May 13 2011

Can Telcos Buy their Way Into the Cloud or is this Deja Vu?

2011 has thus far produced a bevy of acquisitions in the cloud computing sector. The epic buzz around cloud has driven many Telcos to revisit build vs. buy calculations with a renewed appreciation for the economics of buying their way to cloud relevance. Apparently the carriers have realized that the time to market and customer acquisition benefits of purchasing colocation companies (who operate a cloud) outweigh the economic impacts. As a result we saw three significant acquisitions in the first quarter including Terremark purchased by Verizon, NaviSite by Time Warner Cable and most recently Savvis gobbled up by CenturyLink/Qwest. 

Okay, what gives? Didn’t we just suffer through two setbacks in the adoption of cloud computing? Yes. Last month AWS had a prolonged outage as result of problems with their Elastic Block Storage systems. Sony Online also took a big hit as two separate phishing attacks compromised over 100 million users’ confidential data. So clearly uptime and security will continue to plague the adoption of cloud-based services by the enterprise, yes?

Well no, not according to the analysts. Recent studies point towards the continued adoption of cloud by business users. In fact Gartner projected global revenues for cloud computing to reach almost $150 billion by 2014. (The 2011 market is already estimated at ~ $68 billion globally).

Despite some perception hiccups thanks to AWS and Sony, enterprise IT is drawn to the efficiency and economic benefits of cloud. Flexibility and pay-for-use models are particularly appreciable given the uncertainty of the global financial system the last few years. The carriers are looking to capitalize on this shift in enterprise IT while leveraging their existing assets and personnel. At Silent Partner we find this wave of acquisitions reminiscent of the late 1990s / early 2000s when AT&T, Qwest, Sprint and others scrambled to build an application service provider (ASP) strategy.

At a high level, there are some obvious commonalities between the ASP boom of the previous decade and the current cloud computing frenzy. In a client-server world, the appeal of outsourcing your IT requirements is the same for software functionality (ASP) as it is for computational and storage needs (cloud). Thus we find cloud computing companies built in a similar fashion as their ASP predecessors:

  • ASP/Cloud providers own and operate the software application(s) 
  • ASP/Cloud providers own, operate and maintain the underlying equipment (servers, routers, switches, firewalls, load balancers, etc)
  • ASP/Cloud providers make services available to customers via the Internet
  • ASP/Cloud providers bill on a “per-use” basis 

In addition, many of those looking to jump on the cloud bandwagon are the same folks who tried their hand in the ASP market during the dot-com boom. These include telecom companies like Verizon, Qwest and AT&T; software companies like Microsoft and Google; and of course hardware manufacturers such as HP, Dell and IBM.

So, what happened to the ASP market during the previous decade? Didn’t things end badly? Yes, they did and carriers would be wise to revisit their history to make sure they don’t make the same mistakes. There are numerous examples:

Qwest spent heavily to build datacenters and launch its CyberSolutions brand in 1999/2000. The idea was to host ASPs in their facilities as well as offer their own ASP service. After seeing their stock fall by more than 50% in 2002, Qwest sold this division to Corio for a mere $15 million. By 2005, struggling Corio was swallowed up by IBM.

Then there’s the confusing tale of GTE. At one time the largest independent phone company outside of the Bell System, GTE agreed to join ‘em by merging with Bell Atlantic in 2000. Of course, this union produced Verizon and much later the dreaded “can you hear me now” guy. In 2000, GTE Internetworking was re-branded as Genuity. With much fanfare (and a $20 million marketing budget) Genuity launched their Black Rocket managed hosting or ASP platform. By 2002, Genuity struggled to service a massive $2 billion line of credit and as a result filed for bankruptcy protection in November. Level3 ended up acquiring their network and assets for $242 million later that same year.

We could go on with stories of Global Crossing, Cable and Wireless and others but you get the point. 

Luckily quite a bit has changed over the years in order to create a better environment for the carriers. As mentioned above enterprise demand for cloud is there and it’s getting stronger. The “build it and they will come” mentality of the last decade seems to have burst along with the dot-com bubble. Furthermore technological advances in networking, processor speeds and datacenter technologies make for a more viable proposition when it comes to outsourcing your IT requirements. The economics are better but so is the overall level of functionality (security and uptime not necessarily withstanding).

Finally, those carriers making acquisitions are in pretty good financial standing. This means strong balance sheets with low debt ratios and cash reserves. That being said Telcos are also being realistic about the state of affairs in their legacy product suites. After all, competition is fierce for IP services and the price points have been significantly eroded over the last two years. Adding to this problem is the saturation of the residential markets and the continued disconnection of landlines as more people use only cell phones. In summary the major carriers have realized that they must build for the future even if this means through acquisition. To remain relevant and financially viable long-term means you must have a cloud strategy. Here’s a quote from Adam Lowell, Verizon’s COO:

“Every time we see a paradigm shift in computing, we see the number of users go up by a factor of 10. The global presence positions us to be a big player in the next generation of computing, as well. And where everything we do—media, communications, personal data, network intelligence, security protocols and many more—will be stored in the cloud and then delivered around the globe.”

There is still a long road ahead of the Telcos since integrating acquired assets is never an easy task. Recent history has also shown that providing outsourced IT services to the enterprise can be too far removed from the carrier sweet spot. Still the conditions are favorable for cloud and legacy telecom companies must change in order to remain viable in the face of shrinking core revenues.

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