As many have noted before, this company is playing for keeps with network construction. Regardless of the IPO value, the fundamental business is also driving future shareholder value.
Lead story from Internet Telephony mentions SBC:
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Cover Story
April 5, 1999
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Grab it fast
As the world market opens, a new breed of carriers rushes to cash in
JOAN ENGEBRETSON
Like gunpowder and flint, wave division multiplexing and telecom deregulation are a powerful combination. Thanks to technology advances such as WDM, the cost structure of delivering communications services is changing dramatically--and numerous new companies are hoping they'll have an edge by bringing those advances to newly opened markets.
The flurry of network construction is not confined to the domestic market. Several companies, including Primus Communications and Star Telecommunications, are finding new opportunities by building their own networks in key foreign markets. Supporting their business plans are companies such as Global Crossing and Viatel that have begun to lay high-speed fiber to connect countries within a continent or interconnect multiple continents.
Companies like Primus and Star initially focused on obtaining the best rates for U.S. customers to other countries through "creative" interconnection agreements--an opportunity that is still viable for calls to the most heavily regulated countries. But as markets have begun to deregulate, the new focus is on serving international callers in the United States and in foreign countries that have opened their markets.
The term "competitive international carrier" is often used to describe companies such as Primus, Star and Viatel that target retail and carrier customers in domestic and foreign markets. Other companies in this category include IDT Corp., World xChange, RSL Communications and Pacific Gateway Exchange.
What unites all these companies is their trans-national focus--a focus that traditional long-distance carriers increasingly may need to adopt to remain competitive. As SBC Communications' plans for its "national local" strategy reveal, the opportunities for local exchange carriers could be even better.
It is certainly no coincidence that Boston, Miami and Seattle, the first three new local markets that SBC plans to serve, have some of the highest volumes of overseas calling in the U.S.--an untapped new market for SBC whenever it obtains long-distance approval.
From arbitrage to hard assets
As advances such as WDM have caused transmission costs to plummet, virtually all carriers have shared in the cost savings. Today, the transmission cost of an international call is not much higher than the transmission cost for a domestic call (Figure 1). Termination fees, however, are typically higher for an international call.
Such fees, which now represent the biggest cost component of international calls from the U.S., are paid to a foreign carrier for connecting a call to an end user in its country. The highest termination fees are to countries where the settlement system still prevails.
Under that system, a carrier in Country A establishes a co-owned circuit with a carrier in Country B. The carrier in Country A agrees to send a certain percentage of its Country B-bound calls to the other carrier and vice-versa. The two carriers also agree on a per-minute charge for terminating each other's calls. If the carriers send equal amounts of traffic, these per-minute charges cancel each other out. With few exceptions, however, U.S. carriers send more traffic to other countries than they receive, which means only they pay out (Table 1).
Recognizing this, many foreign carriers have insisted on inflated per-call charges, which they claim support network upgrades. U.S. companies, however, often question whether these funds are used as intended (Telephony, Oct. 5, 1998, page 62).
The earliest competitive international carriers built a business on bypassing the international settlement system, often by establishing an interconnection agreement with an alternative carrier in another country. Cellular carriers, for example, can deliver a call anywhere in a country, but they may not be governed by the settlement system and may be willing to accept lower termination fees.
With this kind of arrangement, the competitive international carrier typically does not transport any return traffic. But the savings often make up for that. "There's more margin in one-way termination than with the reciprocal traffic you'd get with an operating agreement," says a Star spokesman.
And sometimes competitive international carriers can pick up business from their foreign partners to third-party countries where settlement rates are high.
Yousef Javadi, chief operating officer of Primus, cites the example of India, which only has direct connections to certain countries. For connections to many other countries, the Indian carrier goes through BT. "When we go in, now they have a choice," says Javadi.
Competitive international carriers traditionally have had some retail customers--Pacific Gateway Exchange, for example, leverages its competitive rates to the Philippines through its PinTouch program that targets Filipino immigrants to the U.S.
But for most of these companies, the emphasis has been on selling to other carriers (Figure 2). Established long-distance carriers such as AT&T, MCI WorldCom and Sprint often use competitive international carriers to connect calls to the least open countries. Typically, the larger interexchange carriers are reluctant to establish their own creative interconnection agreements.
"It's very hard for them to go into a country and set up shop when they're a partner [with the PTT]," says Javadi.
However, since Jan. 1, 1998, carriers have had another way of minimizing termination fees. That's when a World Trade Organization treaty went into effect, setting the stage for carriers to deliver service using switches and fiber installed outside their home country. Currently, more than 20 countries, including many of those that have the highest international call volumes, allow foreign carriers to do this (Table 2). Other countries have agreed to open their networks in the future.
By owning facilities at both ends of an international call, a carrier can dramatically reduce its termination fees (Figure 3). The farther a competitive carrier extends its network into a foreign country, the less it must rely on the foreign carrier's network--and the less it pays the foreign carrier.
Javadi offers a cost comparison based on Primus' experience in Germany. The conventional settlement rate from the U.S. to Germany is still between 8¢ and 10¢, but because Primus has facilities in Germany, it never pays more than 5¢ in termination fees. For calls to Frankfurt, where Primus has a network presence, the company pays only 2¢ in termination fees--and within a certain distance of Frankfurt, it pays 4¢.
Those economics are making the competitive international carrier market more capital-intensive. Traditionally, the infrastructure investment for most of these carriers was relatively low. Each carrier typically had a few gateway switches and a backbone in the U.S., with points of presence (POPs) in the metropolitan areas that generate the highest volume of international calls. Assets outside the U.S. traditionally included leased lines into foreign countries and perhaps more important, agreements with alternative foreign carriers. Today, though, competitive international carriers are looking more like traditional telcos. At a minimum, most have invested in gateway switches, which they have installed overseas. And to minimize the termination fees they must pay, most carriers also have purchased fiber routes within target foreign markets.
"By investing the minimum amount of capital--putting in gateway switches--these carriers realized at some point they would hit a wall," says Robert Pomeroy, vice president of research for financial firm Credit Suisse/First Boston. "They're all talking about dramatically stepping up their facilities investment." He cites the example of Star, which allocated $150 million to capital investment in 1998, compared with $15 million in 1997.
The changes that have coincided with the opening of telecom markets are both good and bad news for competitive international carriers.
The bad news is that there is little to stop any of the dominant domestic IXCs from establishing their own network in the most open countries and gaining the same--or even better--cost advantage as the alternative carriers. MCI WorldCom, for example, already is building a European network; and AT&T, through a joint venture with BT, hopes to achieve better termination rates by leveraging its partner's facilities. Last month, BT launched a pan-European network interconnecting six countries (Telephony, March 29, page 30).
Of course, competitive international carriers will still have an opportunity to handle the overflow traffic of the biggest IXCs or to serve the smallest domestic IXCs that have no international facilities. But the days of the dominant IXCs preferring to connect calls through competitive international carriers because they cannot make their own creative agreements may be on the wane.
Pomeroy sums it up: "This has shifted to a more capital-intensive business that demands these carriers reduce their reliance on wholesale."
Fortunately, as telecom markets become more open, competitive international carriers have the ability to do just that. With their own networks in other countries, they now can pull traffic back to the U.S.--and to other international destinations--from new business and residential customers in these foreign countries.
Some have likened many of these foreign markets to the U.S. in the 1980s when competition first began to appear in the long-distance market.
"In the U.S. today we're all jaded, and we hang up on the phone calls we get from various marketers all the time," says Pomeroy. "In Germany, the situation is different. People are very receptive to a competitive pitch [because] they've been paying too much."
In these newly opened markets, competitive international carriers can be especially attractive to customers who make a lot of international calls.
Toby Dingemans, senior associate for Broadview, points to RSL Communications as one company that is using this approach. "Their strategy has been to build up a domestic network in other countries and to be very competitive in offering international service there. They're trying to be a domestic player in a market and leverage their international backbone," he says.
Myriad strategies
Competitive international carriers that originally emphasized a wholesale strategy based on creative termination agreements--including Primus, IDT, Star and Pacific Gateway Exchange--have recognized that they must invest more in infrastructure and build up their retail base. But each seems to be using its own unique approach to achieve those goals.
Primus Communications has installed switches in seven countries--Australia, Canada, France, Germany, Japan, the United Kingdom and the U.S. It plans to add five more countries, mostly in Europe, says Javadi. Primus' U.S., Canadian and Australian networks are quite extensive, with multiple switches and POPs in each. According to Javadi the carrier can originate and terminate traffic throughout 85% of Canada and 95% of Australia.
In Canada, the U.S. and Australia, Primus typically has become a customer's presubscribed interexchange carrier (PIC), handling domestic long-distance calls as well as international traffic. Most foreign countries have not established a PIC system, but in the more open countries, callers often can dial an access code to place a call through a competitive international carrier.
Primus' international network and its interconnection agreements with more than 30 other countries--a number it plans to increase to more than 40--are a selling point in attracting retail customers in newly opened markets.
"The typical international ethnic customer isn't just interested in calling his birthplace," says Javadi. "He typically has a big calling community in four countries--the U.S., Canada, the U.K. and Australia." Primus has been popular with the growing Indian immigrant population in all four markets, says Javadi. "They are attracted not only by rates to their homeland, but we can offer great value to other places."
Currently, Primus receives about 60% of its revenue from retail customers and 40% from its wholesale business (Figure 4).
"We really are a retail company," says Javadi. "We have in excess of 300,000 customers. But because we have a network, we're open to sell capacity to other carriers. Long-term, our plan is to keep wholesale at roughly one-third of the overall mix."
Star Telecommunications' international reach is similar to that of Primus. Star has interconnection agreements in 42 countries and has built networks in several markets. "The countries we've picked are the ones most U.S. calls go to," a company spokesman says.
To extend its reach domestically, Star has purchased 20% of PaeTec Communications, a competitive local exchange carrier that is building local networks in U.S. cities that generate a high volume of international traffic. Star also has purchased one of the nation's largest calling card carriers, PT-1 Communications, and will use PaeTec's network to support those customers (Telephony, Feb. 1, page 72).
Like Primus and Star, IDT has begun to install facilities in the most open international markets--but it plans to minimize that investment through a network architecture that makes extensive use of backhaul facilities.
As transport prices have plummeted, such a strategy is feasible, says Geoffrey Rochwarger, IDT's senior vice president of telecom. "When you break costs down in minutes, it often makes sense to backhaul the traffic," he says. "It's not necessary to buy multiple million-dollar switches to put in a country to bring minutes in and out. We're finding three or four countries where we're currently deploying gateway switches that should adequately cover the world."
IDT also has found prepaid calling card platforms to be an economical method of drawing minutes out of a country, Rochwarger says. Where possible, IDT partners with a foreign telco in establishing the platform. In some countries, IDT also has established platforms for delivering voice over Internet protocol.
Unlike many competitive international carriers, World xChange never pursued creative termination agreements. Instead, it focuses only on countries that allow foreign carriers to build within their borders. The carrier currently operates in several western European countries, as well as in Australia, Canada, Chile, Guatemala, Japan and New Zealand.
The company minimizes its initial investment by installing a PC-based switch in each foreign country it plans to serve, then upgrading to a conventional telco switch when traffic builds to a certain level.
"In Australia we've been doing $70 million on the back of a PC-based switch, and we're now installing Siemens switches," says Chris Bantoft, World xChange president and CEO.
World xChange often builds deep into a country. It has POPs in most of the 60 terminating regions in Australia and plans to have POPs in each of 20 switching zones in France. A terminating region or switching zone is similar to a LATA in the U.S.
World xChange also has an extensive domestic network. A 35,000-mile backbone provides access to every LATA.
Commercial customers, which account for as much as 40% of World xChange's business in some markets, connect to the closest POP through a dedicated line. Customers set up their PBXs to send traffic to World xChange only for countries that the carrier serves.
Retail customers dial an access code to reach World xChange. Even in the U.S., World xChange prefers a dial-around strategy, rather than requiring customers to designate the company as their PIC.
Crossing borders
While Primus, IDT and World xChange have focused on building out networks within a country, several other carriers--including Viatel and RSL Communications--are focusing on building networks that will interconnect multiple European countries.
Viatel, which began as an international callback carrier, wants to be able to offer seamless cross-border voice and data connections to small and medium-sized businesses that, in the past, had to deal with multiple PTTs and inflated pricing.
"We're building the network for ourselves, but we can also sell extra capacity to other carriers," says a Viatel spokesman.
That extra capacity ultimately may help Viatel expand its U.S. network, which currently consists of just a single gateway switch in New York. That effectively limits the carrier's U.S. retail business to the New York area. Viatel hopes to swap some of its pan-European capacity with one of the carriers that operates a fiber network in the U.S., the Viatel spokesman says.
Viatel's stock has been trading at a premium compared with other competitive international carriers because it has a "first-to-market" advantage, says Credit Suisse's Pomeroy: "Its network is a unique strategic asset that the market values," he says.
RSL Communications' stock also has been trading at a premium, Pomeroy says. Although representatives of RSL did not respond to multiple requests for an interview, a recent report by Warburg Dillon Read points out that RSL has been one of the most successful of the competitive international carriers in reducing its reliance on wholesale. The carrier market now accounts for only 25% of RSL's total revenues, compared with 75% two years ago, according to Warburg Dillon Read.
Most competitive international carriers have long-term leases on trans-Atlantic or trans-Pacific circuits. But one carrier, Pacific Gateway Exchange, hopes undersea fiber will be a cornerstone of its business.
The company, which has built in eight countries and has interconnection agreements in several dozen more, also has invested $200 million in trans-oceanic cables.
"There's a tremendous advantage in having ownership," says Pomeroy. "The cost for capacity is sometimes one-tenth of what you might pay as a non-signatory."
Pacific Gateway Exchange's fiber investment serves several purposes, says Howard Neckowitz, chairman, president and CEO. It increases gross margins, supports a wholesale business to other carriers and enables Pacific Gateway Exchange to swap capacity to extend its geographic reach. The company also hopes to use its wide bandwidth to support bursty applications and is working with several partners to develop new services that will use more bandwidth.
Pacific Gateway Exchange plans to help create cyber-hotels--similar to Internet peering points--to which customers will connect high-bandwidth pipes to support applications such as international videoconferencing.
"Where now customers meet us at [gateway switching points at] 1 Wilshire and 60 Hudson Street, they'll meet us at 70 cyberhotels," says Neckowitz.
Some have argued that it's difficult to go wrong building telecom capacity. As the Internet continues to grow and as the price of voice calls continues to drop, proponents argue that extra bandwidth--particularly in a newly opened market--will not go to waste.
"Competition usually is associated with a very significant increase in volume," says Broadview's Dingemans. "In the U.S., long-distance prices have dropped massively, but total revenues have grown."
Competitive carriers eventually may find that they are in demand from another quarter. Whenever the Bell companies are allowed into long-distance, they too will want the benefits that a facilities-based approach can bring--and rather than build international networks from scratch, they may prefer to acquire a competitive international carrier that already has done much of the work.
Regards,
Jeff |
