`Off-the-scale’ fiber glut rocks the telecom industry

During the past six years, telecom pioneers with big bankrolls crisscrossed the globe, laying down vast networks of
glass fiber to carry the coming boom in Internet traffic.

But like most booms, there’s been a bust.

By Joelle Tessler
Mercury News

The massive construction of long-distance fiber-optic networks has turned into a colossal glut, with billions of dollars
in fiber lines essentially going unused. And the fallout is rippling from Wall Street to Silicon Valley.

Even amid signs of an economic rebound, the fiber glut threatens to slow the recovery — especially in the Bay Area,
home to many companies that make the equipment used to build telecom networks.

“It will be years before we’ll need all the capacity out there,” said Scott Cleland, chief executive of the Precursor
Group, a telecom investment research firm. “We’re off-the-scale overbuilt.”

Much of the great fiber build-out was based on a big miscalculation. While the growth of the Internet has certainly
pushed huge volumes of data over the new networks, the amount of traffic has not kept up with the amount of
available bandwidth — sending bandwidth prices into a nosedive. The price of a T1 connection between New York to
London, for instance, has fallen from about $10,000 a month in 1997 to about $1,000 a month today.

The result: a wave of bankruptcies and layoffs among telecommunications companies overwhelmed with debt.

“These companies were built based on data-traffic hype,” Cleland said.

Among the carriers already in bankruptcy court: Global Crossing, Yipes, Teligent, Winstar, McLeodUSA, ICG, PSINet
and 360networks. Many more — including Williams, XO, Metromedia Fiber Network, Level 3 and Qwest
Communications — are struggling in what Cleland calls the “insolvency zone.”

In Silicon Valley, the troubles have stung many equipment makers — such as San Jose’s Cisco Systems and
Sunnyvale’s Juniper Networks — which have watched orders dry up.

Nationwide, more than 403,000 telecom-related jobs have been cut since the start of last year, according to
outplacement firm Challenger Gray & Christmas.

And Cleland estimates that 14 one-time high-fliers — including carriers like Global Crossing, Williams and Worldcom
and equipment makers like Cisco, JDS Uniphase and Juniper — have lost $1 trillion in market value since the start of

Much of the network-building began in the early days of the Internet. In the mid-1990s, carriers identified a huge
opportunity to transport growing volumes of Internet traffic — including e-mail and Web pages — over networks of
glass strands using beams of light.

“The build-out was driven by all the hopes and dreams everyone had for the Internet,” said Yankee Group analyst
Seth Libby.

The Telecommunications Act of 1996, which aimed to open up the local phone markets and spurred the creation of
upstart carriers, was also behind much of the network construction. “The idea was that competition created by the
’96 Telecom Act would help drive traffic and demand for bandwidth,” Libby said.

A number of companies, such as Metromedia Fiber Network, focused on the so-called “metro” market and built
networks in the nation’s more densely populated cities. Many other carriers, including established players like
WorldCom and upstarts like 360 Networks and Global Crossing, built long-haul networks connecting U.S. cities and
running under the oceans.

Today, the fiber glut exists largely in the long-haul networks. One reason: It’s cheaper to dig trenches and easier to
secure the rights-of-way needed to lay fiber in the countryside — often next to railroad tracks — than in the city.

Connecting big cities

The real problem is that most carriers focused on connecting the same 50 or so “NFL cities.” Among the most
overbuilt routes: San Francisco to Los Angeles, New York to Chicago, Los Angeles to Denver.

Worsening the oversupply, major advances in optical technology have significantly increased network capacity —
enabling carriers to transport more data over the fiber they have laid.

At the same time, Cleland believes, projections of Internet traffic growth proved to be wildly inflated. Between 1997
and 2001, he said, it was accepted wisdom in the telecom industry that data traffic was doubling every three to four
months. But in reality, Cleland said, data traffic has been growing about 100 percent to 200 percent a year since

Many blame disappointing traffic growth on the relative lack of high-speed connections linking homes and
businesses to long-haul networks — the so-called “last-mile” bottleneck. “We built huge highways, but not enough
on and off ramps,” said Jim Andrew, vice president at Adventis, a consulting firm that first predicted the glut back in

About 10 percent of U.S. homes have broadband access. And telecom consultant Jeff Kagan estimates that roughly 5
percent of U.S. office buildings are connected to a fiber ring. With long-haul capacity outstripping hook-ups on the last
mile, Adventis estimates that carriers have wasted $70 billion to $90 billion in overbuilding long-haul networks.

Many analysts also note that there aren’t enough compelling computer applications that require high-speed
connections and huge bandwidth, such as streaming audio and video. This is particularly true now that Napster, the
online music-swapping service, has been shut down.

According to Milo Medin, founder of At Home, the now-defunct Redwood City company that pioneered the cable
modem market, the initial trigger for the telecom collapse was the bursting of the dot-com bubble in 2000. That
shrank an important source of customers for carriers. Then the broader recession hit, prompting companies to slow
spending on telecom services.

The result was a domino effect with serious implications for Silicon Valley’s high-tech economy. Carriers slashed
spending on networking gear from equipment makers like Cisco, Ciena and Nortel. And those companies, in turn,
cut spending on optical networking components from suppliers like JDS Uniphase and Corning. “It’s a food chain,”
Medin said. “If one species dies, the whole ecosystem becomes unstable.”

Despite telecom’s current woes, many believe the long-haul glut will eventually disappear.

“I guarantee that as soon we get enough homes and offices connected, we’re going to suck that bandwidth right up,”
Kagan said. “Unless you believe that the Internet is going back to text rather than forward to audio and video, there is
going to be an incredible demand for bandwidth.”

Indeed, in a study of 22 long-haul routes connecting the 12 largest U.S. cities, consulting firm TeleChoice found that
only four routes were suffering from a glut — with demand for bandwidth running at less than half the available supply.

Confused abundance

Jason Martin, managing director of solutions architecture for Williams Communications, believes Wall Street has
confused an abundance of fiber in the ground with an oversupply of bandwidth.

Fiber must be “lit” with optical networking equipment called optronics, which can fire lasers of light across the glass
strands, before it can transport data. Martin therefore makes a distinction between the “dark fiber” that the carriers
hope to light sometime in the future, and the actual bandwidth available on lit fiber.

What investors don’t see, Martin explained, is that many carriers deliberately laid more fiber than they initially planned
to use in order to prepare for growth. “You have one shot at building a network,” Martin said. “You don’t want to
continue digging up the streets.”

He added that the cost of the fiber itself is only between 8 percent and 15 percent of the total cost of building a
network. “The real cost is in the optronics,” Martin explained.

Russ McGuire, vice president and chief strategist at TeleChoice, estimates that about 22 percent of the fiber on the
22 routes TeleChoice studied has been lit. “There is probably the right amount of fiber in the ground and the right
amount of fiber has been lit,” he said. “It was just done by too many companies.”

The sooner the telecom industry consolidates through bankruptcies and mergers, McGuire believes, the sooner it
will return to health. He predicts the shakeout will ultimately leave just AT&T, WorldCom and “two to three others.”
But many are confident that the sector will eventually recover as the economy rebounds and the Internet continues to

“We are seeing irrational pessimism and panic sweep the industry,” said Sean Doherty, another At Home founder
and now managing partner at a telecom asset banking firm. “But this is not a demand problem. It’s a problem of
unrealistic expectations. There is still good, solid growth in telecom demand.”

Contact Joelle Tessler at [email protected] or (408) 920-5490.

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