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Small phone upstarts losing ground to telecom giants

Several small phone and Internet providers are struggling to launch new services, upgrade their networks and generally try to compete with the giants of the communications world.


Small phone companies losing ground to telecom giants

By Corey Grice
Staff Writer, CNET
October 5, 2000, 10:00 a.m. PT

Small phone and Internet providers are struggling as they try to launch new services, upgrade their networks and generally compete with the giants of the communications world.

The federal Telecommunications Act of 1996 allows these smaller providers--formally known as competitive local exchange carriers, or CLECs (pronounced "SEE-lecks")--to lease access to the networks of the regional Bell local phone companies. The law, intended to open a historically monopolistic industry, allows the competitors to resell the Baby Bells' phone lines while offering new services to differentiate themselves.

But many of these small phone and Internet companies--such as Mpower Communications, ICG Communications and Jato Communications--have recently announced profit warnings, executive changes or other significantly adverse news.

In recent weeks, analysts have expressed concern that many providers would have difficulty recouping large capital investments in their networks. The equipment required to offer advanced voice features and Internet services is costly, but profits from those same services are quickly declining as consumers demand more for their money.

As a result, many analysts believe that only the largest communications carriers, such as AT&T and WorldCom, will thrive in more than a niche capacity.

"The CLEC business model was going to be challenging in the best of times, because telecom is a scale business," said Scott Cleland, a communications industry analyst and chief executive at The Precursor Group, an independent research firm. "All of the communications giants are getting bigger."

Analysts say the money needed to upgrade communications networks is so substantial that many CLECs will need to consolidate to survive.

"The Telecommunications Act opened up the regulations, but it didn't repeal the laws of economics, and that is that telecom is an extremely capital inefficient business," Cleland said. "Telecom is also massively capital see story: Telecom players spend big, but win little intensive up front. While the economy was screaming and capital was flowing, it was a perfect incubation situation for CLECs. But frankly there's an oversupply."

Elliott Hamilton, a communications analyst at market research firm The Strategis Group, agrees. "In some metro areas you have six or seven CLECs fighting over 20 percent of the market and it's tough to make a business," he said.

"The concern that the market has is with the debt they had to take on to build out their networks," Hamilton added. "They kept coming back to the markets every six months for more cash. That's OK when everything is rosy, but then the markets took a dive and capital dried up. Now everyone wonders how long they can operate with their existing cash reserves.

"I think there's a natural fallout coming in the CLEC industry, and that's happening now."

Concerns for the competitors
Although the smaller phone competitors have grown quickly and have made a mark by providing high-speed Internet access or regional voice service, several of the smaller communications providers have run into trouble recently, raising questions about the sector's long-term strength.

Several high-profile incidents stand out as examples.

ICG Communications said last month that network outages hurt its sales and would affect quarterly earnings. Top executives from the company resigned the following day, and ICG this week was sued by shareholders for securities fraud as a result.

Similarly, Mpower reduced its phone line installation and earnings estimates in early September.

Jato Communications, a private Denver-based phone company that provides high-speed Net access in smaller metropolitan areas, two weeks ago disclosed that the company was in a grave situation. Jato has had difficulties securing investment capital and plans to cut back the number of cities in which it provides service as a result. The company also hinted at impending layoffs: "There will be an appropriate reduction in staff as a result of these changes."

In addition, Jato chief executive Gerald Dinsmore resigned and was replaced by Leonard Allsup, one of the company's founders.

Earlier this year, GST Telecommunications, a similar competitive phone company, filed for Chapter 11 bankruptcy protection after running short of cash to fund its operations. GST agreed to sell its assets to Time Warner Telecom for $690 million.

And Cypress Communications recently announced that its revenues for the second half of the year will fall below expectations, sending the stock lower. Cypress, which delivers high-speed Net access to small and midsized business customers in pre-wired office buildings, cited "construction and provisioning delays" for the short fall.

Others, such as Teligent and Winstar Communications, which offer wireless local communications services, have seen their stock prices plummet over the past year to near new lows.

Of course, not all of the competitive local communications and Net providers are foundering. A few have ambitious goals and have raised their target goals. Some analysts believe the overall market continues to expand despite the high-profile stumbles.

But the recent rash of bad news, coupled with analyst reports questioning whether some providers will ever see a solid return on their investments, has raised fears that the troubles are not over.

Gear makers still strong?
The ongoing concern about the competitive local phone provider market also raises questions about whether the equipment makers will be affected.

Some competitive local phone companies such as Mpower, which announced an earnings warning, have reduced phone and digital subscriber line (DSL) forecasts in recent months.

But some analysts believe that, although several communications companies are curtailing spending, the overall market is growing so quickly that the gear makers will not be hurt.

"There have been a few highly visible earnings warnings, but in the aggregate CLEC spending is going up," U.S. Bancorp Piper Jaffray analyst Frank McEvoy said.

One such recipient of CLEC largesse, Copper Mountain Networks, said it expects the market to consolidate but points to the popularity of high-speed Net access lines as evidence there is plenty of market left for it to serve with its DSL-based equipment. "Clearly, there's a transition under way," said Rick Gilbert, Copper Mountain's chief executive.

In a research report released last week, McEvoy predicted strong earnings reports from the broadband access equipment sector for the September quarter.

"Many of the stocks in our broadband access universe have declined by more than 40 percent in recent weeks due to concerns over CLECs financial health and a potential slowdown in overall carrier capital spending," he wrote. "Nevertheless, we believe demand for broadband access equipment remains robust."

McEvoy said he expects most broadband equipment makers to post quarterly sequential revenue growth of 20 percent. "That's strong growth by any measure," he said.

Still others have concerns that spending on hardware will decline in the coming months. Some analysts believe the CLECs need to spend more time automating their systems, which entails installing complex software systems to manage the networks they've recently built.

"We expect to see a lot more money going into software," said Leif Hoglund, director of telecommunications operating systems at RHK, a communications and optical consulting firm. "There's likely to be a shift in money from spending on hardware to spending on software." 

The competitive local exchange carrier (CLEC) sector has fallen on hard times as dozens of carriers spend heavily to fight over minimal market share. A look at how some of the industry's biggest names fare:

Cypress Communications
Construction delays. Second-half revenues expected lower.

GST Telecommunications
Chapter 11 bankruptcy. Sold assets for $690 million.

ICG Communications
Profit warning. Executive and board member resignations. Shareholder lawsuit.

Intermedia Communications
Posted second-quarter loss. Sold controlling stake to WorldCom.

Jato Communications
Executive resignation. Reducing service footprint. Possible layoffs.

Expects to meet or exceed quarterly and year-end expectations.

Mpower Communications
Profit warning. Reduced line installation projections.

Nettel Communications
Withdrew IPO registration in July. Chapter 11 bankruptcy in September.

NorthPoint Communications
Merged assets with Verizon Communications.

Pac-West Telecomm
Posted second-quarter net profit. Revenues 111 percent higher.

Stock trading near 52-week lows.

Winstar Communications
Stock trading near 52-week lows.

Source: CNET

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