization schedules for this equipment. They used these amortization schedules as the basis of their bond repayment schedules. Consequently, the quality of such bonds now must be viewed with increasing skepticism.
Meanwhile, new players with newer networks, therefore lower cost bases, are able to offer less costly transport and connectivity services, which further erode the revenue base of the incumbents. Notwithstanding, these new players have not grown fast enough to reach economic viability. Most are bankrupt or tottering on the brink.
What is left for the incumbents is a high cost obsolete local loop in a era where people want broadband that the copper cannot deliver. Furthermore, the ILEC infrastructure requires a work force of hundreds of thousands to maintain it limiting their financial flexibility in the face of their need to replace that equipment. Legacy ILEC operating expenses are not to going to be able to be rapidly reduced. In the past, as long as operating income was growing, the difference between revenues and expense in the form of earnings would permit the ILECs to try switch to a newer and more cost-effective infrastructure. But today, the difficulty of carrying out such a switch is increasingly obvious.
Googin points out that in 2001 something absolutely critical happened. While ILEC data growth continues, data does not bring in anywhere near the revenue that voice does. Furthermore, voice as measured in number of access minutes to ILEC networks and number of lines in service is now not only flat but actually declining. The result is that revenues are going down while costs are not and profits are disappearing. When the profits are gone, and the bondholders can no longer be paid, the outcome (bankruptcy and restructuring) appears to be inevitable. Our small panel of experts assembled for this issue sees no deus ex machina waiting in the wings to reverse the current course. The only variable looks like the speed of the downfall. There readers will find some difference of opinion in the essays that follow.
In Need of Cassandra?
Who will speak the painful truth? Two years ago the commonly accepted wisdom said that the net heads would take their IP, fiber and stupid networks and sweep the old line phone companies aside. But even then there were some cracks in such an assessment. Andrew Odlyzko three years ago began to explain why the foundation of bandwidth doubling every 90 days on which both the dot com craze and fiber builds of 1996 - 1999 were based was not reality but a myth.
In a similar vein Roxane Googin for about two years has been explaining why the much feared re-integration of telcos into an ILEC led monopoly won't happen either. If Odlyzko delivered the first piece of bad news by telling us we had geared up for a demand that wasn't there, Googin has a her own dose of harsh reality to present. The new technology although itself not yet built into viable companies is eroding the base on which the circuit switched telcos operate rendering their balance sheets unsustainable as well. It is our contention that if we grasp both of them and understand how one flows from the other we will begin to be able to address industry's problems. It is our objective to do just this in this issue of the COOK Report.
We are at about the same point in perception of Googin's message that we were with Odlyzko's at the end of 1999. She has been a subscriber for several years but, until David Isenberg described her analysis in mid December, we had not understood what an important contribution she had to make. We persuaded her to follow up with us what she had begun with Isenberg. She had concluded in Isenberg's Smart Letter #64 isen.com that the industry had tanked and the only recourse to a prolonged downturn would be recognition of the severity of the problem by wiping balance sheets clean and starting over again.
While this injunction may be more easily said than carried out, the conclusion to be drawn is that, until people realize the breadth and depth of the problem, change will not occur. Instead we will simply continue this downward spiral as the black hole of debt absorbs all economic growth, just like Japan. While Wall Street optimists may continue to forecast a second half rebound (just as they did last year) they are simply deluding themselves. Unresolved debt in Japan has contributed to an 18-year decline. If we don't restructure this debt, however, that is just where we are headed.
Roxane Googin believes that problem definition is the order of the day. Agreeing, we asked her to do a core dump. Three hours of interviews just before Christmas have been followed by further extensive voice and email correspondence over the past three weeks. The result is the interview that forms Part One of this issue. We asked David Isenberg, Andrew Odlyzko and Bill Klein (an internet infrastructure equities analyst) to join in reacting to and commenting on the interview. Isenberg's reaction was his Enronization of Telecom article in Smart Letter 67 isen.com.
Comments and questions by Odlyzko, Klein and your editor are contained in Part Two below. In Part Three Googin responds to Odlyzko's critique incorporates a key part of his argument and shows that her key insights are still valid. ---snip
FAC |
