The Redmond, Washington-based company today said it will take a 1.33 percent stake in Qwest Communications, as both companies delve deeper into electronic commerce, Web hosting, and other mission-critical business software applications and services.
The terms of the deal call for Microsoft to purchase $200 million worth of Qwest's common stock at $45 per share.
The deal has significant strategic implications for Microsoft and Qwest. In the near term, Qwest will be able to harness demand for data solutions from small to mid-sized companies that have been squeezed out by the cost of bandwidth, according to Mark Langner, a telecommunications services analyst with investment bank Hambrecht & Quist.
"It's all about commercial data solutions for customers," Langner said. "Customers are asking, 'How can you help me to use data to save me money, or make me money in my business?' That is the key to making money in the communications business going forward."
Thomas Friedberg, an analyst at Janco Partners, sees longer-term value in the deal. "This is basically about the achievement of a strategic vision," he said. "I am not sure there are going to be huge tangible benefits in the next year or so."
Qwest's quest for dollars and dominance
Qwest has been on a mission, cutting one deal after another, as the youthful long distance carrier focuses on building the biggest packet-switched network the industry has ever seen. Qwest expects data traffic to eventually account for the majority of the transmissions on its 18,449 miles of fiber, or about two-thirds of the traffic by the year 2000.
The telco has previously noted that building a network is not a profit-making venture--but that selling services on a network is.
So far, Qwest has mostly been building its massive new network, making money by selling capacity on its unused portions to fund its continued construction. In addition, the company recently teamed with Dutch telecommunications company KPN to expand its services into Europe.
Yet analysts have warned that emerging telecommunications carriers such as Qwest and competitors Frontier, Williams Communications, IXC Communications, and Level 3 Communications, must do more than just provide wholesale long distance minutes to larger carriers.
These smaller carriers will be squeezed by falling profits on voice calls unless they can get into higher profit data services, analysts have said.
Indeed, Microsoft and Qwest hope to generate revenues with this investment by giving businesses a high-speed network service that maximizes resources while reducing costs. They hope the strategic alliance will help generate new sources of revenue for businesses by optimizing management of computing operations.
"Looking five to seven years down the line, I think what this deal does is to put most software retailers out of business, and eventually I think it will put broadcast and cable networks also out of business," Friedberg said.
Changes in content delivery
The deal aims to revolutionize the distribution and delivery of content in the coming years. Instead of watching a television program at a scheduled time on a certain channel, for example, consumers could use the channel's Web site hosted by Qwest and Microsoft and download the show to watch it at any desired time.
In the future, Qwest expects to move more toward video and entertainment offerings.
"There's no question and you'll keep seeing us making steps. You'll see five or six more announcements that will further complement this. You are not going to see us in one swallow change the world, it will be take several bites of the apple," said chief executive Joseph Nacchio.
In much the same way, the deal will help Microsoft distribute its software more efficiently and at a lower cost.
"You'll be able to download software, making it less expensive for you and easier to get," Friedberg said. "For Microsoft, it will increase their earnings margin since it will cut out the middleman.
The Qwest service will be built on Microsoft's Windows NT server operating system and Qwest's Internet Protocol (IP)-based fiber-optic network. Also, to accelerate Qwest's time-to-market with business services, Microsoft will license a broad range of its software to Qwest.
"We believe this strategic relationship demonstrates that Windows NT Server meets communications companies' needs for a stable, secure, and scalable solution to deliver a wide range of new network services," Microsoft president Steve Ballmer said in a statement.
Microsoft's investment is seen as critical because the bandwidth that Qwest can offer is only half of what is necessary for small to medium-sized businesses.
"These businesses need something prepackaged to use since it is more affordable," Langner said. "Qwest can say we have the bandwidth, we have a solution that works with Microsoft NT, you use NT--we can have you up and running in no time."
Langner said he thinks these services will really take off around 2000, but others are looking at the long-term implications of the deal.
"By working with Microsoft and its distribution channels, we believe that we will be able to accelerate by as much as 12 months our own plans for the delivery of Web-enabled applications," Nacchio said in a statement.
Starting in the second quarter of 1999, Qwest hopes to offer businesses a single-source high-speed service that is scalable and secure. Qwest's high-speed network will also support the development, integration, and maintenance of advanced hosting services built on Microsoft platforms.
Qwest will create a new business unit focused on the new markets starting in January 1999.
Qwest expects the new service to generate about $150 million in revenue during the first two years, most of it in 2000. Qwest also expects earnings before income, taxes, depreciation, and amortization to be at a slight loss in 1999, and slightly positive in 2000. The company said its capital expenditures will total about $150 million in the first two years.
"This deal is definitely positive for Qwest," said Goldman Sachs telecommunications analyst Richard Klugman. "It gives Qwest backing by a very reputable party and huge opportunities for managed service revenues."