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Verizon's fiber-optic payoff

Investors squawked a few years ago when Verizon said it would spend billions to take fiber to the doorstep. Now they're cheering.

CHICAGO--Wall Street analysts who doubted Verizon Communications' aggressive move to build a fiber network directly to people's doorsteps are eating crow as the company subscriber rates for its high-speed Internet and TV service fly through the roof.

At the NXTComm trade show here Wednesday, Ivan Seidenberg CEO of Verizon said the telephone company had and now has almost 500,000 Fios TV subscribers.

Verizon has been building the Fios all-fiber network throughout its territory for the past three years. The network takes fiber directly to the side of people's homes and provides near-limitless bandwidth that can be used to deliver a "triple play" of services including high-speed Internet connectivity, telephone service and TV. The company already offers Internet service that runs at 50 megabits per second. And it's testing service at 100Mpbs.

While the largest phone company in the U.S., AT&T, took what appeared to be a less risky approach to broadband-network deployment--taking fiber only into the neighborhood and using existing copper lines to deliver service to homes--Verizon's Seidenberg was adamant from the start that the all-fiber network would give the company the headroom it needed to ensure growth for the future. In 2004, when Verizon started deploying Fios, naysayers said that the budgeted $18 billion it would take to dig up streets and hang fiber from utility poles made the initiative too expensive and too risky to bear fruit.

But now these doubters are being proven wrong, say analysts.

"Seidenberg did the right thing," said Patrick Comack, an equities analyst with Zachary Investment Research. "And (Ed) Whitacre (AT&T's former CEO) got it wrong. Kudos to Seidenberg for having the courage and long-term vision."

The Fios service has transformed Verizon's business.

"Five years ago, Verizon had 1.6 million broadband customers," Seidenberg said during his keynote speech on Wednesday. "Less than 10 percent of telcom revenues came from data. Today, we have over 7 million broadband customers, hundreds of thousands of video subscribers and for the first time in a long time, consumer revenue is growing again."

Much of this growth has been fueled by the success of Fios. Subscriber rates for the service have exploded as the company ramped up deployment during the past several months. At the end of the first quarter of 2007, Verizon reported that it had signed up 864,000 Fios customers, with a penetration rate of 16 percent. And now it has hit the 1 million subscriber mark. More important, Verizon is also selling video to almost 50 percent of those subscribers.

The video factor
Seidenberg said the company now has close to half a million Fios TV subscribers, which will likely put the company at about 200,000 net additions in the second quarter of 2007. Verizon ended the first quarter with 348,000 Fios TV subscribers. These are impressive figures, says Comack.

"Adding more than 100,000 subscribers in a quarter is impressive for any industry," he said. "And Verizon is probably going to do double that this quarter. It's crazy."

Video is turning out to be the most significant element of the company's bundle. Nearly 80 percent of all Fios video subscribers sign up for the triple-play package of services. Bundles are a key element to Verizon's strategy because they help keep customers loyal to the service.

It was this package, and the promise of better and more reliable service, that attracted the Bayer family of Massapequa, N.Y., on Long Island. Rich Bayer, the father of this family of five, said he was frustrated by the quality of his voice and Internet services from cable provider Cablevision Systems. So the family switched to Verizon, becoming the 1 millionth Fios customer Verizon has signed up.

The Bayers have been using the Fios Internet, telephone and TV service for about two weeks now, and Rich Bayer says he and his family couldn't be happier with the service. They also were surprised by "extras" that were offered, such as the multiroom digital video recorder. When the Bayers had cable service they had only one DVR, in the living room.

"Monday nights always turned into a big fight," Bayer said. "This one wanted to watch 24 and someone else wanted to watch American Idol. Now they can go to their rooms and watch whatever they've recorded."

Bayer said Fios is delivering more high-definition TV channels than he had before--Verizon offers 28 HD channels, Cablevision 25--and noted that his bill for Fios is about the same as it was for cable--about $160 a month for the whole package. (Cablevision announced on Thursday, however, that it will add another 15 HD channels next week for a total of 40 channels of HD content.)

Crossing swords over bandwidth
Cablevision is by far one of Verizon's toughest competitors. The company has spent millions of dollars in the past few years upgrading its network to deliver its own triple-play of services. And its services stack up well against those offered by Verizon, with Cablevision's highest level of advertised broadband service pegged at up to 30Mbps of download capacity. It also offers a special 50Mbps service.

The top tier of Verizon Fios broadband is up to 50Mbps. As of the first quarter of 2001, Cablevision reported it had a total of 2.1 million broadband subscribers, or roughly 46 percent of the available market in its territory, which covers parts of New Jersey, New York and Connecticut.

Cablevision has also done very well winning over Verizon phone customers. Cablevision ended the first quarter with 1.3 million voice customers, attracting a third of the available telephony market in its territory

As for Rich Bayer's comments about his experience, a Cablevision spokesman discounted them as pure Verizon marketing.

"We doubt too many of the 1.3 million customers who have said goodbye to the phone company and chosen Optimum Voice (Cablevision's telephony service) would put much credence in transparent phone-company talking points delivered as part of a publicity stunt," he said.

Vince Vittore, a senior analyst with the Yankee Group, said Verizon is likely to face stiffer completion in places like New York where strong cable operators, such as Cablevision, operate.

"Verizon has been very selective about where it's been deploying service," he said. "In the early days, it went after the low-hanging fruit like Keller, Texas. The challenge now will be rolling out service in places where cable operators have been upgrading their networks."

This fierce competition reinforces how important it is for Verizon to offer a near-flawless TV experience. Verizon's executives knew that getting that experience right would be key, and that getting it right meant making sure there was enough bandwidth on the network to deliver several streams of high-definition video at once. It also meant ensuring the service was reliable and met customers' expectations.

The result was a fiber infrastructure that gives Verizon almost limitless capacity. Once the fiber is in the ground, all Verizon needs to do to upgrade the capacity is add a different set of electrical components. In fact, the company is already upgrading its network to a technology called GPON, or Gigabit passive optical network, which will quadruple the capacity. Today, Verizon offers a 50-megabit-per-second high-speed Internet service, but with GPON it will be .

Aiming for reliability
Fiber wasn't the only key technology decision Verizon made. The company also decided to combine elements of the traditional broadcast TV infrastructure with new Internet Protocol television technologies to deliver video. The result was an efficient overlay network for traditional broadcast TV and an IP infrastructure for video on demand and other interactive services.

"We knew that good quality video was going to be a significant differentiator for us," said Mark Wegleitner, Verizon's CTO. "But we also needed to get to market quickly with a product that was reliable and stable. IP certainly gives us flexibility, and we're using it for video on demand. But we didn't have time to wait for the IPTV technology to mature before we deployed."

While Wegleitner admits Verizon will eventually put all of its video over an IP infrastructure, the decision not to deploy on all-IPTV network from the start has helped the company quickly add new features and new customers.

By contrast, AT&T, which opted not to take fiber all the way to the doorstep, is constrained by how much capacity it can deliver and consequently has had to rely solely on new, unproven IP technology to deliver video.

Because IPTV has not been deployed massively yet, it is difficult to know if it will be able to support hundreds of thousands, or even millions, of simultaneous users. As a result, AT&T has been deploying slowly. Since launching the service last year, the company has signed up only about 40,000 subscribers, which includes a mix of Internet and IPTV customers.

AT&T's network is also capacity-constrained, which means it can deliver only one high-definition video stream into a home at once.

Cable's moving target
Verizon's hybrid approach has meant that the carrier has had to develop a lot of technology in-house, although in many ways that has worked to its advantage. Verizon has been able to introduce new services and features much faster than even its cable competitors. For example, Verizon has been offering multiroom DVR through Fios for almost a year. Time Warner Cable is offering that service in only a handful of markets.

Fios subscribers have had media sharing, which allows them to access on their TVs music and photos stored on their PCs, for nearly a year. Verizon has also developed other interactive elements, including Widgets, which allows people to customize weather and traffic information.

The company says more features are coming. Verizon is currently beta testing a new program guide that replaces one initially developed by Microsoft. This new software will eventually allow subscribers to access more content from their PCs including video from YouTube, podcasts, Internet radio and home videos. Eventually, users will be able to share this media with friends and family outside the home.

But while Verizon appears to be in a good competitive position, the company still has a long fight ahead of it. Cable operators have also been hard at work aggressively upgrading their networks to compete against Fios.

In May, Comcast CEO Brian Roberts demonstrated broadband download speeds of up to 100 megabits per second. New technologies such as Docsis 3.0, a high-speed data-transmission standard for cable, will help make this kind of capacity a reality. The transition from analog TV to digital broadcasting, which the government has mandated must be completed by February 17, 2009, will also help boost capacity for cable operators. Today about 60 percent of a cable operator's capacity is used to carry analog channels.

"Cable is going to unleash a tsunami of bandwidth in 2009 when analog is retired," Zachary Investment's Comack said. "Verizon will be able to compete because it has fiber. But the cable guys will crush AT&T, because they just won't be able to match them on bandwidth."