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Lightspeed's Slow Start


AT&T is on top of the telecom world. A few weeks ago, chairman and CEO Edward E. Whitacre Jr. put the latest touch on his empire by closing an $86 billion deal to acquire BellSouth. That completed a whirlwind of acquisitions in which Whitacre has virtually remade the old Ma Bell by gobbling up 13 companies over the past decade with a combined price tag of $285 billion, including assumed debt. Last year, investors rewarded "Big Ed's" voracious appetite by bidding up AT&T's (T) stock price 46%. The cherry on top? Well, that came last month at the Consumer Electronics Show (CES) in Las Vegas, where Cingular Wireless, the company's cell phone arm, stole the spotlight by partnering with Apple Inc. (AAPL) to introduce the sleek iPhone.

Now AT&T is gearing up for the next big telecom battle—for the supremacy of the Internet. AT&T's weapon of choice is Project Lightspeed, a new Internet network that sends bits of data through copper and fiber-optic cables buried in the ground. The high-speed network and its Internet-protocol television (IPTV) technology are crucial to AT&T's plan to bundle phone service, Net connections, and TV—the vaunted telecom triple play. In theory, the system will let AT&T steal customers from rival phone giant Verizon Communications (VZ) and cable companies such as Comcast (CMCSA) and Time Warner (TWX). AT&T says it will pump $4.6 billion into building enough fiber-optic cable and supporting technology to reach 19 million homes by the end of 2008.

But despite AT&T's stellar performance of late, the company faces serious questions about whether Project Lightspeed can deliver on its promise. Technology glitches hobbled the rollout last year. And though the TV service is up and running in fewer than a dozen markets with prices that undercut cable bills, a growing chorus of rivals, analysts, and engineers are skeptical that the network will offer enough bandwidth a few years from now to handle phone service, high-speed Internet, and multiple streams of high-definition TV.

Cable operators have taken full advantage of AT&T's slow start, gleefully swiping phone customers with their own triple-play offerings. Having invested more than $110 billion in network upgrades over the last decade to provide Internet and digital video, cable companies only have to tweak their networks to offer phone service. As of the third quarter, the five largest U.S. cable operators have signed up about 6 million new Net-based phone customers. By contrast, AT&T and Verizon have swiped a combined 222,000 TV customers.

Verizon is placing the most ambitious and risky bet. It plans to spend $18 billion—three times as much as AT&T—to lay fiber to every one of the 18 million homes it hopes to cover by 2010. AT&T is laying fiber into neighborhoods but is using existing copper phone lines to carry video the last few thousand feet. As a result, it will cost Verizon $1,750 to connect each home, vs. $450 for AT&T. Despite the higher price tag, ubs Investment Research expects Verizon to produce a return on its investment by 2011. The reason? It believes the Verizon network's higher bandwidth will lure more phone, Internet, and video customers—at higher prices—and thus generate about four times as much revenue as Lightspeed. On Jan. 29, Verizon backed up the theory when it announced that it ended its first full year of operations with 207,000 TV customers, representing 9% of the 2.4 million homes capable of receiving its video service in 2006. Just a few months ago, the company was hoping to finish 2006 with 175,000 video customers.

AT&T's problems became apparent last December when it was forced to pull back on targets for its TV service. Throughout 2006, AT&T told investors that it intended to deliver TV in 15 to 20 markets by yearend. By November it was in just two cities, San Antonio and Houston. In the last 10 days of December, AT&T unleashed a flurry of press releases announcing it was up and running in nine more markets, including New Haven, Indianapolis, and San Francisco. Still, that's short of its original target. And UBS analyst John C. Hodulik estimates that AT&T has only 15,000 total TV customers in the 11 announced markets, generating $2 million in revenue. The company isn't providing numbers.

It's not surprising, then, that some analysts are skeptical about another claim for Lightspeed: that two years from now, it will produce net earnings before interest, taxes, depreciation, and amortization costs are taken out. Even if AT&T succeeds in building out Lightspeed, analysts believe it will never produce a huge return from video. Rather, they say its value will be more defensive in nature—mostly to help stem phone customer defections, attract new Net customers, and make it cheaper to resolve consumer requests for adding, dropping, or changing services. Handling customer changes are the largest costs faced by a phone company. And by meeting more of those requests electronically with Lightspeed rather than sending technicians to homes, AT&T will save money. But it's far from the video revolution that the company has been selling.

Doubts about AT&T's video project are fueling speculation it will have to buy one of the two U.S. satellite operators, DirecTV Group Inc. (DTV) or EchoStar Communications Corp.(DISH), to accelerate delivery of TV service. "The AT&T IPTV technology is just inferior to satellite or cable in terms of delivering video, and they don't have much time to figure it out," says Aryeh B. Bourkoff, a UBS cable and satellite analyst.

FIXING GLITCHES

On a Jan. 25 conference call, though, Whitacre reaffirmed AT&T's commitment to Lightspeed. "This is our Plan A, and Plan A we're sticking with," he vowed. In an e-mail interview, Whitacre said various technological fixes, such as bonding phone wires, will enable AT&T to "greatly increase bandwidth as needed." Moreover, executives claim to have solved most of the technical and customer-service problems that slowed the rollout. And they remain confident in their decision to bet on a system that's more technically complex than Verizon's, arguing it will result in a TV service superior to anything else on the market. Chris Rice, AT&T's chief technology officer, says creating broadband video "was a lot more complex than people thought it would be. Did we have some bumps along the way? Yes. Did we solve them? Yes."

So far, AT&T TV customers seem happy. The pricing is particularly attractive, given the steep rise in cable fees. AT&Ts basic package of 190 digital cable channels, a digital video recorder, and a high-speed wireless Internet link costs $74, vs. about $90 for a comparable cable package. Alan Weinkrantz of San Antonio, a customer since May, says compared with cable the programming guide is easier, channels change faster, and he can record four programs at once. Most cable systems allow two. "Have I had some jitter and granulation? Absolutely," says Weinkrantz. "I have had the same thing in cable. Tony Soprano froze up on me while he was about to kill someone."

But couch potatoes are not pleased by the unadvertised fact that AT&T is only supporting one high-definition TV stream per household. Services from Verizon and cable companies support multiple HDTV signals. Since the capacity of copper phone lines decreases as the wires get longer, Jean Walrand, a professor of electrical engineering and computer science at the University of California at Berkeley, says Lightspeed may not have enough bandwidth in the future when households have several HDTVs. If copper loops are "longer than a few hundred feet, the bandwidth will drop," he says. AT&T says the average length of its copper loops is 3,000 feet.

Chad Townes, vice-president and general manager of Connecticut for AT&T, told BusinessWeek that homes farther away from its fiber nodes can't handle multiple high-definition streams. But Rice says bonding the two copper wires that run into each home will double the bandwidth of the Lightspeed network. That's possible, Walrand says. He cautions, however, that the fix hasn't been tried in suburbs or office buildings.

In coming months, AT&T plans to roll out some whiz-bang features. Soon you'll be able to program digital video recorders from a cell phone. Deals are being struck to deliver new channels and video-on-demand. But given AT&T's history of overpromising and underachieving in TV, that may not convince skeptics that Lightspeed is ready for prime time.

By Spencer E. Ante, with Roger O. Crockett in Chicago, Jay Greene in Las Vegas, and Ronald Grover in Los Angeles


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