On a Qwest for profits

The telecommunications firm's European expansion, a $700 million joint venture announced today with Dutch communications company KPN, calls for a new IP-based fiber optic network in Europe with a transatlantic connection to Qwest's growing domestic footprint.

The joint venture marks another in a string of bold moves for the youthful long distance carrier, underscoring its desire to build the biggest packet-switched network the industry has ever seen. The company's European strategy mirrors its U.S. plan: overbuild a state-of-the-art network, then sell off capacity to other to carriers and corporations to fund the continued network rollout.

But as Qwest nears completion of its domestic network, slated for the second quarter of 1999, the company must begin lighting it up--that is, filling it with traffic. Analysts said data services may be the majority of Qwest's business since the industry is heading in that direction, and many consumers are unfamiliar with Qwest as a long distance brand.

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, said Jack McMaster, a senior vice president and acting CEO of the new KPNQwest European business.

McMaster said the demand for capacity and bandwidth in the U.S. and Europe is "mushrooming"--and Qwest is ahead of the curve. But building a network is not a profit-making venture, selling services on a network is.

In order to expand its long distance business, Qwest forged an alliance with regional phone giant US West to market its long distance services. But federal regulators, who have stringent requirements on how local phone companies operate, have squashed the partnership.

Regulatory Intervention
When the Federal Communications Commission ruled that established local phone companies could not market Qwest's long distance services, it appeared to be a blow to the upstart long distance carrier. Qwest is appealing the decision.

But analysts said the setback may only be a minor hitch in an otherwise rosy future for the emerging carrier.

Qwest had hoped to market long distance phone service through regional Bell operating companies US West and Ameritech. Qwest and US West already had signed up about 130,000 customers in three weeks for a ten cents per minute offer.

"Qwest was aggressive in striking these marketing agreements," said Mark Langner, a telecommunications services analyst with investment bank Hambrecht & Quist. "It was an opportunistic thing for Qwest to try and do. But it was meant to test the edges of the regulatory environment."

Although Qwest didn't win this regulatory battle, analysts said the effort may have helped to raise the company's profile with the regional phone companies.

"Eventually the RBOCs are going to get loose in long distance and Qwest is better positioned than most to benefit," Langner said. "They're big enough to partner up with an RBOC but they're small enough not to be a real competitive threat."

In the wake of the FCC's ruling, emerging carriers such as Qwest, Level 3 Communications, IXC Communications, Williams Communications, and Frontier, must now market long distance voice on their own.

"[The FCC decision] could cause them to change their strategy a little, but I think there are so many opportunities for Qwest," said Steve Wing, a research analyst at American Frontier, a small cap brokerage based in Denver. "They may still be able to hook up with some of the RBOCs for data services. I don't think this is necessarily the last round in this fight."

"This is a small bump in the road when you're traveling at the speed Qwest is traveling at," McMaster said.

Other observers agree the young company, established in 1997, has plenty of other avenues for making money.

"I don't see the FCC decision as a big blow to Qwest," said Brian Adamik, senior vice president for research at The Yankee Group.

"I think they're best positioned among the emerging carriers from a talent and strategic standpoint. The key for them is no longer building the network but lighting it up," Adamik said. "They're building a network from scratch so they can do it right. That allows them to have a more efficient network."

Dealing With Data
Analysts point to the data services market as the real key industry for Qwest. They said the company's ability to sell voice services will soon be only a small part of its business.

"The deals today are for voice, but tomorrow is about data and Qwest is exceptionally well positioned because of the massive amounts of bandwidth available to them," Langner said. "Qwest's focus will be on selling data services to large businesses and that's very much different from selling domestic long distance voice services."

And Qwest is clear where its profits are coming from.

"Our data business is growing tremendously faster than our voice business," said Qwest spokesman Tyler Gronbach. "We certainly expect our data revenue to outweigh our other revenue in a few years."

Long Distance Details
Qwest would like a piece of the estimated $40 billion consumer long distance market. The company is already the sixth-largest U.S.-based long distance provider.

"Their network is going to be pretty quiet at night and on weekends when most residential calls are made so they want to capitalize on the consumer market," Adamik said.

Until the need for data services blossoms Qwest will continue to look for opportunities to make money on its network, and that means finding long distance voice customers.

"The network will continue to be built out but the focus is to show return on in investment," Adamik said. "The LCI acquisition is a great example of how they're getting new customers."

Qwest bought LCI International, a long-distance carrier, for $4.4 billion in stock. After the deal Qwest had about 2.3 million customers.

"They will continue to add to that through acquisitions and organic growth," Adamik said.