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Software: A key weapon in telecom wars

As the telecom battle rages, service providers will invest in the infrastructure that will provide a competitive advantage on the battlefield. One of the biggest beneficiaries of this investment has been telecommunications software vendors.

Business is war.

This is no more evident than in the highly competitive telecommunications market, which has become a virtual battlefield since deregulation of the industry began in 1982. The Federal Communications Commission (FCC) sent the wheels in motion with the breakup of AT&T in 1982 and shifted into overdrive with the Telecommunications Act of 1996.

Deregulation is the catalyst that has created today's telecommunications competitive battleground. The market now consists of incumbent defenders (such as the regional Bell operating companies, like Bell Atlantic, or AT&T for long distance) that are being attacked by new, competing local carriers like Allegiance Telecom and Qwest Communications. In addition, the proliferation of new technology (faster Internet access, wireless services, and so on) serves to feed the telecom battle.

As the battle rages, service providers are driven to invest in the infrastructure that will provide a competitive advantage on the battlefield. One of the biggest beneficiaries of this investment has been telecommunications software vendors. These firms provide both front- and back-office software applications, allowing firms the ability to wage offensive war as well as defend their strategic market positions.

This software, commonly referred to in the industry as operational support systems (or OSS), has become a critical piece in the plans of telecom service providers to provide integrated (also called convergent) service offerings. For example: a carrier could offer phone, Internet, and wireless services, all charged under a single bill. These services are not only key to winning customers, but also to increasing the retention of existing customers.

A modern OSS enables a service provider to bring convergent products and services to market quickly, as well as provide enhanced customer care. In essence, the OSS has become a strategic weapon in the telco war. More and more service providers are looking to their OSS to provide them with a competitive advantage.

The result has been significant demand for OSS of all types. Historically, most OSS were built and customized in-house by large carriers. Currently, time-to-market requirements and resource limitations force carriers to purchase off-the-shelf software or outsource the technology, to the benefit of OSS software vendors.

To date, the most successful independent OSS software vendors have been billing software providers. This is logical, as the emergence of new service providers dictated infrastructure investments that would allow providers to generate cash flow (bill and collect cash from customers). Demand for billing software will continue to be robust over the next few years, benefiting vendors such as Saville Systems, LHS Group, and Portal Software.

We are just beginning to see the emergence of significant demand for provisioning and order management software--the systems that actually enable telecom vendors to provide products and services to customers. This is a natural evolution; while billing allowed new market entrants to open the doors for business, provisioning will allow them to "scale up" as business volume increases. As a carrier's business volume reaches critical mass, the manual, ad-hoc provisioning systems now in place at many of these newer vendors will not adequately handle the load. Hence, vendors of such systems, including firms like DSET Corporation, are expected to see explosive growth beginning in the second half of 1999 and into 2000.

Finally, the international arena holds tremendous promise for OSS vendors. Europe is two years behind the United States on the deregulation curve, providing OSS vendors with fertile markets in Europe. The continued build-out of telecom networks in Asia and Latin America should generate significant demand for telecom software products. As most developing countries forgo expensive telephone networks for quicker and easier wireless networks, vendors of billing systems for wireless telecom providers (such as LHS Group), should do well.

The information contained herein is based on sources believed to be reliable, but Legg Mason Wood Walker Incorporated does not guarantee its completeness or accuracy. It is for informational purposes only and is not intended to be an offer to buy or sell the securities referred to herein. Opinions expressed are subject to change without notice; and past performance is not indicative of future results. From time to time, Legg Mason Wood Walker Incorporated and/or its employees, including the analyst who prepared this article, may have a position in the securities mentioned.