Qwest Seeks a New Model

SAN FRANCISCO (01/31/2000) - What do you get when you cross a new-world telecom giant with an aging Baby Bell? That's what Qwest Communications is about to find out.

Many, many mergers ago, two aggressive telecommunications companies entered a heated battle for AT&T offspring US West, which provides local phone service across 14 Western states. As it happened, both combatants were captained by former AT&T execs: In one corner sat Bob Annunziata, CEO of Global Crossing.

Across the ring was Joe Nacchio, CEO of Qwest. Nacchio won the battle for his Denver-based neighbor on points - and now faces the daunting task of melding his fast-moving telecom startup with the decidedly slow-moving US West.

At first glance, you might wonder why a high-flying Netcentric company like Qwest would want to buy a low-flying, old-school phone company like US West.

But it's no mystery to Global Crossing's Annunziata. "US West is an incredible opportunity," he says. "They have over 14 million access lines, and a strong local vision. That's a rare opportunity."

The fact is, while companies like Qwest, Global Crossing, Level 3, IXC and Williams are battling to build the biggest, longest, most comprehensive worldwide networks, there is only so much you can do with fat pipes. The real money comes from selling service to consumers. Wholesale bandwidth is a commodity. By buying US West, Qwest gets a direct relationship with millions of customers.

Qwest execs argue that the deal combines the best of the old-world Bell operating companies with the newer, hipper, long-distance and Internet backbone companies. "This isn't a 1980s style deal here, where a merged company cuts some staff here, increases assets there and becomes a more efficient company," says Qwest President and COO Afshin Mohebbi. "The new-world companies realize that to meet their numbers in the new-world economy, they have to have the assets of an old company in order to reach the consumer."

Qwest was founded by Philip Anschutz, who used his holdings in Southern Pacific railroad to secure right-of-way permits for his new company. Anschutz used those permits to lay more than 24,000 miles of fiber-optic cables. The fiber network has created a platform for dramatic growth - in the latest quarter, revenues topped a billion dollars for the first time. But that's just the beginning: With its pending $36.5 billion acquisition of US West, Qwest becomes a $17 billion a year giant, with 64,000 employees.

Qwest's Mohebbi notes that even before the deal is closed, revenues from wholesale bandwidth sales actually account for only 25 percent of revenues, with consumer and business applications and services kicking in the rest.

The mix will change dramatically with the acquisition of US West. One issue the company faces involves long-distance service. The Federal Communications Commission has made it clear that regional carriers like US West will have to meet strict regulatory guidelines before being allowed to sell long-distance services. In order to close the deal, Qwest needs to exit the long-distance market in all 14 states where US West does business.

Bell Atlantic, which faces similar regulatory hurdles in its merger with GTE, has proposed spinning off its Internet division together with its long-distance service via a tracking stock.

Qwest execs believe Bell Atlantic's tracking plan will be rejected by the FCC.

Therefore, the company is taking an alternative plan. Says Mohebbi, "We've already figured into our business plan selling off certain units."

Mohebbi doesn't see that as a problem. "Our network is built for broadband, not for voice," he says. "We have a flat network, a focused network and a simple network. All I want to do is build the platform, and people in the Valley will figure out how to run voice on the Net. We're happy to let a lot of people ride on our coattails."

Qwest would prefer to rely on selling applications and DSL services. On the applications side, the company's most aggressive move to date has been Cyber Solutions, a joint venture with KPMG Peat Marwick offering outsourced application hosting for businesses like General Motors and Campbell's Soup.

"When you can sell a CIO on a whole suite of services, and promise that we'll be first to market with next- generation stuff, it's easy to build loyalty," says Cyber Solutions CEO John Charters. Charters claims the company is ahead of Oracle in application outsourcing, a business Oracle helped define. "We beat them every time we go up against them."

As Qwest attempts to refocus its operations away from commodity traffic and toward higher-margin applications, the company has been re-educating its sales force. Qwest last month held its first ever sales seminar for 1,500 sales reps in Las Vegas. However, the process of shifting the sights of its sales force has left some of the customers for its backbone business feeling disenfranchised. Complained an executive of one Internet service provider:

"Qwest's salespeople are the worst."

While that is no doubt an exaggeration, Qwest admits that it is steering away from selling bandwidth to ISPs. "We're going from a commodity-oriented business to a value-added business," says Doug Mow, Qwest's VP of product strategy.

"That's a whole different level of a relationship with a customer. There's a lot more hand-holding to do."

The company is also going to have to do some hand-holding with its staff while the company goes through the wrenching process of integrating the operations of the far larger and much slower moving US West.

In addition to dealing with what could be a serious culture clash, Qwest faces the daunting task of updating the seriously dated US West infrastructure. "I've tried not to be critical," says Nacchio, before launching into a critique of US West's failures. "To Sol's [US West CEO Solomon Trujillo] credit, they have got a great program under way to upgrade. But the problem is they got caught up in fast network growth and quickly found themselves undercapitalized. When your network is 75 percent to 80 percent utilized, you're supposed to trigger capital budget expenditures. That didn't happen."

Nacchio says US West is on schedule to get basic infrastructure in place, like digital switching, which allows for higher-margin optional phone services like call waiting. However, even those rudimentary upgrades leave US West, which provides service in many sparsely populated Western states, lagging behind other regional telcos.

After the merger, Qwest's biggest and most-able competitor will be SBC Communications, whose Project Pronto is the most aggressive DSL deployment from any of the regional Bell companies. SBC, which recently announced plans to invest $6 billion in DSL technology, claims Project Pronto could reach 80 percent of the Qwest-US West customer base - or 77 million people. To date, the project has 100,000 DSL subscribers.

"I don't worry about SBC. I know how they operate," says Mohebbi. "We're going to make California SBC's nightmare." (SBC previously bought Pacific Telesis, parent of Pacific Bell.) "California is the most lucrative market, for sure, but it's the hardest to defend. US West's territory is by far the easiest to defend."

But while Qwest is busy gearing up to become a regional player with its US West assets, it must keep an eye on its original business plan, which calls for the company to lay enough fiber to wire the world. While a joint venture with KPN, a Dutch telecom company, gave the company greater reach into Europe, the company largely has failed to enter Asian markets. Nacchio promises that will change soon, which he hopes will involve a new joint venture with a Pacific Rim player.

Can Qwest use the acquisition of US West to beat the old-school giants? Nacchio notes that, while he was at AT&T, it took MCI a few years to begin to take away big accounts from his salespeople. "MCI was a little slow off the blocks. In the '80s they started bidding on little pieces. Then they went from bidding on little pieces to more pieces, and then for the whole account. That's what we're gonna do."

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