DSL

DSL Prime News Weekly: The Inside Source

Kennard calls lobbyists "black ninjas," saying, "They are very good, and they work by night." Virata buys Excess Bandwidth, some notes on per-subscriber valuation, Harvardnet arrives in Manhattan, and more.

by Dave Burstein
DSL Prime

"Every morning I check DSLReports for the latest feedback on our service. Usually, it hurts, but the complaints are accurate, if occasionally overstated." A senior provider official, obviously anonymous. DSL Reports is providing the industry an invaluable service, and must be checked by anyone interested in an ISP, whether as customer or investor. That's why we've added Justin Beech to our page of industry leaders.

David Bowie interrupted his concert last night to hold up pictures from the chat rooms at davidbowie.com, and when playing a rare selection suggested the audience record it for an MP3. Learning to change with the net is hard for us all, but Bowie has remained a star for thirty years by adapting; maybe a giant telco can learn to do the same. One thought that has stood up is J.P. Morgan's advice about the stock market. "It will fluctuate." Apologies if our discussion of the market below is too lengthy.

Bill Kennard: "Black Ninjas" create telco legislation
"They are very good, and they work by night"
"How did the access charge on IP telephony get added to the House bill?" the FCC chairman was asked at SUPERCOMM. He's becoming exceedingly candid lately, and explained how influence affects legislation. "I call them the black Ninjas. They work by night, and they are very good." Hence, without hearings or public debate, provisions sought by regulated industries are incorporated. "They've had a hundred years to learn the system, and shouldn't be underestimated." To avoid charges of being anti-telco, DSL Prime notes that while tens of millions of dollars are spent by telcos in Washington, competitors are not without resources: Kennard's predecessor, Reed Hundt, is on the board of NorthPoint and Rhythms' Jeff Blumenfeld led the government side of the AT&T break-up. Jeff Pulver lead the VOIP industry in a rally against the rule, and it presumably will be killed, although it passed the house.

Virata buys Excess Bandwidth
$315M in stock buys into symmetric DSL
G.shdsl is hot, we've previously reported, and Virata wants in. Excess Bandwidth is a Cupertino company with 50 employees, 40 of them engineers, and an SDSL PHY is their main product. Steve Dines is CEO, and they were founded in 1998 by Debajyoti Pal and Stanford Professor Thomas Kailath. Virata is doing very well. They doubled sales this quarter, have shipped 1M Helium chips, and offered 4M more shares for sale to give them a financial cushion.

They'll take Manhattan
The Bronx and Staten Island too for Harvardnet & Plan B
Harvardnet is adding 235 COs to provide complete coverage of the New York metro, with their business-centered DSL service. They have backbone from Maine to DC, and have the potential to be a major competitor to Bell Atlantic. Plan B is a new entrant, concentrating on the business districts of New York and planning 100 COs in other major cities. Transbeam and at least two other companies are installing DSLAMs in the city, adding to the six companies already in place (BA, Covad, NorthPoint, Rhythms, Comdisco/Prism, NAS).

BA — GTE deal and DSL
Strengthens competitive rules, limited service expansion
It was time to cut a deal; the companies needed to get on with their future, and Congress was pressing very hard. The key concession, of course, was that Genuity (the old BBN backbone) would have to remain outside the company until Verizon convinced the FCC that competition had a fair opportunity. Thus was extended the odd Washington game of de-regulating while maintaining authority over the telco, which was (yet again) strongly protested by Republican Commissioner Furchtgott-Ross. Numerous details of competitive behavior, including separate provisions to deliver DSL, were included. But consumer advocates, including Gene Kimmelman, were disappointed.

We would like to judge the agreement against some goals DSL Prime believes in. Competition was protected by numerous procedures, enforced by adding Genuity to the incentive of LD. But open access was not advanced; BA did not make any commitment to carry content in a non-discriminatory manner, which would require opening the edge of the network without tolls. The tariff that excludes all but a handful of ISPs from competing with BA.net was not changed. We used to call it the "AOL tariff", drastically favoring the largest provider, but we now understand its primary purpose was to give BA's subsidiary a virtually unbeatable advantage competing against independent ISPs, who are offered gross margins typically half those BA offers itself. Commissioner Ness has told us open peering (which would bring down backbone costs, currently maintained by a few major players) will be considered in the MCI-Sprint merger, but should have been required of Genuity in this deal as well.

The FCC got snookered on Universal Service
Ivan Seidenberg told a large audience months ago that BA would offer DSL to "90% of qualified lines", effectively promising more than BA agreed to in this deal. (10% low income areas, etc.) SBC, in comparison, promised universal broadband service, and BA could, and should, have done the same. Kennard calls this "regulatory arbitrage" — telling Wall Street one thing, while spending millions to persuade Washington something different. The result was some face-saving provisions that added little to consumer service. The main consumer gain is BA's promise to clean up loops under 12,000 feet; bad loops limit service to more people than distance in many areas.

Wall Street got it wrong on Friday — and right
Dumping Covad was questionable, hitting NorthPoint as well illogical
The folks on Wall Street who drove down Covad, NorthPoint, and Rhythms on Friday were clearly right — the market moved against those companies for the next few days as well. But that illustrates yet again how irrational the markets are. The move resulted from reactions to Bob Knowling's early morning conference call, an articulate and sensible explanation of the new strategy. He believes direct sales to higher margin customers (especially in smaller markets) can exist alongside wholesale sales. My guess is he's right, I'm only guessing. But he also said they would be a few thousand short of the quarterly goal, and lowered his end-of-year goal due to an honest uncertainty. A 26% shellacking was totally out of proportion, and several times the total cost of buying Bluestar.

If in fact alienating ISP customers is so greatly feared, then the logical move would be to buy NorthPoint, who officially "remains committed to DSL wholesale strategy" — that's where the customers would go. That's the sentiment on the ISP mailing list, where a typical comment is: "Boycott COVAD. Support NorthPoint!" But instead, NorthPoint was also trashed that morning, and lost 15% that day. So that left only significant one fact on the table to justify the recommendations — missing the numbers. "The market's just not that friendly anymore," was Jim Cramer's take.

Is a customer worth $30,000, $15,000,$4,100, $3,300, $1,500 $700, $200, or $0
$30,000 per subscriber was a recent, very rough estimate of the difference in stock market value implied in the relative CLEC pricing, and illustrates how out of control subscriber numbers are in explaining value. In fact, one behind the scenes reason Covad went for (some) direct sales is that competitors were paying large bounties to ISPs for delivering customers. It was a way to arbitrage Wall Street, bringing in customers with heavy "market development funds" and the like, and making it back in the rising stock price. Covad had avoided that game, and Wall Street chose to penalize them. $15,000 in market value for each subscriber dropped from the estimates. Ironically, the estimates appear to be deliberately low, so that Covad has a good chance of giving the Street positive surprises in the future, as Microsoft traditionally has. A Vice President - Equity Research at a major brokerage agreed "these numbers are being watched WAY too closely."

$4,100 is a crucial number for telco planning, representing what AT&T spent per customer on Media One. $3,300 was AT&T's latest bid for wireless customers. AT&T may have overpaid, but they suggest how much a customer is worth. Similarly, losing a customer is a similar sized cost to a telco's future, and belongs in all planning for services that can retain your customer, such as DSL. Sol Trujillo recognized this, and invested in VDSL in Phoenix. The other Bells (and presumably Joe Nacchio) ignore this, burying their head in the sand and assuming that AT&T or other competitors will not take away customers if telcos don't invest in their network. Instead, they blanch at spending even $1,500 per customer for advanced services, roughly the volume cost of VDSL or FTTC, because they are looking at only direct return on investment (using a high hurdle rate) and not the future of the customer. (There is a deep question here about whether the ILECs are underinvesting in their future in order to prop up short-term profits, but that's another essay.)

$700 is a low estimate for what the CLECs have been spending for each customer. It finances free equipment, giveaway service, free installs, and much of the ISP advertising that has taught the market to look for DSL. This number is much higher than the $200 or so in most original marketing plans, and explains much of the financial stress on the industry. It currently is disguising a real drop in prices, spending upfront rather than lowering the monthly fee. But with Bell Atlantic due to join BellSouth's $40/month price (and make similar deals for small business), the price is due to plummet. That's great for consumers, but one reason $0 (or less) is the likely profit of DSL providers for the next few years. This is a game for the long-haul, when value-add services and voice (and video?) kick in.

More expensive financing will become a problem
Most DSL providers will need to go to market for more financing sometime in 2001, and they will probably find the cost has gone up. Junk bonds in general are more expensive to issue (an extra 100-125 basis points over treasuries) and the decline in the stock adds to the risk. Most financing to date has included a reserve for the first few years interest, but the cumulative cost of borrowing will be an increasing burden over time, and keep profits even further away.

Some problems are real — but they were just as real last Tuesday
DSL is a wonderful technology with a great future. But that doesn't mean any given company will make it, and in particular on the provider side, competition is becoming fierce. Many net stocks are still high by any traditional measure of value or profit. I had an interesting exchange for several hours last Wednesday with two respected analysts, who were surprised I wasn't a raging bull on the industry I cover. The challenges in the industry should be obvious to anyone who reads this newsletter. But they didn't suddenly become true Friday morning, nor rationally explain the drop.

Don't look to DSL Prime for market advice
All that said, Friday morning market doomsters may have made the right call, knowing their peers would overplay the numbers. It's at least as likely it was a self-fulfilling prophecy, that Merrill Lynch and other commentators drove down the market by their letters. That's why we urge you not to take our comments for market advice. The more we learn, the more we see the randomness of the markets, the madness of crowds, and the utility of a dartboard in picking stocks. We wish we knew how to make a fortune stock-picking, but haven't found the formula. We're happy to exchange information about companies with financial analysts, but not to predict the market. Ironically, no matter how much we say that, the more Wall Streeters subscribe and call us up.

Is Covad smart to back away from residential?
Implicit in seeking higher average selling points is emphasizing business rather than residential customers, and that is reflected in his projection of lower numbers but similar revenues. Until the press conference, Covad, the early leader among the CLECs in home DSL, was expected to push hard as line-sharing drives down costs. Prices are coming down (look for Bell Atlantic to match BellSouth's $39.95), and NorthPoint and Rhythms, Bob acknowledged, are becoming more effective competitors. So it looks like Covad will go slow this year, although his 2001 projections suggest they will make up for it next.

In-box

• Derek Williams of Yes Television wrote they are in trials of video delivery with both British Telecom and Kingston in the UK. They are looking for US partners, but need a network designed to deliver video speeds in the megabytes, which few in the States are prepared to do.
• Mike Borsetti wrote a while back questioning our estimates of growth of bandwidth demand. We had referenced AT&T and MCI that the internet backbone demand was doubling every four months, which would give a 64x growth in two years. He pointed out that much of that growth was new users, and wondered how we factored that in. We know how hard it is to predict the future, but suggested such a growth in demand was likely in three or four years. That would raise current peak demand from about 30K/subscriber to 2 meg, more than coincidentally a realistic video rate. We therefore suggested measuring a DSL system by how many 2 meg, non-blocked, streams it can carry (recognizing that multicasting and local intelligence also play a part.) Such dramatic increase in usage seems to us likely, but few networks are designed for such growth. We are very interested in hearing (on or off-the-record) from network engineers who have been monitoring the growth in demand in the real world and can shed light on actual trends.

Briefs

• US West has been a leader in their DSL offerings but a laggard in covering the smaller towns in their territory. They just announced 30 more cities, without suggesting how close that would be to serving all their customers, cleaning up lines, or reaching out with DLCs. They just got merger approval from Washington, and we hope when the merger is finalized they will move forward. Now that JATO has stood aside, they need a strong regional competitor, comparable to Vitts in New England, which has connected nearly every CO in New Hampshire and Vermont, as well as parts of Mass and New York.
• The Texas ISP Association has reached a tentative agreement with SBC for dramatically different terms of the ISP DSL sales agreement. Till we have more details, we're holding off on an article about the ILEC/ISP struggle, made even more timely by Covad's moves. Details expected at a Dallas meeting July 6.
• 3Com jumped into ethernet over VDSL for the building market.
• DSL.net's investment in Live Vault continues their transformation from a provider of standard services into a resource for customers. Live Vault will offer secure on-line backup, while other deals they have made include ADP for payroll services. They just reached 300 cities in their original 2nd tier strategy, but also are becoming active resellers, judging by the four direct mail pieces we've received from them in Manhattan.
• Nightfire won Arrival as an early customer for its service bureau, hosting loop qualification and on-line ordering for the new CLEC Arrival. "Swami" Swaminathan briefed us on eSupplierExpress, which he believes will build a base of hosted customers who will look to Nightfire to maintain the ever-changing business rules of the many companies involved.
• 300 Nextel workers are ready to file suit for employment discrimination, seeking damages well above Texaco's $165M. SBC, Bell Atlantic, and others have vigorous programs in place, but many smaller companies haven't stopped to look at the practices of their field staff and contractors. Discrimination is bad business, but not uncommon in our society. Make sure you never face a suit like this because of careless procedures.
• New Edge opened its 200th CO. They look to be the leading national wholesaler of DSL in smaller cities, and have plans to grow very fast.
• Juno is working with AT&T to test open access to cable modems.
• mPhase turned up the first 12 beta customers for video, voice and data at Hart Telephone in Hartwell, Georgia.
• NorthPoint, GTE, and 19 manufacturers created the G.lite Working Group to promote that standard.
• The FCC Technological Advisory Board meeting on June 28 will include on the agenda "Current technological trends in telecommunications services, including changes that might decrease, rather than increase, the accessibility of telecommunications services by persons with disabilities." Dave Farber, on leave from the University of Pennsylvania, leads the Board.

Chips

• Analog Devices announced their chips would include Aware's VeDSL that transports voice traffic over the copper loop within the ADSL data stream. Because VeDSL avoids the use of ATM or IP to carry voice, the complexity and cost is reduced. This is an alternative to voice gateways, especially for telcos with switches in place.
• Virata released Magnesium, a Texas Instrument DSP chip combined with Virata software, offering echo correction, voice encoding, and other functions for Voice over DSL. It's combined with other Virata chips as Azurite.

International

• Efficient announced the sale of routers to Tokyo Metallic. Last week we reported Japan is opening, and look for a rush to supply equipment. AT&T Excite is working with Jupiter Cable to beat DSL to market.
• AsiaInfo and Redback will work to co-ordinate subscriber management with billing and other services for China. (DSL Prime has very limited info on developments in China, and would very much appreciate being forwarded information and news articles.)
• KPNQwest is launching ADSL in Geneva and Zurich, and plans to expand nationwide now that the market is open to competition. They've turned on their first customers in Germany.
• At VON Europe 2000, General Bandwidth demonstrated a Voice over DSL gateway compliant with European standards.
• Cable & Wireless Optus, key Australian CLEC/ISP, will use Lucent to build a national DSL net.

Deals

• Disney Interactive will be supplying a channel for PlayNow, which distributes through NorthPoint & US West, as well as cable companies. Trials are also underway with Bell Atlantic. Cox and MSDW just lead a $36M funding round.
• Concurrent Computer sold two MediaHawk Video Servers to Shanghai SinceTech for video on demand.
• Orckit won at least part of the contract for DSLAMs from Sweden Telia, which also works with Nokia. How did Ericsson give way at the Swedish telco?
• Alltel ordered $105M of AFC DLCs.

Stock Market

• Accesslan raised $35M from BancBoston Ventures, Accel, Sequoia Capital and others. They count Network Plus as one of the largest VoDSL installations on the market, and Edge Networks is installing iSlams in buildings in Atlanta and New York.
• US West invested in Time Domain, whose Ultra Wideband technology is an alternative to DSL.
• Compaq, Intel and Microsoft agreed to invest $45 million in Digital Island, an edge server company with ties to America On Line. $50M of Compaq servers will be used to stream audio and video in Windows Media Format.
• 3Com invested $20M in CAIS and will co-market equipment for the MTU market.
• Gabriel and Trivergent look to merge.
• The Supreme Court will hear GTE's challenge of the FCC's cost rules based on "forward-looking" costs, which reduces the base used by the ILECs to calculate rates, a crucial cost factor.

People

• Dan Foster, recently lured from Rhythms to Phoenix Networks to be CEO, has also displaced founder Pete Roberts as President. Roberts, who has a clear vision of delivering quality and advanced highspeed services, will now be a consultant.
• George Kerns left GTE/BBN to become COO of Harvardnet.
• VersaPoint in Amsterdam hired Robert van Maasakker as CFO and Mittu Sridhara as CIO.
• Nina Eigerman now senior vice president of Digital Services at Darwin.
• NHC appointed Kenneth Hovaldt EVP, Sales and Marketing as the test vendor looks to come to market.
• Charles Lenis is now VP sales at Pixstream.
• Norbert Dawalibi left IBM to be President and CEO of Rhythms Canada.

Copyright 2000 Dave Burstein. The DSL Prime Newsletter is reprinted with permission.

"The power of the printing press belongs solely to those who own the presses" —A.J. Leibling
The Internet is the cheapest printing press ever invented.

 —End