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Letter From Europe

Scott Clavenna picture PRAGUE, Czech Republic, November 28, 2000 — at the Pan-European Carriers Conference hosted by Euroforum — Prague’s a beautiful city, everyone agrees: High Baroque palaces, charming squares decorated — somehow more authentically than any American city block — for the Christmas season, chic urbanites comfortably at home in Versace and Hugo Boss.

Yet this city still has that peculiarly grim quality of Eastern Europe: It’s been raining constantly, serious nihilistic smoking is going on in every café, and the atmosphere seems to be burdened with an unhealthy added measure of gravity. Today the rain actually increased when the sun came out. Optimism is hard won in this climate.

What a perfect setting for talking about pan-European carriers. There are more than twenty of them, and most of them started frantically building out ultrahigh-capacity fiber networks across Europe during the past two years’ ideal nexus of telecom liberalization, triple-digit bandwidth demand, and a raging bull market.

The first player in this field dates back several years, when European railroad companies set up Hermes. When the gold rush started, however, the Americans moved in. WorldCom Inc. (Nasdaq: WCOM) arrived. Then Hermes got bought by Global Telesystems (NYSE:GTS) and Qwest Communications International Corp. (NYSE:Q) clubbed up with the Netherlands incumbent operator to set up KPNQwest N.V. (Nasdaq/Amsterdam:KQIP). At about the same time, Level 3 Communications Inc. (Nasdaq: LVLT) turned up, as did Global Crossing Ltd. (Nasdaq: GBLX). Next came a bunch of European startups, including Carrier1 International SA, Interoute Telecommunications and Viatel Inc. (Nasdaq: VYTL).

Money was plentiful, and bandwidth demand forecasts generally agreed on growth rates of 200 percent to 400 percent per year. New entrants and stalwarts alike added their own ambitious plans to the mix, with major network announcements from British Telecommunications PLC (BT) (NYSE: BTY), Cable and Wireless PLC (NYSE: CWP), Energis PLC, France Telecom SA, LDCom Networks, Metromedia Fiber Network Inc. (MFN) (Nasdaq: MFNX), Pangea Ltd., Storm Telecommunications Ltd., Teleglobe (Toronto: BCE), Telia AB, and 360networks Inc. (Nasdaq: TSIX; Toronto: TSX.TO) increasing the buzz around this massive pan-European “opportunity.”

Why, then, is everyone here looking so tense?

Money. There isn’t any left at the banks, the public bond markets, equity markets, or just about anywhere else one might look for an additional $200 million to finish construction of a network spanning London and Milan. The public pan-European carriers are 75 percent to 85 percent off their 52-week highs. Private carriers remain deep in debt, with service contracts to customers they may not be able to fulfill because these customers happen to reside in cities not yet connected to the fiber backbones. Pricing of capacity has been eroding at rates of 50 percent to 75 percent per year, and the value-added, high-margin services promised by these carriers haven’t yet come to fruition.

According to Bob Koenig of Deutsche Banc Alex Brown LLC, most pan-European carriers remain fixed in a “construction” mode of operation rather than a “services” mode, meaning they measure progress primarily in the reach of their network rather than the profits from services. A construction mode is fine, even encouraged, if capital markets remain optimistic. But since the bear market’s beginning in March, funders have been pressing hard for revenues and have for the last three months been telling carriers the well is now dry, there will be no more capital.

A company that isn’t funded through their network buildout is facing a rather dire twelve months. Iaxis, once appearing as a unique, forward-looking carrier in the European market, is little more than a tombstone today (see Ciena Spooks the Market). Other carriers watch nervously for the next victim. In this market, ascendancy through attrition leaves one feeling a bit wary, and not much of a victor.

The themes of this conference, though not explicit, emerged early and clearly:

  • There are too many pan-European carriers. A shakeout is underway and it will likely be unpleasant. A struggling carrier will have a hard time finding money or a buyer, and may be left to the same fate as Iaxis. Bankruptcy.

  • There is a lot of capacity being deployed, and folks are beginning to wonder just what will be done with it all and when. There may be a glut for an unbearably long while, as local carriers struggle to deploy broadband access services in highly regulated markets.

  • Internet data centers, colocation, and hosting look to be a big deal soon, as these large network operators look to these services as a way to generate high-margin revenues quickly.

  • Consolidation is inevitable, the easy way or the hard way. Six or seven carriers will remain standing, all adopting varying degrees of “diagonal integration.”

    Next year will be an interesting one. Capex growth will undoubtedly slow, extending the trend now occurring in the U.S. and keeping share prices depressed. Pricing of capacity will continue to decline, creating market opportunities for bandwidth-intensive network applications and services while putting pressure on wholesale carriers to move up the value chain without threatening their initial customers.

    Where are the bright spots in this rather gloomy picture? I can think of three:

  • First, this will be a boon for optical switch companies, an obvious beneficiary of a market asking for equipment that efficiently exploits massive bandwidth in network cores, transforming these capacious cross-border transport platforms into true service platforms.

  • Second, metro optical networks are being expanded quickly to get the most lucrative customers online. Gigabit Ethernet, next-gen SDH, and metro DWDM vendors should see consistent uptake of their equipment throughout the next three years.

  • Third, as Web hosting, colocation, and bandwidth exchange facilities come online, the vicious cycle that now characterizes this market may turn virtuous again. These POPs will provide distributed platforms for new service providers to quickly address emerging IP services opportunities over a scaleable optical network.

    At least, everyone here certainly hopes so. Kafka’s dystopian vision has never really been in fashion in the carrier community, and they don’t much like the feel of it now.

    Scott Clavenna is president of PointEast Research and director of research at Light Reading http://www.lightreading.com
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