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Bandwidth exchanges turn into high-capacity money pits
by Patricia Brown
10/03/01, 2:10 p.m. ET
It’s been two years since Enron Communications Inc. (Portland, Ore.) and Global Crossing Ltd. (Hamilton, Bermuda) completed the world’s first bandwidth trade in 1999, lending credence to the idea that bandwidth is a commodity that can be traded like energy or other utilities. However, players are still struggling for footing and significant returns. Other players that joined the fray-including Williams Communications Group Inc. (Tulsa, Okla.), Dynegy Global Communications (Houston) and El Paso Corp. (Houston)-are learning that trading bandwidth is hardly a straightforward or quick path to profit, particularly with long-haul capacity gluts.
Band-X Ltd. (London), a telecom trading exchange that matches buyers and sellers of dark fiber, clear channel bandwidth and switched minutes, says prices are 90 percent off last year’s highs. Indeed, Tim Stronge, director of research with TeleGeography Inc. (Washington, D.C.), says prices are coming down by 50 percent per year. In 1997, a transatlantic STM-1 (155 Mbit/s) connection cost $16 million for the life of the line. By the end of this year, it’s expected to cost $400,000. “Prices are continuing to drop fairly dramatically and will probably continue to drop on certain routes for a period of time,” says Donald Noonan, vice president of networks at Band-X.
Some price stabilization is occurring, but not in the critical routes that will help bolster the finances of many players supplying capacity. “We’re starting to see price stabilization on very small bandwidth increments,” says Noonan, “but large capacity-which is what’s affecting most carrier bottom lines-continues to fall.”
A few key players are lucky enough to be subsidiaries of deep-pocketed energy conglomerates, which are in it for the long haul. They’d better be: Most exchanges are bleeding cash. Enron’s broadband business lost $102 million in the second quarter of 2001 on revenue of $16 million. Dynegy Global reported losses of $20 million in the second quarter, after investing $700 million on its 16,000-mile U.S. fiber network as well as on its European network. Dynegy does, however, expect to reach positive earnings before interest, taxes, depreciation and amortization (EBITDA) by year’s end, and it hopes to reach positive net income in 2002.
One major obstacle is provisioning. Unlike with energy, high-bandwidth circuits can’t be easily turned on and off. It takes months, and traders need at least that long to provide a client with requested capacity. This makes a spot market with fluid buying and selling-a critical element on commodity trading floors-nearly impossible.
Some analysts say exchanges won’t be a viable proposition until circuits can be turned on and off in real time. “For this market to take off, you’ve got to get the carriers on board, and you’ve got to have volatility in prices,” says Seth Libby, an analyst at The Yankee Group (Boston). “We don’t have volatility. There are no upward or downward bandwidth swings, which carriers need.”
Other analysts believe exchanges will remain in a holding pattern for the short term. “The cycles in the telecom market are severe and more cruel to these players” than other traded commodities, says Ciara Ryan, a principal at Andersen (Chicago). “I don’t think they’ll want to pick up any more assets until there’s some consolidation in the market and prices start to stabilize.”
Another fundamental problem is a result of the inadequate number of potential buyers. Telecom companies aren’t confident that their customers will want applications requiring these speeds, says Stephen Young, principal consultant at Ovum Ltd. (London). However, he says, “investor concerns about carriers’ ability to manage risk will force carriers to embrace the trading of commoditized bandwidth.”
Analysts agree that a market will exist eventually. “Once contracts are standardized and neutral pooling points are established, commoditization and the subsequent liquidity will unlock the derivatives market, driving a financial trading market for bandwidth commodities,” Young says.
Eighty-nine percent of respondents to a recent Andersen survey expect bandwidth trading to have at least some impact on their company. A full 94 percent expect a liquid traded-bandwidth market to emerge within three years, with the New York-London route expected to emerge first as the most liquid city pair.
Traders also remain optimistic. Enron claims it increased bandwidth trades from one per month in April 2000 to 20 per day in April 2001. In the last quarter of 2000, Enron completed 321 trades, which rose to 580 in the next quarter. Dynegy’s trading group averages five to 10 trades per week, double last year’s figures.
Still, “the market isn’t evolving as quickly as we expected,” says Dane Howell, director of Dynegy’s broadband trading and origination group. He concludes that all of the assets are in place but that an overall culture change is necessary before carriers begin trading.
Enron and other players are willing to wait. “It took Enron three to four years to make a profit in gas and electricity trading,” says Libby. “Enron has been in the business for a while, and I don’t think it’s going to be deterred by initial losses.” However, he does expect the company to keep an eye on the short term.
Switched Gets Rich
While the overall bandwidth exchange market is struggling, one segment-the market for buying and selling switched voice minutes-is surging. As the most widely transacted of all exchange products, it’s also generating the most money. Analysts say companies swimming in these waters, such as Band-X Ltd. (London), Arbinet-thexchange Inc. (New York) and RateXchange Corp. (San Francisco), are among the best positioned in the bandwidth trading business-at least for now.
The volume of switched long-distance minutes traded on Band-X’s exchange rose by 30 percent in the first quarter of 2001, compared to the previous quarter. Its facilities-based business and routed IP access business grew by 20 percent in that same time. “Our switched minutes business is growing by leaps and bounds,” says Band-X vice president of networks Donald Noonan. “Band-X has never been a promoter of the idea of considering bandwidth a traded commodity. The business we’re in is deliverable services.”
Arbinet-thexchange is seeing a monthly increase in volume of 20 to 30 percent. “We’re operating a run rate of 2.5 million per year,” says Chris Reid, the company’s director of marketing. “That’s doubled in the last four months.” Arbinet-thexchange provides a neutral platform for carriers to trade switched voice minutes, voice over Internet protocol (VoIP) and wireless traffic.
The overall industry slowdown has been good for the switched-minute business because most carriers are forced to find other ways to make money from their installed networks, says Reid. “On the sell side, a lot of these guys are looking at the exchange as a way to do a couple of agreements and start terminating minutes on that network. On the buy side, our service lowers the overall cost to terminate traffic.” The overall industry slowdown has been good for the switched-minute business because most carriers are forced to find other ways to make money from their installed networks, says Reid. “On the sell side, a lot of these guys are looking at the exchange as a way to do a couple of agreements and start terminating minutes on that network. On the buy side, our service lowers the overall cost to terminate traffic.”
Investors seem to be buying into the Arbinet-thexchange business model. In July, the company announced that it had closed a $35 million round of private equity funding. Arbinet-thexchange currently has switches in New York and London and expects to have one in Los Angeles soon.