Lightspeed's slow start

06 Feb 2007

AT&T is on top of the telecom world. A few weeks ago, chairman and CEO Edward E. Whitacre Jr. put the latest touch on his empire by closing an $86 billion deal to acquire BellSouth. That completed a whirlwind of acquisitions in which Whitacre has virtually remade the old Ma Bell by gobbling up 13 companies over the past decade with a combined price tag of $285 billion, including assumed debt. Last year, investors rewarded 'Big Ed's' voracious appetite by bidding up AT&T's (T ) stock price 46%. The cherry on top‾ Well, that came last month at the Consumer Electronics Show (CES) in Las Vegas, where Cingular Wireless, the company's cell phone arm, stole the spotlight by partnering with Apple Inc. (AAPL ) to introduce the sleek iPhone.

Now AT&T is gearing up for the next big telecom battle"”for the supremacy of the Internet. AT&T's weapon of choice is Project Lightspeed, a new Internet network that sends bits of data through copper and fiber-optic cables buried in the ground. The high-speed network and its Internet-protocol television (IPTV) technology are crucial to AT&T's plan to bundle phone service, Net connections, and TV"”the vaunted telecom triple play. In theory, the system will let AT&T steal customers from rival phone giant Verizon Communications (VZ ) and cable companies such as Comcast (CMCSA ) and Time Warner (TWX ). AT&T says it will pump $4.6 billion into building enough fiber-optic cable and supporting technology to reach 19 million homes by the end of 2008.

But despite AT&T's stellar performance of late, the company faces serious questions about whether Project Lightspeed can deliver on its promise. Technology glitches hobbled the rollout last year. And though the TV service is up and running in fewer than a dozen markets with prices that undercut cable bills, a growing chorus of rivals, analysts, and engineers are skeptical that the network will offer enough bandwidth a few years from now to handle phone service, high-speed Internet, and multiple streams of high-definition TV.

Cable operators have taken full advantage of AT&T's slow start, gleefully swiping phone customers with their own triple-play offerings. Having invested more than $110 billion in network upgrades over the last decade to provide Internet and digital video, cable companies only have to tweak their networks to offer phone service. As of the third quarter, the five largest U.S. cable operators have signed up about 6 million new Net-based phone customers. By contrast, AT&T and Verizon have swiped a combined 222,000 TV customers.

Verizon is placing the most ambitious and risky bet. It plans to spend $18 billion"”three times as much as AT&T"”to lay fiber to every one of the 18 million homes it hopes to cover by 2010. AT&T is laying fiber into neighborhoods but is using existing copper phone lines to carry video the last few thousand feet. As a result, it will cost Verizon $1,750 to connect each home, vs. $450 for AT&T. Despite the higher price tag, ubs Investment Research expects Verizon to produce a return on its investment by 2011. The reason‾ It believes the Verizon network's higher bandwidth will lure more phone, Internet, and video customers"”at higher prices"”and thus generate about four times as much revenue as Lightspeed. On Jan. 29, Verizon backed up the theory when it announced that it ended its first full year of operations with 207,000 TV customers, representing 9% of the 2.4 million homes capable of receiving its video service in 2006. Just a few months ago, the company was hoping to finish 2006 with 175,000 video customers.

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