The Race To Wire Europe

Phones, TV, the Net--Who Will Prevail?

Dial into a British Web site called Band-X, and you see firsthand how radically Europe's telecom industry is changing. A London-based brokerage for phone lines, Band-X offers telephone companies a chance to hawk their extra capacity online to competitors or corporate clients at cut-rate prices. That's a huge change from just a few years ago, when phone rates were practically carved in stone. Thanks to fierce competition, benchmark Paris-London long-distance rates have tumbled 70% in the last six months.

Band-X is just one soldier in an army of dealmakers and entrepreneurs closing in on the Continent's $200 billion telecom industry. The battlefield now spans phones, software, and media and the fighters include global leaders as well as upstarts no one had heard of just a few years ago. Microsoft Corp.'s William H. Gates III is trolling for a piece of Germany's cable-TV market to anchor his growing European portfolio. MCI WorldCom Inc. Chairman Bernard J. Ebbers is spending $1 billion a year to wire Europe with fiber-optic cable.

Then there's Roberto Colaninno, chief of the rejuvenated Olivetti. He has astounded the business world with his successful hostile takeover of his much larger rival, Telecom Italia, battling off a counterbid from Deutsche Telekom in the process. The move sent alarms ringing through Europe. "This was the first time a company that had practically no money was able to do a hostile takeover simply because it wanted to," says Maximilian Ardelt, telecommunications chief at German conglomerate Viag.

TOUGH CALL. In many ways, the takeover encapsulates the transformation of European telecoms. Deregulation and privatization made Telecom Italia, a former state monopoly, a target. And with markets surging, the amount of capital hungry for hot deals has increased tremendously in Europe. So has the tolerance for risk. When Colaninno offered an unusual mix of cash, stock, and debt to Telecom Italia shareholders, he found enough takers to win the day. Now, his investors are betting he can turn Telecom Italia into Italy's dominant provider of Internet services and an attractive partner in otHer high-tech ventures across Europe.

For all its promise, Europe is a far rougher market to gauge than North America. Even with the new common currency, it remains splintered by languages and governments. And the differences in technology are vast. While Northern Europe is plugged into the Web at near-American levels and has among the largest cable-TV audiences in the world, the Mediterranean countries remain virtual cyberdeserts, and uncabled to boot. Despite fast growth, Europe has only half the personal computers per capita that the U.S. does, and a third the Web-surfing population.

At the same time, Europe's phone companies are pushing into mobile telephony far more aggressively than their U.S. counterparts. So while few Europeans have fast Internet connections to their PCs, they could soon be surfing the Net at warp speed on their mobile phones. In the next decade, analysts expect technologies on the two continents to converge. In the meantime, the U.S. remains a developing market in mobile services--while Europe plays catch-up at getting wired for the Internet.

The game of catch-up spells opportunities that are sure to spark more communications deals in Europe. And the winners will control the lucrative convergence of Europe's telephone, TV, and Internet markets. Next to the U.S., this is the key place where players big and small are scrambling to stake out a position in the new digital age. "In this market, those who think defensively are going to have trouble surviving," says James G. Richardson, Europe president for network heavyweight Cisco Systems Inc. For Cisco and other communications equipment suppliers, Europe is the fastest-growing market.

BROKEN LOCK? A host of newcomers--from New York's Viatel Inc. and London's Colt Telecom Group PLC to big names such as MCI WorldCom--are hustling to fill the surging demand for communications services. Former national champions are already feeling the pain. Deutsche Telekom, for example, has lost 30% of its long-distance phone market in the last year to startups. With time, these newcomers should break the German behemoth's hammerlock on the local market and offer digital services, including interactive television, through high-speed phone lines.

Competition is coming from nonphone companies, too. Software king Microsoft is teaming up with publishing giant Bertelsmann for what appears to be a multibillion-dollar bid for Deutsche Telekom's cable-TV business in Germany. Microsoft wants to plant its products, both information and software, on Europe's Web. Its sites could eventually lead Europeans to shopping and service providers via TV or cable modem. Cable- TV technology can also offer phone services. So Microsoft could soon be taking on Europe's phone giants.

But the biggest challenge to phone companies comes from upstarts. Viatel is typical. For years, the eight-year-old company eked out a living in niche markets such as prepaid calling cards. Then, a year ago, Viatel issued $890 million in junk bonds to bankroll an 5,400-mile fiber-optic network connecting 40 cities in Europe. Now, Viatel is underselling the big companies with cheap long-distance service. Its stock has risen seven-fold in the last year.

The next battle will be over the so-called last mile. That's the critical connection from high-speed networks to individual homes. So far, the former monopolies still control the last mile. Except for Deutsche Telekom, few are hurrying to upgrade these connections with high-speed technology. So Europeans are still stuck with dial-up modem speeds, even while superfast fiber cables stretch across their continent.

CABLE NET. One way to skip a costly battle over the last mile is to use cable networks to wire homes for the Net. That's Microsoft's approach. Before it even looked at a cable deal with Deutsche Telekom, Microsoft had bought two cable companies in Britain andinvested in a Dutch cable operation. To turn the cable into a two-way hookup costs roughly $600 per home. But once that is done, the cable can zip data at a blistering 4 megabits per second, fast enough for live video on a home PC.

Cable-TV companies should start rolling out major Internet connections across Europe by next year, analysts say. This will present telecom companies with nasty choices. Do they lay out billions upgrading local phone lines to compete with the cable-modem threat? Or do they move on to next-generation technology? A modem due to emerge from the labs next year couldprocess a mind-boggling 25 megabits per second through the phone line, enough to power four TV channels simultaneously.

Thus, European phone companies could jump into the TV business--just as cable companies reach for the phones. This mingling of digital businesses should lead to tempestuous times in Europe, with more buyouts and new alliances. When they're over, communications on the continent will look very different from today. Far less certain is which companies will come out on top. The game is just beginning.

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