With demand still increasing, there are trends, opportunities, and threats currently facing the participants in this dynamic high-risk industry.
JULIAN RAWLE, Pioneer Consulting
The submarine cable installation and maintenance market is experiencing a period of unprecedented growth. And yet, one of the key features of this market is that margins at all levels are being squeezed.
Of course, the Internet is the underlying driver of demand for new international capacity. That, in itself, is producing some interesting dynamics. The rate of growth in user penetration in the United States and Europe is slowing. At the same time, many governments in the Asia-Pacific region are now developing strategies to develop their country's information-technology (IT) capability and encourage Internet take-up. Figure 1 shows how that has led to the industry's focus shifting from the Atlantic to the Pacific.
Nevertheless, the Atlantic market is far from mature. In early January, Cable & Wireless (C&W-London), traditionally conservative in its global network development, announced Apollo. This "son of Gemini" will be the first 80-wavelength (3.2-Tbit/sec) transatlantic system when it's brought into service in the second quarter of 2002. C&W has avoided some of the risk by obtaining system-supplier financing and gaining some provisional pre-sales commitments. But that still represents a vote of confidence in continued transatlantic Internet traffic growth.
There are other drivers for growth. Deregulation in many parts of the world has led to the creation of "new carriers." These companies are challenging the old paradigms by building private systems that offer the customer greater flexibility in pricing and service. National self-interest, particularly in countries where deregulation of the telecommunications sectors has yet to be fully implemented, also leads governments and incumbent operators to make a play in this arena.
Then there is the special breed of new carrier-building truly global networks. Where Project Oxygen failed, others have still dared to tread. The key, of course, has been to arrange a strong financing package at the front end of the project. That generally consists of equity, high-yield debt, and pre-sales. With the financing in place, FLAG, Global Crossing, Level 3, and 360networks have been able to embark on extended rollout programs.
That also gives their suppliers confidence for their own planning cycles. Other companies, such as Teleglobe, Verizon, and Primus, go for a mixed bag of cable ownership and capacity leasing. The common thread, however, is that all these companies have a vision of providing their customers with ubiquitous, high-quality service.
As for the "private cable versus consortium" approach to cable system deployment, the jury is still out. None of the above-mentioned new global carriers has returned a profit to their shareholders yet, and their stock prices have taken a battering in the last 12 months.
Much has been made of a looming "capacity glut." True, capacity prices have fallen dramatically in the last five years and will continue to do so for the foreseeable future. But this decrease has been mainly due to technological improvements and deregulation, rather than the number of routes available between countries or continents. The recent break on the China-U.S. Cable brought Asia-based Websites almost to a standstill, which only serves to highlight that peak-time demand and supply on key routes are still not in balance.
Lead times for development of major international cable systems have been drastically shortened. The average long-haul cable project, from initial announcement to "ready for service" (RFS), now takes less than 18 months, making life harder for the forecaster. With shorter planning horizons, there is a tendency for medium-term forecasts to suffer from "planner's droop."
Figure 1 shows investment in all cable systems that have been announced. Years 2001 and 2002 are robust forecasts based on known RFS dates, and 2003 consists of projects that are still in the formulation stage. Pioneer Consulting believes that there is considerable upside potential to 2003 and beyond, as new projects are announced in the second half of 2001 and into early 2002. By this time, the current jitters in the financial community over "tech stocks" will have stabilized and financing should be available.
The period 2000-01 has seen unprecedented activity, particularly in the Asia-Pacific region, placing a strain on the supply chain. Cable manufacturers have increased production to 200,000 km per year. However, much to the consternation of their customers, they remain cautious about making any large investments in production capacity. Perversely, that has helped the supply and demand imbalance by causing significant delays in the development of proposed intercontinental systems. It has also led to some interesting negotiations between those system suppliers that own cable manufacturing capacity and those who do not.
Pioneer predicts that over the next five years, there will be structural changes in the ownership of the world's cable-producing facilities that will address the current supply and demand imbalance. That could take the form of downward or upward vertical integration. Alternatively, change could come through the entrance of new players.
Systems suppliers' strategies have diverged significantly in the last three years. Figure 2 shows some of the major supplier contract values for intercontinental systems from 1998 to 2001. Tyco set up its own global operator, Tycom, which is using Tyco facilities to build and maintain its own global network. At the same time, Tyco must somehow manage the real conflict of interest with its traditional customers, the international carriers. Tyco has also been responsible for shaking up the maintenance market with its private Seahorse service offering.
Both Tyco and recently Alcatel have been willing to get involved in equity deals to win installation project business. It remains to be seen whether a portfolio of disparate telecom holdings is ultimately of benefit to these companies. Tyco and Alcatel have also seized opportunities to purchase marine installers. In Tyco's case, the purchase of Temasa was a strategic move in its partnership with Telefónica to develop South America. Alcatel's purchase of Telecom Denmark's fleet and commissioning of four new vessels were aggressive steps into the marine installation market to gain control of what the company perceives to be a scarce key resource.
In contrast, the Japanese system suppliers have remained relatively stable. NEC stunned the market in 2000 by winning bids for AJC, APCN-2, and EAC Phase 2, with prices well below market level. Having won these contracts and committed to certain time frames, NEC discovered that both cable manufacturing capacity and marine installation vessels were in short supply. This situation threatened the profitability of these deals and led to a non-exclusive strategic alliance between NEC, as turnkey system supplier; OCC, a key Japanese submarine cable manufacturer; and Global Marine Systems Ltd., the market leader in marine installation and maintenance of submarine fiber-optic cables. Pioneer foresees this dynamic of industry consolidation continuing.
KDD-SCS made its first foray into Atlantic waters with TAT-14. Technological and landing rights issues have caused the original RFS date to slip. The company has also led Global Crossing's EAC Phase 1 and must be disappointed not to have won Phase 2. Question marks remain, however, over the commercial sense of the relationship with its parent company. This issue is understood to have been central in the recent resignation of KDD-SCS's president.
Fujitsu benefits from their strong relationship with Alcatel. It led the SEA-ME-WE-3 project, commissioned in 1999, and they recently won the race for NAVA-1. Rumors of the formation of a "Japan Inc." conglomerate system supplier continue to surface from time to time, but there is no outward indication that this rumor is anything but talk. Figure 3 shows the market shares of some of the leading undersea cable suppliers.
Pirelli continues to contribute to the world's supply of cable and Siemens/ NSW has been active in a number of smaller regional projects. However, neither of these suppliers has the scale or resources to challenge its larger competitors for the big projects. Nortel Networks is rumored to be interested in returning to the submarine sector.
Similarly, at the bottom of the food chain, the marine installers are most concerned about the demand-supply balance. The explosion in the number of submarine cable projects and the relatively good margins available have encouraged new entrants with new or converted vessels. At the same time, the traditional players have also increased the size of their fleets. Currently, there is a shortage of tonnage, but by 2003, Pioneer predicts that the market for submarine cable installation and maintenance vessels will be in balance.
Pioneer foresees continued healthy demand for submarine cable systems into 2005. Asia-Pacific will be the most active area from 2001 to 2003, but will suffer some constraints due to the varied levels of economic and technological development within the region. Traditional landing points such as Singapore and Hong Kong will quickly become congested, presenting new challenges for both cable installers and maintainers. Western operators, hoping to build-out their global network through the Asia-Pacific region, will also incur some pain in overcoming cultural differences.
South America, driven by the demand for connectivity to the United States, will also develop quickly in this period, although governments' commitments to raising Internet penetration have yet to be proven.
AJC and Nava-1 have catalyzed interest in the Australian market. But doubts remain over the likely bandwidth demand from a limited population. On the other hand, Telstra has embarked on an aggressive regional strategy that has seen a potentially bandwidth-hungry tie-up with PCCW in Hong Kong. PCCW recently has had financial difficulties due to the collapse in its share price, and Telstra has had to deal with grumblings from its shareholders.
Nevertheless, the new joint venture Inter net Protocol (IP) backbone operator, "Reach," has been established.
India appears to be coming up very fast on the rails. With deregulation beginning and a cheap well-trained IT workforce already telecommuting to Silicon Valley, it is no surprise that two major international projects already have been announced.
Of course, everyone talks about China and its huge potential. The first wave of inward telecom investment was generally unsuccessful, but China's entry into the World Trade Organization gives cause for optimism. China Telecom continues to be a major player in the various consortia cables in the region and jealously guards Chinese landing rights. Pioneer believes that Asia-American Network (China-US 2) will happen, but it may not be in the traditional consortium format.
Africa remains at the bottom of the investment league table. The completion of SAFE (RFS March 2002) will provide the first high-bandwidth international connectivity to the continent. Africa ONE would further bring the region into the global community as well as improve intra-regional communications.
This bright outlook of activity in almost every part of the globe is not to say that subsea network deployment and operation is a risk-free proposition. Increased competition from global deregulation and the unilateral action of the Federal Communication Commission has eroded international carriers' margins. That has caused them to put extreme pressure on the system suppliers and their subcontractors.
System installation costs and lead times have been drastically reduced. Carriers are seeking to reap the benefits of the current technology before the next generation makes their system obsolete. Delays in implementing systems represent huge revenue losses for carriers. Appropriate liquidated damages therefore are imposed on the system suppliers to encourage effective project management and on-time delivery.
Installers are constantly seeking innovative and cost-effective methods of installing cable, inevitably leading to questions about the resilience of these major systems. There have been numerous well-publicized incidents of newly installed cables going down. In some cases, that has even led to lawsuits by the cable owner against the supplier that installed the system.
Indeed, Pioneer predicts the international submarine cable maintenance sector, so long the Cinderella of the industry, is going to be brought much more into the spotlight. Carriers will increasingly demand improvements in cable reliability and repair intervals. That will require new technological developments in fault-location and diagnostic systems. It may also encourage system suppliers to seek new ways of minimizing the amount of vulnerable system technology that has to go under the water.
About 80% of long-haul cable faults occur in relatively shallow water. The main causes are damage from fishing gear and anchors. Burial of cable has become increasingly necessary in these areas and the average burial depth has steadily increased. Where required, cables are now buried beneath the sea bed to a depth of at least 1 m. In some areas, such as in the approaches to key East Asian hubs, some cables are being buried to depths of more than 5 m. That requires the use of expensive specialist burial tools and is an extremely lengthy process.
Another major incidence of cable faults occurs at the optical repeaters and branching units in a system. Current technology requires repeaters in a long-haul system to be installed every 40-70 km. These units are highly sophisticated pieces of equipment, which are designed to work under extreme water pressure and can cost between $500,000 and $1 million. Production faults, poor-quality splicing of the unit into the cable, and mishandling during the laying of the system can all result in significant repair costs.
Although encased in a series of protective claddings, the fiber-optic cable itself is also vulnerable. Poor handling during loading or laying and inaccurate laying of the cable on the undulating sea bed can lead to unacceptable fiber loss. When a fault occurs on a working system, it often takes time to locate the fault, mobilize a repair vessel, and install a replacement unit or cable section. In the meantime, it costs the carrier literally millions of dollars a minute in terms of lost or rerouted traffic.
Who could have imagined even five years ago the forward leaps the industry has made in terms of getting more bytes down a pipe? Research is currently focused on cramming more wavelengths at higher bit rates down the same fiber-optic pipe. But the boundaries of this development are finite. According to Bell Labs, "If the explosion in bandwidth continues on its current course of doubling every year, this capacity [50 THz, the region of optical transparency of silica fiber where the attenuation is sufficiently low for long-haul transmission] will be reached in only eight to 10 years."
SONET/SDH remains the preferred architecture for international submarine networks, and the reasons are clear. It is a well-understood technology that is cost-effective. Moreover, it has the capability to allow carriers to migrate their voice traffic to IP and still provide the quality of service demanded by customers.
Figure 4 shows the dramatic impact on the market made by DWDM. Systems laid down in 1998-99 that were designed to provide enough capacity for at least 10 years, have become obsolete overnight. DWDM also brings scalability and route portability to the carrier's marketing mix.
At the global level, Pioneer foresees increasing competition driving down margins and requiring economies of scale to survive. Access to the latest technology will be critical. That's where the strategies of two of the larger system suppliers pose a considerable threat to the market equilibrium. Tyco has moved into the carrier market with its own planned Tycom Global Network. Alcatel has moved down the supply chain into installation and maintenance. Both have shown an increased willingness to take equity stakes in new systems and partner with carriers.
This strategy must ultimately create a conflict of interest when supplying customers that own competing systems. Is there a day coming when these two suppliers of over 65% of the market begin to restrict access to their latest technology to only affiliated cable owners? That would certainly cause a tremendous shake-up in the industry and could potentially put the Japanese suppliers back in the driver's seat. Whatever the outcome of this current dynamic, Pioneer believes there is great potential for vertical integration and consolidation at the system-supplier and marine-installer/maintainer levels.
At the carrier level, the industry is fragmenting into specialist service providers that use the latest technology, particularly in the last mile, to differentiate their offerings. They are a major threat to the traditional public-network operators, but that is unlikely to adversely affect demand for new long-haul cable systems. However, the "mini-consortium" is likely to be the most favored commercial structure for such systems, because it shares the risk without compromising time-to-market.
Julian Rawle is a senior market analyst for the submarine fiber-optics industry at Pioneer Consulting (Boston). Rawle can be reached via the firm's Website, http://www.pioneerconsulting.com.