DSL Gets the Gift of Gab

Competitive local exchange carriers, or CLECs, are branching out from data transmission into phone calls.
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SAN FRANCISCO -- The phone jangled as Cynthia Ringo was preparing lamb chops for a dinner party at her Morgan Hill, Calif., home one April evening. Another telemarketer, she thought. "I almost took his head off," laughs Ringo, CEO of CopperCom, a private maker of Internet phone systems.

In retrospect, Ringo's restraint was wise. On the other end was Alex Nassar, an engineer at her company who was demonstrating that weeks of fine-tuning CopperCom's products succeeded in producing clean, echo-free telephone calls over Internet pipes called "digital subscriber lines," or DSL.

The phone call may not go down in the history books alongside "Watson, I need you," but it was a key moment nonetheless. Clean voice calls over Internet lines is a rich vein that telecom companies are starting to mine after years of effort. This month the 50 employees in CopperCom's Santa Clara, Calif., headquarters will start making routine phone calls through DSL. Later this quarter, the company will ship the products commercially.

More importantly, the success of companies such as CopperCom is crucial to the new generation of phone companies called competitive local exchange carriers, or CLECs, that help other service providers such as

MCI WorldCom

(WCOM)

cater to corporations using DSL lines.

Rhythms NetConnections

(RTHM)

,

NorthPoint

(NPNT)

and

Covad

(COVD)

must branch into phone calls to win and retain corporate customers -- and perhaps hasten profits.

The catch: These young carriers will find themselves competing directly with the Baby Bells when they launch DSL phone services. The Baby Bells lag behind the CLECs in delivering high-speed Internet access, but they offer a suite of services that include voice and data calls. To be ready, the CLECs need to convince small- to medium-sized businesses they can be reliable.

In early tests with WorldCom in June, Rhythms ran voice calls through copper wires via digital packets. Later this year Rhythms will start selling these new phone services, followed shortly by Covad and NorthPoint.

The importance of the voice calls is ironic. In the Internet age, voice decidedly lacks sex appeal on Wall Street. Shares of Rhythms, NorthPoint and Covad have tripled, doubled and quadrupled, respectively, from their IPO prices earlier this year, largely because investors are excited about their plans to feed a voracious demand for Internet data. These three young carriers are building networks that connect customers, mostly businesses, to the Internet via copper wiring. They also carry traffic for Internet service providers. Rhythms and NorthPoint use ISPs as an intermediary to reach corporate networks.

Rhythms and its peers are appealing because they aren't asking corporations to change their internal phone networks to computerized systems, says analyst John Freeman with the technology research firm

Current Analysis

. Rather, these carriers simply place outgoing phone calls onto the Internet for part of the journey.

DSL Carriers Spark Early Enthusiasm

Source: Baseline.

Now the CLECs must branch into the spoken word.

"You can't say: I just want to be your communications provider as long as it's just data," says David Williams, a marketing vice president with

GST Telecommunications

(GSTX)

, a carrier that intends to offer DSL phone services with its partner Covad by early 2000. Corporations large and small, he says, want to write one monthly check for communications, not two.

"It's going to be a great sales tool," says Matt Davis, analyst with the

Yankee Group

, a market research firm. Davis says the three carriers might be able to halve the prices of phone and data services in the next 18 months, because voice calls travel more cheaply as Internet packets.

Once a reliable data network is in place, adding voice signals carries almost no incremental cost. Voice is almost a "100%

profit margin," says Jim Linnehan, vice president of research with the investment bank

Thomas Weisel Partners

.

And voice calls will be no small part of DSL carriers' business, accounting for as much as 10% of their revenue by the end of 1999 and crossing the 20% line sometime the following year, according to Freeman. Linnehan estimates voice services making up 15% of DSL traffic a year from now.

Of course, voice calls over Internet lines alone aren't the biggest draw. More important is the ability to pair voice and data services. At least one investor says they may give away voice calls to bring in more Internet-data business. "Maybe that's going to be a necessity" to keep customers, says David Brady, portfolio manager with

Stein Roe & Farnham

, who says he's thinking about buying shares of Covad.

Covad already has won the trust of

Beginning to End

, a Web advertising firm in San Francisco, for the complex task of hosting videoconferences with clients. Would they be receptive to running voice calls over the same DSL lines? "We would be thrilled to deploy them, provided it's fail-safe," says Beginning to End CEO Keith Lindbeck.

These carriers better keep the customer happy if they are ever to improve their yawning losses. Revenue at Rhythms, for example, will grow 350% to $48.8 million in 2000 from this year as its subscribers triple, Linnehan forecasts. But the company's net loss will also grow to $4.89 a share in 2000 from $2.87 a share in 1999, he says. Weisel underwrote Rhythms' initial public offering in April, but has no underwriting relationship with NorthPoint and Covad.

At least in the lab, the CLECs have moved beyond the tin-can-and-string phase of DSL voice calls, which will help satisfy customers. When Ringo of CopperCom talked with

TheStreet.com

, she called by DSL and then by cell phone. DSL was less choppy.

"It has happened more quickly than we expected," Ringo says. Echoes Catherine Hapka, CEO of Rhythms and alumna of

US West

(USW)

: "It's happened, it's here and we're doing it."