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WorldCom implosion could smother switch industry

Posted: 09 Jul 2002 ?? ?Print Version ?Bookmark and Share

Keywords:WorldCom? telecommunication chip? optical transmission? switch? semiconductor?

In the aftermath of the WorldCom implosion, developers of telecommunication chip sets and subsystems have had far more to ponder than whether WorldCom would last through the summer. The bigger issue was whether the other U.S. service providers would.

A report released Tuesday (July 2) by Probe Research Inc. suggested that the number of carriers might shrivel to a mere handful (two interexchange carriers and two or three incumbent local-exchange carriers) within the next year or so and raised the specter of a disappearing customer base.

Suddenly, existential issues that plagued only the optical transmission and switching specialists six months ago are now reaching into the heart of all switching and router markets. If there are not enough public-network customers to sustain a dedicated hardware business, the effects could be devastating on both inventory and product development at semiconductor companies exposed to telco markets.

To be sure, for most equipment vendors the effect of the WorldCom collapse itself is likely to be small. Like most carriers, the company had stopped spending anyway, a phenomenon that has already led to tanking stock prices, sweeping layoffs and mass startup extinctions among OEMs.

"This was merely a case of the type of consolidation we'd been expecting all along," said John Burnham, market strategist at Juniper Networks Inc. "It may have come in a harsh form over the last week, but we'd been planning for precisely this kind of consolidation, and we hope to benefit from it."

Moreover, most equipment vendors?particularly the startups?have already crafted new strategic plans, in some cases making a 180 turn to focus on equipment that fits existing networks but decreases operational expenses. As reluctant as they may be to spend on new equipment, carriers can't afford to continue their current operational procedures. The manual provisioning of circuits, requiring a truck roll to every point-of-presence involved in a link, is a particular sore spot. Given the chilled economy, any product that can lower day-to-day costs permanently becomes attractive.

The uncertain future of the service provider industry has put several multiservice-switch vendors in limbo. Business at companies like Gotham Networks Inc. has for all intents and purposes ceased, and ultimate dispositions were uncertain. Gotham had operating phones this past week, but representatives would not return calls to comment on reports from Gotham's investors that the company has decided to shut its operations. The scene at Mahi Networks Inc. and other players was reported to be similarly tenuous.

"It's hard to say who's a permanent victim," said one independent marketing contractor who had worked with Gotham. "You've got companies that are keeping control over their assets and retaining a few folks to answer inquiries. But some of the furloughs and summer vacations they'll be taking might become semi-permanent. I know where I haven't been paid, but I'm no longer sure when to call a company dead and gone."

The going will be increasingly tough for newcomers aiming to serve only the carrier market, said Juniper's Burnham, since the few remaining carriers will likely choose the larger equipment providers. But the worst thing a startup can do, he added, is to cut its marketing so deeply that potential customers forget it exists. At worst, this can start a death spiral, and at best it throws a pall over the company. Such a mood is common at many of the startup OEMs near Juniper's Massachusetts operations, insiders say, and it is also felt within WorldCom itself.

Bad morale, and worse

In Colorado Springs, 500 were let go from WorldCom's software development center and a telemarketing center at the end of June, but a survivor of those cuts said off the record that there's little excitement among those still employed for working on new projects. Staffers assume that the company's MCI, WorldCom and UUnet networks will still be around after a Chapter 11 filing, but they're not sure if new CEO John Sidgmore will parcel out Internet, long-distance and specialized packet services to separate bidders, or attempt to keep an intact company.

"Everybody had problems with [former CEO Bernard] Ebbers and his gang, but it's no longer a question of just bad morale," the development manager said. "It's really an issue of what [WorldCom] company you're working for, and which pieces might be left in the weeks to come. I've never seen such a weird environment."

In a report issued just after WorldCom's $3.8 billion financial restatement, RHK Inc. suggested that WorldCom and Qwest might be the only two long-haul backbone providers to go under. For its part, the Probe Research report fingered another company, Level 3 Communications Inc., as also vulnerable.

RHK predicted the U.S. government would ensure that the UUnet Internet backbone would not shut down, since the broadband packet group within WorldCom has contracts with the Defense Information Systems Agency. But Probe Research, in its report, termed UUnet close to operationally unstable, putting the entire Internet in crisis. The research house predicted further layoffs, further cuts in capital expenditures, delays in necessary network upgrades and a halting of network maintenance.

Equipment vendors also are watching the fate of two WorldCom metro fiber subsidiaries, Metropolitan Fiber Services and Brooks Fiber Inc., as reports emerged this past week that IDT Corp. wanted to buy them.

Meanwhile, said RHK analysts Melanie Swan and Kate Horricks, as other service providers begin poaching WorldCom's consumer and enterprise customers, they might need more equipment to handle the influx of traffic. Despite a glut of core capacity, some links have become oversubscribed, and those situations are worsening as carriers continue to freeze capital spending. Ciena Corp. CEO Gary Smith has been quoted as saying the cuts in capex are "unsustainable."

Indeed, "[WorldCom's] $35 billion in revenue is not going to disappear. It may get displaced to other carriers, but it won't go away," said Michael Howard, president of research firm Infonetics Research Inc.

Synonym for Enron

The disclosure that WorldCom had misstated $3.8 billion in capital expenditure numbers?$3.06 billion in 2001 and $797 million in 2002?turned the company into a synonym for "Enron" overnight. Effects on the stock were severe enough to put WorldCom under danger of delisting.

"If they had been honest, the stock would have dropped but it wouldn't be close to zero," said Howard. WorldCom stock fell to 6 cents per share on Monday (July 1), recovering to 10 cents the next day. Last year it was in the $10 to $20 range.

The Probe report took pains to say that WorldCom's problems did not lie in its admitted juggling of the books alone. Probe chief executive officer Allan Tumolillo called every aspect of the WorldCom business model "wrongheaded. The data side of the company was allowed to spend without constraint, without regard to revenue generation or expense containment. The voice side sat back and lost market share and engaged in endless price wars, which crippled the industry."

Even if the company had been honest, Probe said, the model of acquiring new companies for so-called "efficiencies" was a recipe for disaster. The long-term outlook for Qwest and Level 3 is little better, the report suggested.

For all the recent bad-mouthing, a couple of analysts found one quality to admire at WorldCom. The RHK report observed that a WorldCom bankruptcy could be especially taxing on startups, since "WorldCom was one of the last service providers willing to try newcomers," a sentiment with which Infonetics' Howard agreed.

Howard said he visited WorldCom's advanced-technology labs last month and found serious amounts of startup equipment there, much of it targeted at metropolitan networks. "I heard that they laid off a bunch of people in those labs, but that they kept the metro people," he said. "So one hope out of WorldCom is that they're still looking for better, more efficient ways to build out metro networks."

RHK believes the federal government might help to oversee a scenario in which WorldCom would be split and sold off along consumer, business and Internet service lines. Juniper's Burnham said that one trend being seen in Europe is a return to government support for PTT organizations that had been semi-privatized. This may be repeated to some extent in the United States, he suggested, as government structures a new role after the failure of full privatization at both the long-haul and the competitive local-exchange carrier level.

? Loring Wirbel and Craig Matsumoto

EE Times





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