Verizon's Gutsy Bet

Will its massive rollout of fiber-optic cable -- right to customers' homes and offices -- keep it ahead of the pack?

Ivan G. Seidenberg hardly looks like Old Man Telecom. The chief executive of Verizon Communications (VZ ) Inc. is only 56 and has the build and intensity of someone much younger. But sitting in his sun-filled, 39th-floor office in Midtown Manhattan, Seidenberg points out that he joined the company as a cable splicer's assistant in the Bronx when he was 19. He even keeps his cable splicer's shears, knife, and sheaf tucked away in his desk. "It's hard to believe, but I've been here for 37 years, more than one-third of this company's history," he says. "I feel an obligation to make sure this company is well positioned for the next 100 years."

Now Seidenberg is launching a series of sweeping initiatives to make good on his vow. From hardball pricing tactics that have knocked rivals back on their heels to a capital-spending war chest that's the largest in telecom, he's determined to transform what was once just another sleepy phone company into the pacesetter for the industry. "When you're the market leader," says Seidenberg, "part of your responsibility is to reinvent the market."

At the heart of this reinvention is the most ambitious deployment of new telecom technology in years. Verizon plans to roll out fiber-optic connections to every home and business in its 29-state territory over the next 10 to 15 years, a project that might reasonably be compared with the construction of the Roman aqueducts. It will cost $20 billion to $40 billion, depending on how fast equipment prices fall, and allow the lightning-fast transmission of everything from regular old phone service to high-definition TV. No competitor yet dares follow suit, fearing it could be their financial Waterloo. "We'll watch them closely and go to school on them if they have found something economic," says Ross Ireland, chief technology officer at SBC Communications (SBC ) Inc., the second-largest phone company after Verizon.

Seidenberg is being no less aggressive when it comes to the wireless technology that has consumers and companies equally abuzz -- Wi-Fi. In an unprecedented move, Verizon is blanketing Manhattan with more than 1,000 Wi-Fi hotspots that will let any broadband subscriber near a Verizon telephone booth use a laptop to wirelessly tap the Net for the latest news, sports scores, or weather report. If the rollout goes well, Verizon will duplicate this wireless grid in other major cities. Next up: third-generation wireless service, known as 3G, which lets customers make speedy Net connections from their mobile phones. Verizon will begin to deploy 3G in September, at least three months before any of its major competitors. "The other guys will say they want to be the best follower. The guy on the frontier takes a lot of arrows, so they say, 'Let someone else roll out 3G and fiber-to-the-home.' Well, that someone else is Verizon," says Alex Peters, lead manager of the $200 million Franklin Global Communications Fund, which bought an undisclosed number of the company's shares last year.

Verizon is leading the way with its pricing strategies, too. In March, the company became the first Bell to slice its broadband Internet service by 30%, to $35 a month. That's typically 10% to 20% cheaper than cable players such as AOL Time Warner (AOL ) Inc. and Comcast (CMCSK ) Corp., which have grabbed an early lead in broadband service. Even the musty long-distance business is getting a jolt of innovation: Earlier this year, Verizon became the first Bell to offer unlimited long-distance and local calls for one flat rate, typically $55 a month. Customers loved the idea, and Verizon quickly zoomed past Sprint (FON ) Corp. to become the third-largest consumer long-distance player in the country. Now, every other Bell has introduced its own flat-rate service.

What's behind Seidenberg's sudden series of audacious moves? Two major reasons: competition from cable companies and the CEO's vision of his industry's future. The cable assault is most pressing because Comcast and its brethren are cutting into Verizon's cash-cow local-phone business and swiping most of the customers in broadband, the fastest-growing segment of telecom. To compete, Verizon plans to use its fiber-optic lines to offer Net access that's 20 times as fast as today's broadband -- and bundle that with local phone service.

Just as important is Seidenberg's conviction that telecom as we know it is history. In its place will emerge what he calls a "broadband industry" that will use the new, superfast Net links and high-capacity networks to deliver video and voice communications services with all the extras, like software for security. If he's right, other companies will follow Verizon's lead and the communications industry will be remade. Seidenberg thinks ubiquitous broadband will transform broad swaths of the economy. High school students, for instance, could download the video of a biology lecture they missed. Doctors could use crystal-clear videoconferencing to examine patients in hard-to-reach rural areas. "The cable industry focuses on entertainment and games. The broadband industry will focus on education, health care, financial services, and essential government services," he says. "I think over the next five to 10 years, you will see five, six, seven [segments of the economy] reordering the way they think about providing services."

Over the long term, the strategy will put Verizon into completely new businesses. Though video may not be its primary focus, the company says that within five years it expects to distribute video services, which could include TV programming and movies on demand, so it can compete directly with cable companies. "I think it's terrific....It could definitely work," says Sumner M. Redstone, chairman and CEO of Viacom (VIA ) Inc., whose holdings include MTV Networks (VIA ) and Paramount Pictures (VIA ), and where Seidenberg is a director.

There are plenty of people, however, who think all that time spent up on the 39th floor has left Seidenberg a bit light-headed. Can any company afford to do what Verizon is attempting? The company says it will pump $12.5 billion to $13.5 billion into capital expenditures this year, the third-largest capital budget in the world after DaimlerChrysler (DCX ) and General Electric (GE ) Co. That's on top of the $3 billion a year it's paying in yearly interest because of its $54 billion debt load. How can Verizon pay for all this? Its business is one of the great cash machines of Corporate America. The largest local-phone operator and the largest wireless company, Verizon generates about $22 billion a year in cash from operations. That's 50% more than SBC, twice as much as BellSouth (BLS ) and nearly three times as much as AT&T (T ). More than any company in the industry, Verizon can make enormous bets and pay for them out of its own pocket. Seidenberg expects to cover the fiber-optic initiative without raising the capital budget above the current level, while he continues to reduce the company's debt. "Funding is not an issue," he says.

Still, plenty of critics question whether Seidenberg is leading the industry in the right direction. SBC and Qwest Communications (Q ) International ventured onto a different path when they announced partnerships with satellite-TV service EchoStar (DISH ) Communications on July 21. The deal will allow them to combine voice, video, and data on a single bill -- sooner than Verizon and at a fraction of the cost. And rather than a massive fiber rollout to offer broadband Net service, SBC is focused on DSL, where it has a big lead on Verizon. Other industry experts think Verizon's plan may not make financial sense. "Frankly, I'm skeptical," says former Federal Communications Commission Chairman William E. Kennard, managing director of investment company Carlyle Group.

The skepticism stems in part from history. Verizon was formed from the merger of Nynex and Bell Atlantic in 1997 and the melding of the combined companies and GTE in 2000. The predecessor companies tried, and failed, several times in the 1990s to capitalize on the convergence of television and communications. Bell Atlantic and Nynex helped launch Tele-TV in 1994 to develop interactive-TV programming, but the project folded after several years. Bell Atlantic also announced a merger with cable-TV powerhouse Tele-Communications Inc. in 1994, only to see the deal fall apart a few months later.

Now Verizon faces cable companies that are spoiling for a fight. The cable industry has spent more than $75 billion since 1995 to upgrade their networks for high-definition TV, fast Internet access, and telephone service. The phone companies "have to make sizable investments to catch up," says David N. Watson, executive vice-president for marketing at Comcast, the nation's largest cable operator. "And we won't be standing still." In fact, Comcast and the other cable companies are hell-bent on torpedoing Seidenberg's plans by destroying Verizon's profits before it can use them to get into the video business. Cable players are expected to nab 3.7 million phone lines nationwide by 2005, up from 2.2 million last year, according to market researcher Kagan World Media. That, along with competition from AT&T Corp. and wireless companies, caused Verizon to lose 3.7% of its local-phone lines in 2002.

The competitive threat is compounded by Verizon's labor situation. The company is locked in intense negotiations with its two main unions over a new contract for 75,000 of its 228,000 employees. Far apart over issues of health-care costs, work-rule flexibility, and organizing in the wireless unit, the two sides may very well be headed for a strike when the current contract expires on Aug. 2. Verizon has trained tens of thousands of managers to assume union duties should the talks fail. "There is no clear break. Sometimes you can see it in advance. This time, we can't," says George Kohl, director of research for the Communications Workers of America.

Verizon's labor issues won't disappear even if a strike is averted. More than half of its workers belong to a union, while rival cable companies are typically nonunion shops. Verizon has what it says are the highest costs in telecom, with union workers in New York earning an average salary of $62,000, plus overtime and benefits. More important, Verizon has less flexibility than competitors when it comes to laying people off or reassigning them to high-growth units. On July 11, a labor mediator in New York ordered Verizon to rehire 2,300 workers the company had thought it had the right to lay off. It quickly announced it would rehire an additional 1,100 workers who were making similar claims in mediation.

Asked about all the skepticism, the understated Seidenberg responds with a wry smile. "People that watch our industry tend to be skeptical when there's hard work involved, but we've shown the resolve to get up every morning and do what it takes," he says.

Seidenberg and other execs insist much has changed at Verizon since the miscues of the '90s. In February, the FCC changed the regulations so that Verizon and other Bells won't have to share their new networks with rivals at government-controlled prices. Although final details have yet to be released, the decision strengthens the business case for building the networks. At the same time, the price of rolling out fiber to homes and offices has dropped by 50% over the past five years, and it will likely decline another 50% over the next few. "This is not a trial. It's a deployment," says Bruce S. Gordon, president of Verizon's consumer division. "The decision has been made, and it will happen. There's no going back."

If Seidenberg is right, he's positioning Verizon to thrive in the coming decades. Short-term, the deterioration in the core local-phone business probably will cancel out growth in new services. Analyst Simon Flannery of Morgan Stanley (MWD ) expects revenues to stay flat at $67 billion this year while net income declines 10%, to $7.5 billion, not including a $3 billion noncash charge for an accounting change and a write-down from international operations. Profits could even shrink again in 2004, to $7.2 billion. After that, Verizon's prospects look better. As broadband services are rolled out to more of its customers, Flannery estimates that the company's revenues will hit $70 billion in 2005 and net income will recover to $7.6 billion. "They are definitely the industry's future," says Brian Adamik, chief executive of market researcher Yankee Group (RTRSY ).

Leave it to Seidenberg to do what others think impossible. The son of an air-conditioning repairman, he grew up in the working-class Gun Hill section of the Bronx. If he had potential for greatness, it was well hidden. Without the money for college, he started working for New York Telephone splicing cables in 1966. He was quickly drafted into the U.S. Army and wounded in Vietnam. After he returned to his old employer in 1968, his raw determination emerged. With his company helping to foot the bill, he earned a BA in mathematics from Lehman College, of the City University of New York, and an MBA at Pace University. He married his high school sweetheart, Phyllis, and they now have two children. During this time, he spent 12 straight years going to night school.

He worked hard on the job, too. As the youngest person on a work team laying cables at Co-op City in the Bronx, Ike, as he was called at the time, would remeasure the cable lines of other workers to see if they were the right length. Perhaps most surprising, he did it without getting throttled by more-senior workers. How? He never tried to take credit for the extra work from supervisors. He simply told the other workers so they could correct any errors as a team. Plus, he was a likable guy who played in the regular lunchtime football games. Seidenberg worked in operations and engineering before moving to Washington to handle regulatory affairs. In 1995, he became chairman and CEO of Nynex Corp.

It could have been a brief, shining moment of glory. When the local-telephone industry was deregulated in 1996, Nynex looked like takeover bait: too small to determine its own fate. Still, Seidenberg figured out a way to get the necessary scale by cutting savvy deals and sharing the spotlight. First, after the Bell Atlantic merger, he let Bell Atlantic Corp. CEO Raymond W. Smith run the combined companies for a couple of years before taking over. Then he waited his turn while GTE Corp. CEO Charles R. Lee ran the show, taking full control only after Lee stepped down as co-CEO last year, at the age of 62. "He's a master boardroom player," says Kennard.

Even now, Seidenberg is eager to let his lieutenants take the limelight. He often has Vice-Chairman Lawrence T. Babbio Jr., who runs the traditional phone business, and Verizon Wireless Services CEO Dennis F. Strigl represent the company in public forums. "All of these people could be CEOs in their own right. They are warriors, and they are on a mission," says Seidenberg. Yet they profess fierce loyalty to him and Verizon, which has been an island of stability in a churning sea.

The commander will need all the warriors he can get. Within two years, the cable-TV companies are expected to be in the phone business big time. They already have 15% of the market in a handful of Verizon neighborhoods where they offer phone service. Cable companies like Comcast, Cablevision Systems, and Cox Communications are planning to expand their phone operations in 2004 using Internet technology that's cheaper and packed with features like inexpensive second and third phone lines. At the current pace, the cable companies will probably have 30% of the phone market over the next decade, says telecom analyst John Hodulik of UBS.

The fiber strategy will help Verizon defend itself. By offering TV, superfast Web access, and feature-rich Internet-based phone services, Verizon could reduce potential customer churn by 50%, Hodulik estimates. Assuming fiber is deployed, he thinks the company will have 2007 net income of $7.9 billion on revenues of $79.7 billion. Those numbers are 2.5% and 5.7% higher than his forecasts before the fiber strategy was outlined.

Although these are the early days, high-speed fiber connections are proving popular with consumers. Verizon already is installing fiber in Brambleton, a planned community in Loudoun County, Va. Only 200 homes have been built so far, but that will grow to 6,000. Liz and Steve Levy are among the early adopters. The high-speed Net connection helps them stay in touch with neighbors over the community Web site, and Liz Levy uses it to maintain a Web site for her stationery business. They get pitched by satellite-TV companies all the time, but they won't switch. "It works really well, and I like getting all the services from a single company," she says.

Still, there's no guarantee that Seidenberg's broadband vision will become a reality. No company has attempted what he is doing on such a massive scale, and even smaller initiatives have shown mixed results. Construction of a fiber network in Eugene, Ore., was cut back because the economics of the effort didn't pan out. The city had originally planned to extend its optical links into homes and businesses, but it canceled the plan in March, 2002, as the economy soured. "We just couldn't make the numbers work," says Lance Robertson, communications coordinator for the Eugene Water & Electric Board.

Whether the numbers work for Verizon will depend on its costs for the new network. Installing a fiber-optic line in a home or business has dropped to about $2,000 today from more than $4,000 five years ago, according to market researcher Render, Vanderslice & Associates. The firm expects that will fall another 50%, to $1,000, in the next five years, although that will depend on how quickly Verizon and the Bells buy equipment. Doreen Toben, Verizon's chief financial officer, says costs have just now come down enough for the initiative to make financial sense. It should be profitable if the company's expense per line comes in between $1,200 and $1,800.

Verizon has a card up its sleeve. About 45% of its customers are wired via telephone poles and other above-ground connections, according to Verizon Chief Technology Officer Mark Wegleitner. That's compared to 32% for BellSouth, 28% for SBC, and 13% for Qwest. Why is that key? It's as much as 30% cheaper to upgrade a line on a phone pole than it is to upgrade one buried beneath a sidewalk or someone's lawn.

Despite the challenges, Seidenberg has a track record of patient investing that pays off in the end. Consider the wireless business, 45%-owned by Vodafone Group (VOD ) PLC. In recent years, it invested more than its rivals and has reaped the reward. Today, with 33 million subscribers, it's far larger than No. 2 Cingular, a joint venture of BellSouth Corp. and SBC. And it's ahead on many financial metrics, from revenue and earnings growth to profitability. "We're trying to replicate wireless' successful model in other parts of the company, but it takes patience," says Babbio.

Verizon's wireless data plans should keep that growth engine humming. Beginning this September, it will introduce wireless systems in Washington and San Diego that let customers download data at peak speeds of 2.4 megabits a second. That's about five times faster than a DSL connection. While rivals are expected to deploy comparable technology, Verizon is ahead of the curve. Competitors won't roll out the technology until 2004 or 2005. By getting to market first, Verizon expects to maintain its above-average growth.

Rivals are skeptical. "The real question is, is the market ready for it," says William E. Clift, Cingular's chief technical officer. Seidenberg thinks all of these investments will create something of lasting importance and have a positive impact on the overall economy. "As broadband becomes more pervasive over the next three or four years, all the 'excess capacity' in long distance will get absorbed," Seidenberg says. "Microsoft or IBM would never say there's overcapacity. They envision a world in which you always need more capacity to handle all the things they can make. The problem is, we don't have that capacity where it needs to the home and office."

It will require near-perfect execution. But Seidenberg performs well under pressure. One afternoon in 1969, the young cable splicer and his buddies took a break for a game of touch football at Ferry Point Park in the Bronx. Pat LaScala, a cable splicer's assistant who had played high school football, told Seidenberg to go out for a pass as far as he could. "He ran right into a tree and got some big welt on his eye," LaScala recalled. "But he caught the ball." Today, he needs that poise more than ever. This time, it's no game.

By Steve Rosenbush

With Tom Lowry in New York, Roger O. Crockett in Chicago, and Irene M. Kunii in Tokyo

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