Top Stories: Internet Telephony: Reality Will Have a Tough Time Living Up to the Dream
[ASND reference]
By Kevin Petrie
Staff Reporter
4/28/98 1:56 PM ET
thestreet.com
Editor's note: This is the first in a four-part series outlining
the brewing business of Internet telephony. Plenty of
companies are making big bets on this much-hyped
market as a path for future growth. Part two of the series,
which will run Wednesday, examines the battle between
giants Cisco and Lucent for dominance. In part three, on
Thursday, we'll look at the companies that build the
"gateways" to the Internet. And we'll wrap up Friday with
part four, which examines prospects for the companies that
make gateway components. If you have comments on this
series, please send them to letters@thestreet.com.
It's an intoxicating vision.
People around the world will ring up colleagues and send
faxes via boxes tied to the Internet, bypassing conventional
phone service and saving big bucks using a technology
called Internet telephony. Sure, the equipment market may
be tiny now -- less than $250 million -- but the potential is
huge.
Networker 3Com (COMS:Nasdaq) estimates that
corporations will spend $8 billion to $15 billion annually on
Internet Protocol telephony, called IP, likely the dominant
flavor of Internet telephony. That figure equates to about
one-third of the data networking market today. Even a more
conservative estimate, this one from analyst Francois de
Repentigny at research firm Frost & Sullivan, projects a
$3.2 billion market in 2002.
Those who buy into the vision see Cisco (CSCO:Nasdaq)
keeping its blistering growth alive by branching from strict
data systems into Internet telephony, or running traditional
voice or fax services over data systems. The overall
networking industry, after its core market has slowed
slightly, will gain another engine for growth.
Led by giant Lucent (LU:NYSE), the slow-growth
phone-gear market also will find another leg, the story
goes. Meanwhile, a host of innovative companies such as
VocalTec (VOCLF:Nasdaq) and NetSpeak
(NSPK:Nasdaq) will thrive building telephone gateways to
the Internet along with related products. Dialogic
(DLGC:Nasdaq) and Natural Microsystems
(NMSS:Nasdaq) will make loads of money supplying
gateway components.
Wall Street, awash in cash, is drinking in this vision,
figuring somewhere in this new world called Internet
telephony waits the next Intel (INTC:Nasdaq).
But evidence is mounting that this dream will crystallize at
a slower rate than investors first thought when it emerged
in the last year or so. A few early birds are testing the
technology, but it's awfully tough to find corporate
customers -- likely the bulk of the market -- committing to
Internet telephony. Quality remains spotty, which means
the early draws will be cost savings and faxing, which is
more tolerant of delays. Phone carriers are considering
with characteristic caution the enormous task of upgrading
to a new, reliable infrastructure. And don't forget, the
Federal Communications Commission might levy a
"universal service" charge on Internet calls and diminish the
cost advantage for U.S. customers. Longer-term the
marketing pitch must center on the advantage of customer
call centers and broad network integration, a tougher sale
than simple cost savings per minute.
Cisco and Lucent, each a titan in its field, are leading their
peers into a bruising battle for the networks of the 21st
century. Only one leader is likely to emerge. Gateway
companies, including NetSpeak and VocalTec, have
created a commodity business that the large players
intend to steal.
There is one group of startups in the market that looks
better positioned to thrive solo -- the gateway-component
vendors, Dialogic and Natural Microsystems in particular.
Their expertise and "arms dealer" status might just shield
them from the big guys.
How Internet Telephony Works
Most major networkers --
Cisco, Ascend, 3Com,
Bay Networks and others
-- are revamping their
routers and other data
products to handle
digitized packets of voice
and fax traffic.
Inter-Tel, VocalTec,
Lucent, NetSpeak and
Northern Telecom are
major suppliers of
gateways. Cisco and
Ascend have products
that act as gateways.
Sources: NationsBanc Montgomery Securities, PITA Group
What compounds the risk for some of these companies is
that most of their stocks already are richly valued. Cisco
and Lucent are brushing record highs -- not because of
Internet telephony, but if they stumble in this market it still
could dent their market values. Asia's recent slide is
instructive: In real terms the region represented a small
part of U.S. sales but was huge in terms of potential
growth. So when economies there wallowed, investors sold
the stocks of U.S. exporters to the region. Many gateway
and other small players have soared on the promise of
Internet telephony.
"I think that hype might be ahead of reality" because
deployment will proceed slowly, says analyst Bill Rabin at
J.P. Morgan. "The truth is that nobody has a clue how this
market is going to develop." The potential, however, is just
so huge that no one can afford to let the train pass them
by.
The new carrier Qwest (QWST:Nasdaq) is an example of a
company that is preceded by its reputation. Shares of
Qwest have soared on Wall Street enthusiasm about its
plan to run voice and data across a network based entirely
on Internet Protocol. But so far the company has made
most of its money renting network space to carriers like
Frontier (FRNT:Nasdaq) and GTE (GTE:NYSE) for
conventional services.
"This revolution, like most that are inspired by technology,
will take time," says an article published in January in
Business Communications Review. In it, a BCR survey
showed 59% of corporate customers expect to run only 5%
or less of their internal phone calls on IP. Another 28%
expect to make no calls using IP in the next three years.
The key for vendors will be to find early adopters -- fully
30% of respondents think 10% or more of their internal
voice calls might run through IP.
Analyst Sam Kim at Amerindo Advisers says that IP
telephony will develop slowly because it still cannot
guarantee the service reliability that carriers need. His fund
once owned shares of Cisco and Ascend (ASND:Nasdaq),
but currently it owns no stock with a stake in Internet
telephony.
"If somebody can solve that quality of service problem with
IP, we'll look at it very carefully," Kim says. Do any
candidates come to mind? "No, sadly."
So what will drive the growth? Proponents have long argued
that the Internet phone business is a play for the next
century -- not immediate explosive returns. Rather, fax
service, e-commerce (for example, connecting Web surfers
to customer call centers), call-filtering features and the
broader advantages of network integration will gradually lure
the masses.
But de Repentigny at Frost & Sullivan sees little support
among customers, at least for now. "Corporations are not
demanding it at all, in Cisco's case particularly," he says.
He does find it a natural evolution for Cisco to make, and a
somewhat halting one for Lucent and Northern Telecom
(NT:NYSE), an Ontario-based supplier of phone gear and
rival of Lucent.
Phone carriers will purchase this gear cautiously, and use
the trillion-dollar infrastructure that's already in the ground.
"They're all trying to leverage what they currently have,"
says Craig Johnson, principal of the PITA Group, a
consulting firm for purchasers of technology. "You do not
throw things away."
All of which in the end may sober up the true believers.
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