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Talk about a dual-tracking system. Intellispace CEO Marc Josephson's new corner-office suite at Sixth Avenue and 43rd Street in Midtown Manhattan practically mirrors his business plan. Through one bank of windows, Josephson oversees a room stuffed with fiber-optic cable equipment and young techies, while through another set, he looks out over a sea of office buildings.
Connecting these two scenes is Intellispace's business. Founded by Josephson in 1995, this upstart telecom sells dedicated data access to small- and medium-size business customers. The company has wired about 400 buildings for service, mostly in big cities on the East Coast. And in June, Josephson had his best sales month yet when Intellispace logged 90 new customers, boosting its total to 450. For an encore, he expects to sign up an additional 100 by the end of July.
The Intellispace attraction: rates that Josephson claims undercut the big telcos, plus services that blow the Baby Bells away, including cutting-edge 10-gigabit Ethernet data transport. "We use far less cash to light up buildings and get customers than anyone else. We are hooking up 30 to 50 buildings a week," says Josephson.
LEANER AND MEANER.
Intellispace is one of a handful of young upstart data and telecom companies trying to snatch business away from the former Baby Bells. Called competitive local exchange carriers, or CLECs, these small companies arose from the 1996 Telecommunications Reform Act, which opened many markets to new competitors. For most CLECs, it has been a four-year slog through regulatory hurdles, expensive buildouts, service snafus, and painful reliance on the Baby Bells -- their chief competitors -- for access to major local-telephone exchanges.
But now the CLECs appear to be turning the corner. Collectively, they held 6% of the business-data and telecommunications market at the end of 1999, according to Merrill Lynch Managing Director Ken Hoexter. That share is expected to jump to 12% by yearend. As of last year, only one CLEC was profitable, and five were breaking even on a cash-flow basis, according to the industry trade group, the Association for Local Telecommunications Services. But by yearend, some 50% of the CLECs should be running at break-even rates, says Hoexter.
Key to this profitability is a heavy CLEC concentration in the highly lucrative business-data-services market, a $23 billion annual pie in the U.S. that is growing at double-digit rates each year. Not burdened with sales of legacy systems or upgrading infrastructure designed originally for voice transmission, the CLECs say they run meaner and leaner than the old telcos. Many are focusing on the latest Ethernet technologies that provide significant cost savings as well as greater flexibility and ease of use.
According to Josephson, Intellispace pays a mere $15,000 to wire a building and needs only two customers per building to turn a profit. That, in turn, drives the cost of data transmission down, forcing big telcos to try to match the CLEC in service, technology, and price. "If CLECs weren't around, the incumbent [telcos] would still be charging $2,000 a month for [high-capacity] T-1 lines," says Jonathan Askin, the general counsel for ALTS. According to Askin, broadband pipes that can push the same amount of data traffic as a T-1 now cost as little as $100 per month.
BELLS AND DSL.
That's not to say that the Baby Bells are standing still. SBC, the largest of them, is investing $6 billion over the next few years to extend broadband DSL access to tens of millions of new consumers. SBC also is adding 1,000 salespeople next year and will make a big push to market DSL service to businesses. As they introduce new data services and equipment, the cost structure for the old-line telcos, likewise, drops, because such systems are cheap to install and operate.
Furthermore, the Bells tout their reliability and long business history. "I don't know if I would sign a seven-year contract with a data CLEC unless someone can do some tea-leaf reading," says Joseph Simon, SBC vice-president for global broadband.
Some analysts, such as Peter DeCaprio, a principal at Thomas Weisel & Partners, believe the Bells haven't responded as aggressively in the smaller markets as they could have and instead have focused on corporate customers. Now, the Baby Bells are starting to put out feelers to the small and midsize business market that CLECs figured was theirs to own.
BUYING SPREE?
Perhaps more crucial to CLECs' future is the demand of shareholders for profitability. The handful of publicly traded CLECs were battered in the recent market downturn, and their shares remain depressed. Likewise, values of privately held CLECs have plummeted.
That could mean consolidation comes sooner rather than later. "With the sector depressed, it will be interesting to see which one of the public guys takes a chance and goes on an acquisition spree," says DeCaprio. There's an upside for the CLECs here: By consolidating, they may be able to mount a more serious challenge to the bigger telcos not only for the small fry but for bigger customers up the food chain.
Copyright 2000, Bloomberg L.P.
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