Bell Weather

Vendors seek RBOC sweet spot.

The capital markets have begun their climb out of the cellar, buoyed at first by companies with security and videoconferencing products, and then by a big push from the regional Bells, which likely will dominate telecommunications in the wake of the Sept. 11 terrorist attacks.

"Wall Street understands that the market is going to contract sharply," says Alan Tumolillo, chief operating officer of Probe Research. "Investors are going to throw their cards to the big companies that have the resources to restore service at a time of crisis."

While the tech-heavy Nasdaq Stock Market fell 15 percent the first week it reopened, most of the regional Bells, listed on the New York Stock Exchange, gained 10 percent to 12 percent, Tumolillo notes. "For the next couple of years, the regional Bells are going to reassume a very strong position."

Overall network equipment sales may slow, because the Bells will have less incentive to spend in a time of diminished competition. But this could be good news for the carriers largest vendors — though figuring out which companies they might be is getting tough.

Cisco Systems, Lucent Technologies and Nortel Networks, already reeling, saw their stock prices tumble in the days following the terrorist attacks. And yet, the regional Bells dont want to deal with the small vendors either, unless the vendors have proven, reliable, robust products the Bells cant get from the behemoths.

Lucent and Nortel made strategic blunders when they jumped suddenly to next-generation optical switches, ignoring that the regional Bells had put into writing that they dont want to redo their entire networks.

Even as SBC Communications and Verizon Communications were awarding huge contracts to Nortel and Lucent, the two vendors ignored the clear signs that the optical migration would be slow. The Bells had filed papers with the states saying that they preferred to add modular upgrades to their existing Time Division Multiplexing switches, migrating gradually to a hybrid system that would accommodate IP or Asynchronous Transfer Mode technology for data traffic.

Playing Nice

In the heady days of 1998 and 1999, IT seemed possible to succeed by selling equipment to the emerging companies that were challenging the Bells for dominance, and that werent burdened by legacy equipment. But with many of those new carriers bankrupt, and with the stock prices of even the most promising of the crop — Level 3 Communications and XO Communications — down more than 90 percent from their highs, its almost essential that vendors find a way to play with the Bells.

"Cisco has this idea of being the company of the future, but they cant ignore the Bell guys, even though they are frustrated by them," Tumolillo says. "Who wouldnt be?" To remain top players, vendors may have to acquire companies that have the products that appeal to the Bells.

The telecom lesson of the terrorist attacks is that its essential to have several different ways to communicate during times of crisis. Cell phones proved absolutely crucial to communications, as did the Internet and the landline regional Bells.

Still, the tendency on Wall Street will likely be to reward those companies, such as the regional Bells, that can offer all three services.

The Bells should strike now, when Congress is smiling on them for their robustness and not scowling at them for their near monopoly of local ser-vice, analysts say. "Congress wont touch these guys for a while," Tumolillo says. "Bush is a pro-Bell guy, the FCC [Federal Communications Commission] is pro-Bell, so unless Bush falls flat on his face during this crisis, I expect the Bells to fly high."

Thats not to say the ascendancy of the Bells would necessarily be good for the industry as a whole. "It will mean a lot of smaller vendors will get consolidated out," Tumolillo says.

The Bells arent innovation leaders. They tend to buy very conservatively, preferring standardized equipment. Theyre not interested in a dozen different routers or several versions of Multiprotocol Label Switching. If the Bells hadnt been forced to face competition 20 years ago, there may not be an Internet, analysts say.

"The government is making a poor policy decision by discouraging competition when you really need it," Tumolillo says. "If they leave it to the Bells, there will be less innovation, and much less overall spending."

There may be an opening for vendors such as Riverstone Networks, Sycamore Networks and WaveSmith Networks that have less expensive products that let carriers migrate to next-generation networking at their own pace. All in all, the terrorist attacks will be a negative on spending.

"There are a few islands of good news in an ocean of bad news," says Roger Wery, director of Pittiglio Rabin Todd & McGrath. "September has been a terrible month. The carrier market isnt going to be back for massive capital investments for at least three or four quarters."

The U.S. was teetering on the brink of recession before the terrorist attacks, which had an immediate and devastating effect on the airline and hotel industries.

Massive layoffs in industries that rely on telecom equipment likely signal drops in bandwidth consumption, which would have "a very negative impact on the need for optical equipment," says Sterling Perrin, an IDC senior analyst. "We see the cons really outweighing any boosts." Perrin expects that the optical industry to bounce back in early 2003; before the attacks, IDC was predicting the industry would bounce back mid-2002.

Wall Street is punishing long-distance companies for plunging rates. While regional Bells stocks surged since Sept. 11, long-distance companies AT&T and Sprint barely inched up, and WorldCom fell a bit.

Last week, the combined stock value of the regional Bells — BellSouth, SBC, Qwest Communications International and Verizon — was $414 billion. AT&T was worth $68 billion, Sprint was worth $22 billion and WorldCom was worth $40 billion.

Analysts say we should expect to see mergers or acquisitions in the next 18 months, tying each long-distance carrier to a regional Bell. "All three are vulnerable for a takeover," Tumolillo says.