Net phone companies race clock
By Dan Goodin
Staff Writer, CNET NEWS.COM
April 17, 1998, 12 p.m. PT
URL: news.com
Excerpt: "As 10 percent to 25 percent of all telephone calls are projected to be made with IP within the next
few years"
news analysis Internet phone companies are racing to cash in on what may become a
billion-dollar industry before the government's wheels of bureaucracy can pick up speed.
Born from a start-up culture rather than the historically plodding environment of their Bell
predecessors, these companies are looking beyond any potential regulatory complications that
may arise from a report issued late last week by the Federal Communications Commission.
Although the agency left the door open to regulation down the road, analysts do not foresee any
insurmountable obstacles for the burgeoning industry--at least not yet.
In releasing its report to Congress last Friday, the FCC sent a somewhat mixed signal to the
industry. While the agency said it would be premature to impose fees on
Internet telephony companies immediately, it went on to say that many of them
appear to be no different from traditional analog phone carriers.
That renewed fears that the government may impose regulatory fees on
companies that use Internet technology to provide long distance and other telephone services.
While traditional phone companies such as AT&T and GTE must pay so-called access fees and
universal service fees, Internet telephony companies have so far been exempt.
Concerns about the report have been reflected in the decline of stock prices among Net phone
companies, which may have to temper the pace of their development. But analysts say the
short-term decline should not deter the industry.
"There's really no reason for companies like IDT to get beaten up by
this report," said Vik Grover, a senior equity analyst covering the
telecommunications industry at Kaufman Brothers. "It's foolhardy for
the Street to think Internet telephone companies could exist perpetually
without regulation when you're talking about billions of minutes and 10
percent market share," he said, adding that he sees no reason to change
the short- and long-term buy recommendations he has made for IDT
and Level 3 Communications.
Grover cites a number of reasons for his continued confidence in
Internet telephony companies. For one thing, he and other analysts say
the real action is in the international market for Internet phone services.
For another, he said, if Internet telephony is subject to regulation, companies could avoid fees by
building their own local networks, as a number of companies are in the process of doing. Finally,
he said, regulation "could result in the reevaluation of what is a fair access fee" and ultimately bring
fees down.
Still, the report has done some short-term damage. Before it was even formally released, the
report caused several high-flying Internet telephony stocks to plunge.
Most notably, IDT dropped 25 percent early this month following rumors of the report's
recommendations. The stock price of IDT, which uses traditional phone networks and the Internet
to provide a broad range of telephone services, has dropped another 10 percent since the report
was issued.
Other phone companies embracing Net technologies, including ICG Communications, Level 3
Communications, and Qwest Communications, also experienced dramatic drops after rumors of
the report began to circulate. Qwest and Level 3 have regained some of that ground but are still
well below their 52-week highs.
IDT spokeswoman Sarah Hofstetter said there was no question that the company's stock was
affected by the report. Analysts who follow the Internet telephony market agree that the report has
brought down the share prices.
"It won't be a huge blow, but it's definitely a setback," said Francois de Repentigny, an industry
analyst with Frost & Sullivan. "It means that the prospects for rapid growth are diminished, and it
will allow incumbents like AT&T and MCI Communications to have time to catch up."
He explained that the biggest reason for businesses and consumers to choose Internet phone
services in the near future is the lower prices they offer over traditional services. If Internet phone
companies are forced to pay regulatory fees, the price of their services will certainly rise. But de
Repentigny adds that regulation will "stifle the growth of Internet telephony, but only domestically
and only in the short term."
That's because the FCC regulation won't extend to the international market, where long-term
growth of the industry is expected to be the highest. He added that enhanced Net telephony
services--such as sophisticated messaging, faxing, and wireless features--eventually will make the
technology appealing even if its prices aren't much lower than traditional phone service.
Under federal law, traditional long distance companies are required to pay access fees to the local
phone carriers on each end of every call made. That means a carrier such as Sprint, when
completing a call from San Francisco to New York, must pay Pacific Bell and Bell Atlantic
between 2-1/2 and 3 cents per minute to each.
In addition, Sprint is required to pay into a universal service fund designed to ensure that phone
service is offered even in areas such as inner cities and remote regions where the costs are high.
So far, Internet phone companies have been exempt from paying fees because they are classified
as "information services." The exemption would disappear if the FCC reclassifies the companies as
"telecommunications services"--as it suggested it might in last Friday's report.
Internet telephony takes advantage of the so-called Internet protocol, or IP, an open standard that
carries email and other traffic over the Net. Traditional phone networks require that a direct
connection be established between the caller and the receiver and remain open even during breaks
in conversation.
IP networks, by contrast, are much more efficient. They break up data into tiny packets and send
them over numerous connections. The difference not only saves money but also makes it easier to
offer enhanced features, such as videoconferencing and messaging.
As 10 percent to 25 percent of all telephone calls are projected to be made with IP within the next
few years, Wall Street has taken a keen interest in Internet telephony companies. Former parent
Peter Kiewit Sons spun off Level 3 amid strong demand for its private stock. And in the last year,
IDT's stock has skyrocketed 430 percent, while shares of National MicroSystems have more than
doubled.
In light of the FCC's report, however, companies may need to revise some of their business
strategies. If regulations "are not onerous or they are delayed, we will actively pursue IP
telephony," said Shelby Bryan, president and chief executive of ICG. "If we have horrible
regulations, we'll go do something else for a living."
He added that the Englewood, Colorado-based company is reviewing its business plan every
month and is hoping that IP telephony "will be a huge part of our business in the future."
ICG is not alone. Most other companies vying for a space in the IP telephony market provide
enough other services that regulation--should it become a reality--won't stop their momentum, said
Riyad Said, a senior analyst at Friedman Billings Ramsey.
Long distance and other phone services "are going to be a piece of this much bigger market, which
is effectively the utilization of IP-based networks to support voice and data," Said predicted. "I
don't see [the report] in any way as a death knell for these companies. These networks will
continue to be a viable and great way to handle data and voice communications."
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