Magazine

Broadband Bust


It's not hard to imagine why Jack McMaster might feel a little bitter. The 45-year-old telecom veteran spent the past 3 1/2 years building KPNQwest (KQIP) into the largest high-speed data network in Europe, with service in 18 countries and 2001 revenues of $730 million. Worth $38 billion at its peak in March, 2000, the Hoofddorp (Netherlands) company was a darling among analysts, who thought it was a likely winner in the dash to create a new class of independent pan-European carriers for growing torrents of e-mail, Web pages, and digital media.

Then came May 31--a day of reckoning for the entire industry. That's when KPNQwest, faced with widening losses and debt of more than $2 billion, filed for bankruptcy and said it might shut down its network if a buyer didn't show up pronto. The collapse of the joint venture between former state-owned Dutch telco Royal KPN and Denver-based U.S. carrier Qwest Communications International Inc. came with virtually no warning. The venture's troubled corporate parents announced they wouldn't pony up any more money, and banks promptly canceled their credit lines. But it was only the latest in a brutal string of telecom bankruptcies that have cost investors tens of billions of dollars and demolished the dream of vital new telecom competition in Europe. Says a discouraged McMaster: "The notion of a new era has gone from boom to dust."

Change some of the names in this telco drama, and you might as well be in the U.S. American upstarts such as Global Grossing Ltd. and Williams Communications also ran out of money after trying to grow too fast. But Europe's disaster could be even more injurious, since it comes just as the telco industry is laboring to extract itself from the 3G fiasco. With sky-high debt choking the region's old telecom giants and burned investors shying away, there's little money available to salvage the ruins of Europe's telecom adventurism.

The carnage is everywhere you look. Among a host of broadband providers, only a few pan-European upstarts are still standing, including Colt Telecom Group PLC (COLT) and privately held Interoute Telecommunications PLC, both based in London. The bulk of telecom service is back in the hands of the former state monopolies, which are staggering under their own debt loads. Worst of all, the rush to build long-haul data highways was not matched with equal investment in local and regional infrastructure, leaving Europe's network rife with bottlenecks. It's as if the Continent were crisscrossed with vast autobahns, but the on- and off-ramps remained rutted dirt paths. Prices for local business connections remain high, while only about 7% of homes across Europe have zippy broadband Net connections--half the rate in the U.S.

Getting the situation fixed will take years and cost billions more. Analysts say a huge amount of consolidation is still required to take excess capacity out of the telecom system. In the end, Europe may be able to support only three or four super-telcos. But there's ample opportunity for upstarts to beef up regional services in and around major cities. And, to stimulate "last-mile" connections, policymakers have to finish the job of deregulating local service. Indeed, the European Commission is so worried about this shortage of broadband connections--especially in the Continent's poorer southern countries--that it's considering diverting billions from its $92 billion annual infrastructure budget to subsidize service.

How did things get so bad? No doubt, there was serious miscalculation by overambitious entrepreneurs and eager investors. During the tech boom of the late 1990s, dozens of companies sprang up across Europe to take advantage of newly deregulated telecom markets and the explosion of Net traffic. Most, such as Atlantic Telecom Group, Carrier1 International (CONEQ), Pangea (PAPO), and Viatel (VYTLQ), had no plans to offer local or long-distance voice service. Instead, they wanted to be so-called backbone providers, ferrying data between cities and countries over fiber-optic networks. The European startups--along with a gaggle of American interlopers such as WorldCom (WCOM), Global Crossing, and Enron--spent an estimated $15 billion wrapping the Continent with fiber.

Then the bottom fell out of the market. Some blame lies with the dot-com crash and a slowing global economy, which throttled growth in demand for bandwidth. But, unquestionably, the biggest factor was a giant mismatch between supply and demand: In their zeal to grab market share, Europe's backbone upstarts collectively built 100 times more capacity than the market could absorb. "One or two European networks made sense, but building 12 was a disaster," says telecom analyst Paul Wright of brokerage Loomis Sayles & Co. in Boston. Indeed, of the tens of thousands of miles of fiber-optic cables snaking their way along the sewers and rail beds of Europe, only about 10% of the glass strands have ever been activated, estimates Washington (D.C.) researcher TeleGeography Inc. The industry "was killed by optimism," says Martin Varsavsky, chairman of Jazztel, a Madrid-based provider of telecom services delisted from the Nasdaq on May 31.

The result was a price collapse. In just the past year, the cost to zap a stream of bits from Frankfurt to London has plunged 72%, while London-to-Madrid connections have fallen 63%, figures TeleGeography. Eight carriers have gone bankrupt since the start of 2002 because revenues weren't high enough to pay the bills, and because the stone-cold debt and equity markets weren't willing to cough up more dough.

Upstarts also fatally overestimated the extent of European union. According to Dieter Finke, CEO of Hannover-based LambdaNet Communications, a pan-European bandwidth provider, only about 4% of data traffic in Europe crosses national borders. LambdaNet has survived, in part, by focusing on service within three countries: Germany, France, and Spain. Failed rivals, Finke says, "thought

Europe was more homogeneous than it is." Besides, what pan-European traffic there is comes almost entirely from the limited number of multinational corporations, which tend to award business to established players like BT Group PLC or Deutsche Telekom.

Unfortunately for investors, the collapse of Europe's broadband upstarts hasn't yet run its course. While some networks have been abandoned, other failed operators are being resurrected by investors who have snapped up their distressed assets for pennies on the dollar. AT&T (T), for one, may buy part of KPNQwest's network. Pangea and Viatel are emerging from bankruptcy with cleaned-up balance sheets and a new focus on low-cost services. And Hong Kong-based hedge fund Sofaer Capital Inc. has acquired the vestiges of Atlantic Telecom Group and Carrier1 since the start of 2002, for "a few million pounds," says partner Philip Corbishley. They're being rolled into a new low-cost provider called Gamma Telecom that aims to undercut rivals' prices. "We're tracking these failures like a pack of wolves, and feeding off the dead bodies," Corbishley exults. The danger, observers say, is that such bottom-feeders could prolong the capacity glut--and the price slump.

Specialization will be the key to survival in this game. Ohad Finkelstein, CEO of London's Interoute, says his company is thriving strictly by leasing out space on its own far-reaching fiber network, rather than by offering bandwidth services. LambdaNet has taken the opposite route: It rents fiber capacity from providers such as Interoute and delivers only packaged bandwidth to other carriers. Such narrowly focused offerings emulate the outsourcing model used successfully in other industries, says Finke. Smart ideas. Too bad it has taken all this time, and billions of wasted dollars, for Europe's broadband upstarts to wise up. By Andy Reinhardt, with Stephen Baker in Paris and bureau reports


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