Verizon's Mega-Makeover

Its network upgrade may create a new industry standard

For more than a century, the phone companies in America have drawn their power and wealth from their venerable networks of switches and the copper lines that lead to nearly every home in the country. But now the biggest of the Bells, Verizon Communications Inc. (VZ ), is coming to grips with the limitations of the traditional phone network -- and it's making ambitious plans to replace it. "Having watched this industry for 35 years," says Bruce Gordon, president of Verizon's retail division, "I don't believe it's a network that will take us into the next decade."

So Verizon is pulling out its wallet to retool. Faced with growing competition from cable-TV companies and others, it's committing itself to the most dramatic network upgrade in its history. As BusinessWeek Online reported on Mar. 18, the plan is to hitch every customer in its local-phone region to a blazing fast connection. This means speeds of 5 to 10 megabits per second, up to 20 times faster than today's typical broadband connections through digital subscriber lines or cable modems. That's fast enough to provide voice, video, and digital-TV signals on a single connection to the customer.

The company won't say how much the project will cost or how long it will take, but it's sure to cost billions of dollars, and could take 10 or more years to roll out. "These copper loops will be replaced by fiber-optic technology. We'll begin initial rollout in 2004, if technical trials...and regulations go well," said Vice-Chairman Lawrence T. Babbio in a Mar. 19 conference call.

Verizon's gambit may well be the best news out of the telecom sector since the industry went into a recession nearly three years ago. During the boom, the industry fell prey to over-ambitious business plans and ill-conceived mergers, cobbled together with financial engineering. Such practices led to the bankruptcy of industry giants like WorldCom Inc. and Global Crossing Ltd. Instead of wasting investors' money paying a huge premium to buy another company, Verizon is proposing to invest slowly and steadily in the improvement of its network.

The benefits could be enormous. Verizon, which has a 2003 capital budget of up to $13.5 billion, one of the largest of any company in the U.S., could help stabilize the struggling telecom-equipment sector. The spending would trickle through the tech food chain and into the economy. More importantly, it could provide a platform for the innovation of new products and services, from digital entertainment to cheap video calls.

Pulling this off, though, will be quite a challenge for a company that failed at several high-tech ventures in the '90s. Verizon's merger with John Malone's cable empire, the former Tele-Communications Inc., fell through. Its attempt to enter the interactive-TV business fizzled, too. And while Verizon has stumbled, cable-TV companies have raced out to an early lead in broadband.

Still, Verizon's offering, when it arrives, should make today's broadband look positively pokey. The company stands to benefit from plummeting prices of high-speed technology, which are off as much as 75% since the '90s. High-speed wireless technologies also have become better and cheaper. These are systems that dispatch fast streams of data to antennas miles away. To reach every customer, Gordon says, Verizon is betting on a combination of fiber and wireless -- but is keeping quiet on the details.

The market is also forcing Verizon's hand. Customers, eager to swap MP3 files, download movies, and work at home, are demanding more bandwidth. And they are beginning to enjoy alternatives. By bundling voice, video, and data, cable-TV operators have already captured 2% of the U.S. phone market -- and they're reaching up to 30% in certain cities such as San Diego. Cox Communications (COX ), Cablevision Systems (CVC ), and Comcast (CMCSK ) are expected to expand their phone business during the next few years, as cheaper Internet-based technology takes root.

By building a new network, Verizon is diverging from the other Bells. To respond to the cable threat, SBC Communications Inc. (SBC ) is mulling an acquisition of satellite-TV operator DirecTV Inc. BellSouth Corp. (BLS ) has invested heavily in DSL services, but says it has no plans for a next-generation network like Verizon's. "We've made so many investments in broadband, it's hard to say right now if we'll make any more," says BellSouth spokesman Jeff Battcher.

Regulatory relief in Washington bolsters Verizon's investment plans. The Federal Communications Commission ruled in February that the Bells won't have to share next-generation networks with competitors at low, government-established rates. On Mar. 19, regulators also released Verizon from final restrictions on its ability to offer long-distance phone service. These regulatory changes encourage the company to invest in the construction of new networks by improving the potential return on its investment.

Plenty of challenges lie ahead. Verizon paid down $10 billion of debt last year but still ended 2002 with a heavy $54 billion of IOUs. Stress on the balance sheet, combined with the need to pay a dividend, limits the company's financial flexibility. CEO Ivan G. Seidenberg, a former union cable splicer, will be under pressure to seek painful concessions from organized labor to lower costs for the broadband project ahead. He'll have to move fast, too. Verizon already faces enormous competition from wireless companies and resellers, such as AT&T and WorldCom, which eat away at the company's core business. These resellers have captured about 8% of the market as of 2002. That share is expected to double by 2004, estimates communications analyst John Hodulik of UBS Warburg.

Verizon can't afford to stumble this time. Its revenue growth, even including the new wireless and DSL businesses, was a paltry 1.5% last year. True, it was tops among the Bells. But that grouping, with its old-fashioned switches and wires, is tethered to the past. Verizon, to its credit, is looking to bust out.

By Steve Rosenbush in New York

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