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April 1, 1999

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If You Can't Build It, Buy It ... Or Borrow It

Posted: 04/1999

If You Can’t Build It, Buy It … Or Borrow It
By Ken Branson

‘We just want the damn network’ and other telco Internet entry
strategies.

What is a telecommunications service provider to do about the Internet? Some are buying
Internet service providers (ISPs) or courting them as customers. All are struggling to
include Internet access in their mix of offerings.

"Obviously, telcos are buying or partnering with ISPs," says Susan Sweet, an
Internet and telecom analyst with Ovum, a London-based consultancy. "They’re also
making alliances with cable operators to gain access and finding ways to bundle services,
trialing IP (Internet protocol) telephony–all to provide value-added services."

Sweet and other observers point out that buying an ISP, or forming an alliance with
one, can secure tangible and intangible benefits that the carrier otherwise would have to
build or buy one at a time. These include IP networks, the hardware that makes up those
networks and the people who know how to run the networks. A carrier that buys or allies
with an ISP also gets customers it might not have won on its own. Of course, networks,
employees and customers all come with their own baggage, which may be heavier to lift than
a carrier’s executives imagined.

In 1997 and 1998, several North American carriers purchased ISPs. ICG Communications
Inc., Englewood, Colo., bought Netcom On-Line Communications Services Inc., San Jose,
Calif.; Frontier Corp., Rochester, N.Y., bought Global Center Inc., Sunnyvale, Calif.;
WinStar Communications Inc., New York, bought GoodNet Inc., Phoenix, and PacNet Inc.,
Seattle; GST Telecom-munications Inc., Vancouver, Wash., bought Whole Earth Networks Inc.,
San Francisco; and Intermedia Communications Inc., Tampa, Fla., bought Digex Inc.,
Beltsville, Md.

"A lot of those acquisitions have been to get the technical expertise," says
John Devolites, a Washington-based partner at Arthur Andersen LLP who follows
telecommunications and Internet companies. "Most of them have been to acquire
customers and expertise. Most of these carriers aren’t IP-based phone companies. Where
they’re trying to get an in is in trying to provide multiple levels of service to
differentiate themselves."

"Long distance companies are recognizing they need to partner with
portals and other Internet specialists in order to thrive in this marketplace."

–Jeffrey Kagan, independent telecom analyst, Atlanta

When ICG and Netcom announced their intent to merge on Oct. 13, 1997, ICG president and
CEO J. Shelby Bryan sketched what he thought was an unbeatable combination.
"Together, the combined company will have a broader product and service offering
ranging from dial tone to Internet access and web-page hosting and support–all from a
single provider," he said.

A little more than a year later, however, ICG agreed to sell the U.S. dial-up part of
Netcom to Mindspring Enterprises Inc., Atlanta. For $245 million in cash and stock,
Mindspring got all the sales and marketing people who dealt with Netcom’s retail
customers, and its 400,000 dial-up customers. ICG kept the nationwide backbone network and
the people who run it. Bryan says that selling the retail dial-up side was part of the
plan all along. "We just wanted the damn network," Bryan says.

It was the network that William J. Rouhana Jr., and his colleagues at WinStar wanted,
too, when they bought GoodNet Inc. "It was, and is, a tier 1 ISP with an ATM
(asynchronous transfer mode) backbone," says Rouhana, WinStar’s chairman and CEO.
"They provide not just Internet but ATM services. We’ve set up our WinStar broadband
services division … to give a full range of broadband choices–Internet, ATM, frame
relay. Then we’ve expanded our Internet related services to do [web] hosting and
design."

Hilary Mine, executive vice president of Probe Research Inc., Cedar Knolls, N.J.,
believes that all service providers eventually must decide to be either facilities-based
providers of bandwidth or reselling providers of content. "After all, America Online
[Inc. (AOL), Dulles, Va.] is a value-added reseller of UUNET," a subsidiary of MCI
WorldCom Inc., Mine says.

Indeed, AOL’s Compu-Serve division just entered a strategic relationship with MCI
WorldCom. In this initiative, called MCI World-Com Internet, CompuServe will offer a
customized portal and other content-related goodies to MCI WorldCom long distance
customers, who will pay $16.95 per month for the first 150 hours of local Internet access.
MCI WorldCom, in addition to providing the customers, will provide backbone service over
UUNET. The deal was announced Feb. 4.

"Long distance companies are recognizing they need to partner with portals and
other Internet specialists in order to thrive in this marketplace," says Jeffrey
Kagan, an independent telecom analyst based in Atlanta. "That’s why you are seeing
AT&T and MCI WorldCom partner with successful Internet players. It’s actually a smart
move, since you can’t be an expert in every area, so you are better off working with
experts than trying to be an expert in every field."

Most of the carriers that purchased ISPs in the past two years seem to have a foot on
both sides of Mine’s divide. Most, like ICG, wanted the network and the brains behind it.
But most have fewer dial-up customers to shed than Netcom had, and many are reluctant to
shed them. Some even expect to grow their number of dial-ups selectively.

When GST bought Whole Earth, it got the usual: the backbone, the techies to run it, the
marketing people to sell it–and 34,000 dial-up subscribers. It got David Williams, a
founder and former chief operating officer of the ISP, and now GST’s vice president of
data marketing. In this case, Williams insists, the fit was right. Whole Earth has been
integrated into GST, and GST now offers the full range of voice, data and Internet
services, mainly to business customers in the western states and Hawaii.

But GST also tries to make the most of the 34,000 dial-up customers, Williams says.
"Our focus will remain primarily on our business customers," he says. "But
one of the major cost components for the dial-up ISP is telecommunications. So there are a
lot of synergies in being able to provide that ourselves in the areas where we operate.
We’ve got the dial tone, got the backbone, and that’s a natural fit."

Williams says GST markets its dial-up directly in areas where its telecommunications
services are particularly well dug in–in Hawaii, for instance. The combined GST and Whole
Earth networks offer a backbone for whatever services seem likely to succeed in a given
market.

Frontier Corp. may have gone farther than most of its competitors in making use of a
newly acquired ISP across all its business segments. Frontier’s stated priority is to
serve businesses that spend between $5,000 and $50,000 per month on telecommunications,
and that means voice, data, Internet access and web-hosting capabilities. When Frontier
acquired Global Center, it also acquired one of the world’s premier web-hosting
operations, and the company has worked hard to make the most of it.

A Sampling of Recent Telecom/Internet
Acquisitions and Strategic Investments

Acquirer/Investor

Target

Transaction Value (US$Mil.)

Date

Qwest Communications International Inc.

Xlink Internet (Germany)

$26

February ’99

Global TeleSystems Group

DataNet/Net Force (Hungary/Czech Republic)

$20

February ’99

British Telecom plc

Arrakis (Spain)

$16

February ’99

Cable & Wireless plc

ECRC Network Services (Germany)

$44

January ’99

MCI WorldCom Inc.

OzEmail (Australia)

$318

December ’98

StarHub *

CyberWay (Singapore)

$40

December ’98

SBC Communications Inc.

Concentric Network Corp. – 4% investment

Not Disclosed

November ’98

Hong Kong Telecom

Star Internet (Hong Kong)

$31

November ’98

France Telecom

WEB A/S – 80% investment (Denmark)

Not Disclosed

October ’98

Level 3 Communications Inc.

Miknet (Germany)

Not Disclosed

September ’98

Qwest Communications

Icon CMT

$185

September ’98

RCN Corp.

JavaNet

$16

August ’98

Cable & Wireless plc

MCI’s Internet assets

$1,700

May ’98

Scottish Telecom

Demon Internet (UK)

$110

April ’98

France Telecom

Oleane – 67% investment (France)

Not Disclosed

March ’98

AT&T Corp.

@Home – Partial investment

$1,000

March ’98

Qwest Communications

EUnet International (The Netherlands)

$154

March ’98

RCN Corp.

Erols Internet

$84

March ’98

RCN Corp.

UltraNet Communications

$27

March ’98

GST Telecommunications Inc.

Whole Earth Networks

$10

March ’98

Sprint Corp.

Earthlink Network

$124

February ’98

Qwest Communications

AGIS Internet – 20% investment

Not Disclosed

January ’98

Frontier Communications

GlobalCenter

$180

January ’98

WinStar Communications Inc.

GoodNet Internet

$22

January ’98

ICG Communications Inc. **

Netcom Online

$284

October ’97

MCI WorldCom Inc.

CompuServe

$1,186

September ’97

Intermedia Communications Inc.

DIGEX

$150

July ’97

GTE Corp.

BBN

$616

May ’97

* StarHub is a consortium of Singapore Technologies, Singapore
Power, British Telecom and NTT
** ICG later sold the majority of Netcom’s Internet assets to MindSpring Enterprises

Source: Arthur Andersen LLP, Chicago

"There isn’t a user in North America who hasn’t used us to get access to
content," says Jon Russo, Frontier’s senior vice president of data product marketing.
As a web host, Frontier and its Optronics network are hosts for Yahoo! Inc., Newsweek
magazine and The Washington Post, to name only a few. Russo says Frontier leverages
Global Center’s people, backbone and customers in ways that fit each of Frontier’s
targeted markets. Frontier offers dedicated access to the Internet in its various roles as
an ISP, a competitive local exchange carrier (CLEC), an incumbent LEC (ILEC) and a long
distance company, as a retailer to small to medium-sized businesses and as a wholesaler to
carriers.

Frontier has 100,000 dial-up subscribers inherited from Global Center, but it doesn’t
market dial-up Internet access except in the 33 markets where it is the ILEC. In those
places, access to the Internet is one more value-added service to Frontier’s customers.

Frontier, GST and other carriers have been aggressive in building network capacity–or
in acquiring it from the likes of Qwest Commun-ications International Inc., Denver, or
Level 3 Communications Inc., Omaha, Neb. Packet switching, synchronous optical network
(SONET), ATM and IP are the technological hallmarks of such carriers.

Buying an ISP is not the answer for every carrier, however–particularly if the carrier
has a lot of ISPs for customers. US LEC Inc., Charlotte, N.C., is such a carrier. US LEC
offers Internet access in cooperation with its many ISP customers. The alternative–buying
an ISP or building one’s own IP network–is too ghastly to contemplate, says Jeff Blackey,
US LEC’s marketing vice president. It’s expensive, of course, but also may be suicidal.
"You don’t want to compete with your customers," he says.

For carriers that want to get their customers and the Internet together in a profitable
way, but lack US LEC’s regiments of ISP customers or the resources of GST, ICG or
Frontier, there is another possibility: resale.

EPOCH Internet, Irvine, Calif., provides wholesale services on its backbone for
carriers with this offer: We’ll sell you dedicated and dial-up Internet access wholesale;
we’ll train you, give you an integrated billing system, let you brand the service with
your brand and bundle it with whatever else you offer. Other large ISPs–UUNET, Herndon,
Va.-based PSINet Inc. and Armonk, N.Y.-based IBM–have similar offers. In recent months,
telecom carriers have come to the table with wholesale offerings. In February Qwest and
Frontier joined Sprint Corp. in bringing a dedicated Internet access services to
resellers. IXC Communica-tions Inc., Austin, Texas, also offers wholesale dedicated
Internet access plus dial-up. Wholesaler Williams Network, Tulsa, Okla., has announced a
phased launch into wholesale Internet services, beginning with transit. The carrier
expects to offer dedicated access later this year.

GST, Frontier, WinStar, ICG and the others all have plans they’re trying to execute,
but none of them has a crystal ball. The last year has been full of surprises for them.
WinStar’s Rouhana, who bought GoodNet for its backbone and its geeks, was pleasantly
stunned to discover he also had acquired a cadre of telemarketers who could sell T1 lines
over the phone to business customers. "I didn’t think it was possible," he says.
"To me, that’s a sign of how much demand there is out there for bandwidth."
GST’s Williams does his best to execute in the present and plan for the future, but his
experience tells him just how dicey the future can be.

Asked if he had any idea, when he co-founded Whole Earth in 1994, that he would be
where he is, doing what he is doing, in 1999, Williams confesses he hadn’t a clue.
"There wasn’t a crystal ball big enough to show you that much future," he says.

Ken Branson is business and finance editor for PHONE+ magazine.

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