Om Malik writes:
Over the past two years, a new alternative to this last mile connection has emerged. This is the cable television network. The cable networks had long been dismissed as a clunky patchwork of disparate networks, of not much value except for beaming channels selling baubles and trinkets. In past five years cable companies have spent billions of dollars upgrading their networks for two-way communications, and thus becoming a viable option to phone companies copper connections.
This new last mile connection comes with high-speed Internet, which makes it possible to make phone calls over the Internet, cheaply. This is a marked shift from the traditional way of making phone calls. For nearly a century, when a phone call was made, a virtual circuit was created between the caller and the recipient. Expensive switches and other gear that cost tens of millions of dollars helped create these virtual circuits. Technologists have figured out a way to send the same voice traffic over the open Internet.
Powerful computers running a specialized piece of software that can do precisely the same thing for a few thousand dollars have replaced the old multi-million dollar switches. (This has already devastated two major switch makers, Lucent Technologies and Nortel Networks, which have seen a sharp decline in revenues and have let go thousands of employees.)
With a few thousand dollars, any one can set up a phone company, and go into the business of offering phone service. This has created a situation not so different from the early days of commercial Internet, when mom-and-pop service providers sprouted up all over the United States. There are dozens of these voice service providers, who are offering unlimited phone calls for as little as $20 a month. With nearly 33 million high-speed connections in America, it certainly is a big enough market.
What we are witnessing is commoditization of the only communications service that makes money: voice calls. As a result you have lots of large companies (and some small companies) with mostly unsustainable financial structure of the incumbents in a declining business, with massive and overwhelming fixed costs on their balance sheets. This is putting pressure on the ability of these companies to raise money from the debt markets, and is forcing them to cut costs mainly through continued lay-offs.
The next five years are going to be even more painful for the telecom industry, which will see its revenues shrink, and its suppliers vanish. This painful restructuring will eventually end with fewer and mostly likely with new players. Telecommunications adds up to a substantial portion of the US economy, and its continued troubles dont bode too well for the future.
If you thought the communications business was brutally competitive, the Darwinian winnowing is just getting started. As the telephone, cable and satellite companies elbow their way into one another’s turf, prices will decline and companies will fail to meet their growth targets.
Welcome to the world of Susan Kalla, a senior telecom analyst at Friedman Billings Ramsey Group, whom we dubbed Dr. Doom three years ago (“Sell, She Said,” March 12, 2001).
She earned that moniker by slapping Underperform ratings on the telecom-equipment stocks she covered, a shocking move in the era before Sell recommendations came into vogue. Kalla came to her conclusion by polling the service providers to determine their demand for telecom equipment instead of heeding the rosy forecasts of CEOs. Investors who heeded those warnings were spared the agony of watching the equipment providers’ stocks shrivel to single digits.
Now she has broadened her scope to the entire communications industry — telecommunications, cable and satellite — and concluded that revenues will rise by less than 1% annually, to $274 billion by 2006. That’s far from the 4% annual growth the industry is promising.
The $17 billion shortfall means the industry has committed to too much capital spending and its bottom line will suffer. Shares of telecom players could fall 15% annually as competition heats up. The cable companies, which have higher debt levels and trade at loftier multiples, could face even greater risk.
“Everyone knows there’s going to be a war, but they don’t know the war is going to be this bad,” she states.
The cable and telecom markets, once clearly defined and with high barriers to entry, have started to merge into one giant, commoditized market. Regulatory hurdles have fallen in tandem with the price of equipment. So instead of having six competitors in the cable market and six competitors in telecom, there will be 12 companies going head to head. And each competitor will offer the same package of video, Internet and telecom services. “Bundle is a euphemism for discount,” she warns.