A Welcome Nudge From The Net

Equipment makers are cashing in on demand for Internet gear

Ever since the telecom boom came to a screeching halt in 2000, it seemed the downturn that hammered communications-gear makers would never end. But now, as phone companies roll out a slew of new whiz-bang services, relief is finally arriving. The overall telecom gear market is expected to rise 11% in 2005, to $84.6 billion, and keep going to $102.4 billion by 2007, according to Synergy Research Group Inc.

Remarkably, this growth will happen with no help from the traditional telephone market. Demand for the gear that phone companies have used for decades to handle basic phone calls is in a free fall, plunging from $55 billion in 2000 to $15 billion in 2004 -- and it's expected keep on shrinking.

So what's driving the growth? Credit the Internet. Desperate to move into new markets to parry attacks from cable and cellular rivals, phone companies are adopting gear similar to what runs the Net. Since it can handle any kind of digital traffic -- be it a phone call, e-mail, or a Desperate Housewives episode -- this gear is the most cost-effective way for phone companies to build new businesses and protect old ones. In the 1990s, says Scott G. Kriens, CEO of router-maker Juniper Networks Inc (JNPR ).,"Everyone expected this [move to Internet-style technology] to happen overnight. When it didn't, they figured it never would. Now it has."

That's largely because the latest gear can now match, or even surpass, the reliability and features of traditional approaches. Take voice-over-Internet-protocol (VoIP), which has long promised a way to offer basic phone service at a fraction of the cost of old technology. While VoIP services in the past suffered from scratchy sound and frequent disconnections, the quality and features today can exceed those of traditional phone service. Carriers such as AT&T (T ) are using it to offer unlimited calling for as little as $20 a month. Merrill Lynch & Co. (MER ) expects the market for VoIP gear to hit $4 billion by 2008, from $800 million in 2004.

Another sweet spot will be for gear that carries video and other byte-hogging media over traditional copper phone lines. Ringgold Telephone Co. in Ringgold, Ga., for example, has purchased two cabinets of gear from startup Calix Inc. to offer TV-on-demand services to head off competition from its local cable-TV rival. "We're not seeing any growth in our wireline business, so we had to find other things to do," says Executive Vice-President Phil A. Erli.

This rising tide of telecom spending could lift many ships. Startups such as Calix, Kasenna, and Ikanos Communications (IKAN ) were founded to supply phone companies as they move to Internet-style gear. But the industry's old guard may also benefit: Lucent Technologies (LU ), Alcatel (ALA ), and Nortel Networks (NT ) are likely to be tapped as prime contractors to oversee the roll out of new services. That would be sweet relief for the long-suffering.

By Peter Burrows in San Mateo, Calif.

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