IP: The Telecom Crash of 2002

[Dave Farber <dave () farber net>]

Look at end of Dana's article for comment by Gerry Faulhaber djf

------ Forwarded Message
From: "Dana Blankenhorn" <danablankenhorn () mindspring com>
Reply-To: "Dana Blankenhorn" <danablankenhorn () mindspring com>
Date: Fri, 28 Jun 2002 16:58:18 -0400
To: <farber () cis upenn edu>
Subject: Worldcomm and what comes next

Dave: Some of my readers suggested I send this to you regarding Worldcom.
It's from my issue of May 6 and appears online at
http://www.a-clue.com/archive/02/cl020506.htm

--

A-Clue.Com (http://www.a-clue.com)
by Dana Blankenhorn
Volume VI, No. XVIII
For May 6, 2002

This Week's Clue: The Telecom Crash of 2002

This may come as news to you, but Worldcom
(http://finance.yahoo.com/q?d=t&s=WCOM+) will not be the last big telecomm
power to go bankrupt. Bernie Ebbers won't be the last such executive to get
the Ken Lay treatment
(http://www.nytimes.com/reuters/business/business-telecoms-worldcom.html?dlb
k).

The expected bankruptcy of the largest Tier One Internet Service Provider
follows the bankruptcy filing of Global Crossing, and the more-recent filing
of Williams Communications (http://news.com.com/2100-1033-888913.html).
Sitting in the bankruptcy waiting room are such companies as Qwest
(http://quote.yahoo.com/q?h=1&s=q&d=v1) and AT&T
(http://quote.yahoo.com/q?h=1&s=t&d=v1).

Do you notice the pattern? All these filings prove the same point, Moore's
Law applies to fiber. Because fiber capacity can be expanded exponentially
using Wavelength Division Multiplexing, with capacity increasing by a factor
of 1,000 (http://www.firstpr.com.au/telco/articles/wdm_links.html), the
billions of dollars invested in the 1990s ringing the globe and every major
city with fiber can't be recouped. Infinite supply and a finite demand
creates a price of near-zero.

Since Internet telephony has also been incorporated into phone switches over
the last few years, turning voice into bits, long distance voice prices too
are plunging toward zero. The latest estimate I read was that it costs
2/10th of a cent per minute to move a long distance voice call, and 155 Mbps
fiber lines were recently leasing for as little as $15,000 per month
(http://dc.internet.com/news/article/0,1934,2101_1016421,00.html). Those
10-10-220 calls (run by Worldcom) are a major rip-off.

The billions of dollars invested in fiber throughout the 1990s were invested
based on the assumption that the value of fiber bandwidth would rise over
time, due to increased demand. But even if phone companies, cable companies,
wireless providers and ISPs had managed to convince people to buy broadband,
even if sites were free to deliver broadband content, and even if everyone
had "last mile" services at affordable prices, Moore's Law would not have
kept bandwidth prices level. It's not just a matter of having everyone wired
to broadband, but of everyone demanding the services of broadband at once,
that fills those fiber pipes.

Moore's Law is putting all of the telecommunication industry's big balance
sheets - voice and data, national and international, wired and wireless - in
the dumper. Since it's cheaper to buy an "all you can eat" long distance
plan from a cellular provider than a wire line carrier, AT&T and Sprint are
just as threatened as Worldcom. This competition will eventually put
cellular providers under pressure. Moore's Law operates everywhere, meaning
such giants as Deutsche Telekom, British Telecom, and Cable & Wireless are
all under threat.

I've been warning about this for years. But it doesn't really help to be
right.

The question is what will we do about it? In Net Paradox
(http://www.netparadox.com/) David Isenberg and David Weinberger propose
that governments take major networks out of bankruptcy and run them as
public utilities. In his latest "Cook Report"
(http://cookreport.com/11.03-4.shtml) Gordon Cook claims the ILECs, or the
"Teleban," are succeeding in getting government policies that force
consumers to buy their monopoly services at monopoly prices.

But even a government bailout of the ILECs and re-monopolization on behalf
of the "Teleban" would be a short-term fix. Moore's Law is irresistible, and
it applies to radios, not just fiber. Other nations are applying this
Moore's Law of Radios to their own wireless worlds, so American
intransigence could mean Mexico or even South Africa will have better
service than Americans within the next five years. In any case, America's
monopoly of telecommunications capacity is going to end, because it's so
cheap to reproduce it.

Even if you're totally "clued-in," Moore's Law means that billions of
dollars in long-term debt, originally rated AAA, won't be repaid. It can't
be, because the customer revenue needed to repay it can't come in.

The first point to be made today is we're just at the start of this crash.
Enron, which was highly leveraged based on rising bandwidth prices (it tried
to make a market in the stuff), was just the tip of the iceberg, the canary
in the mine shaft. These early-year bankruptcies are like the recent calving
of the Ross Ice Shelf (http://nsidc.org/iceshelves/larsenb2002/). The actual
event is like global warming, only in fast-motion.

The second point is that this doesn't completely sink the telecommunications
equipment sector. Moore's Law means that wireless broadband will continue to
improve, and thus such "last mile" solutions will find a market. New fiber
routing systems and diodes that increase fiber capacity will continue to be
sold, to someone, because they do pay for themselves. But a lot of people
talked in the 1990s about the idea that "bandwidth is free" and as they get
their wish some will find it a nightmare.

How should we deal with this? The first and most important thing to do is go
through the grieving process, starting now. We're still in denial - we need
to reach acceptance. This is a titanic financial event, and given the
inter-relationships between the public sector and telecommunications
(financial interdependencies in many developing countries) it's going to pop
to the top-of-the-stack for real policymakers, not just elites. Left
unmanaged (and it's unmanaged today) we're talking about a reversal of the
recent "recovery" by the third quarter, with many of our very-best jobs
disappearing. We're talking about a deflationary spiral rivaling that of the
1930s.

What's the solution? Government will have to step in and buy this unused cap
acity at some point, spinning it out (hopefully at a profit) following a
reorganization. That's what the laws of capitalism demand - stock and
bondholders made mistakes and must pay. It's funny, though, how many "market
conservatives" will be calling for bail-outs in the next few years. When
they do, bring a laugh track.

There's another lesson. Connectivity by itself is worthless. Only services,
content, and software are meaningful. There must be a market negotiation to
value services, content and software, in a world where their delivery costs
nothing. Trying to ban technology turns the economy's chief profit-center
into nothing but a cost-center. This
(http://zdnet.com.com/2100-1105-891781.html)  can't be borne.

There's a lesson for you and I in all this as well. Make something unique,
then make something else. This is something folks in the computer business
have accepted for decades. It's the only way out of Moore's Law. And it's
coming to a telephone near you.





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------ Forwarded Message
From: "Faulhaber, Gerald" <faulhabe () wharton upenn edu>
Date: Fri, 28 Jun 2002 18:26:00 -0400
To: "'Dave Farber'" <dave () farber net>
Subject: RE: comments

Re: the Blankenhorn piece: a lesson well learned.  It is certainly true that
the bandwidth providers expected unlimited bandwidth (remember "Internet
traffic is doubling every three months"?  Andy Odlyzko put paid to that
canard).  And stockholders went along with it; apparently nobody did the
compound interest calculation.  So, yes, bandwidth glut, Global Crossing in
the tank.  Moore's Law helped, but stupidity carried the day, I think.

LD companies in the tank for a different reason, although this contributed
to it.  But mainly, LD is no longer a stand-alone business; the margins are
razor-thin.  Once the RBOCs get their 271 approvals, the LD companies are
toast (except AT&T Business).

But Worldcom and Global Crossing are a whole other story.  They just used
the system to lie, and boost their EBITDA and market analysts bought it.
What are these guys paid to do, put lipstick on pigs?  This isn't about
telecoms, it's about lying and then getting caught.  This is Enron/Arther
Anderson, not telecoms.  This is a much more fundamental hit to American
capitalism; I hope the Bushies understand how deeply this can wound our
economy.

Professor Gerald Faulhaber <http://rider.wharton.upenn.edu/~faulhabe>
Business and Public Policy Department
Wharton School, University of Pennsylvania
Philadelphia, PA 19104
215-898-7860



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