Telecosm - Ike Elliott

Disappearing Act: LEC Line Losses Continue

The trend of many years is continuing at the nation's biggest phone companies: people are cancelling their traditional landline phone service in droves.  This week, Verizon reported over 3.6M switched access lines lost in the past year, and last week AT&T reported a loss of 5M lines in the past year.  Qwest reports their 1st quarter results next week, so we'll have a complete 1st quarter picture at that time.  Meanwhile, here is a look at line losses in calendar year 2007 at the big three telcos:

LEC Access Lines	EOY 2006	EOY 2007	Lines Lost
AT&T	66,469,000	61,582,000	4,887,000
Verizon	45,100,000	41,441,000	3,659,000
Qwest	12,299,465	11,500,000	799,465
Total	123,868,465	114,523,000	9,345,465

9.3M lines lost in one year!  That's like the entire Chicago metropolitan area turning off their residential phone service in one year.  And that's assuming every man, woman, and child had their own residential phone line. 

Where are all of these lines going?  It's not like these folks are just deciding they don't need phone service any more.  Over the next few days we'll dive into the data on how many lines are going to wireless, cable, and VoIP services. 

Comcast Wins a BUNGL For HD Compression

The Associated Press is now reporting on the additional compression that cable companies are imposing on High Definition channels, that I reported on earlier this month.   The 3:1 compression creates a visibly inferior experience.  As one user put it:

"I couldn't really tell if what I was seeing was really better than what I saw on regular television"

The point here is that users are being ripped off, paying for high definition channels that they aren't really receiving, and for that achievement, I'm awarding a BUNGL to Comcast. 

This makes two BUNGLs for the cable industry, giving them sole position of first place! 

AT&T Exec Hypes Internet Growth

Dan Caruso highlighted comments from an AT&T executive's talk as an example of Internet growth hype in a post on his blog a couple of days ago.  Jim Cicconi, vice president of legislative affairs for AT&T, was speaking at Web 2.0 forum in London a few days ago when he made comments ranging from ludicrous to meaningless to merely believable.

Being that this is a blog, we'll focus on the ludicrous:

"In three years' time, 20 typical households will generate more traffic than the entire Internet today."

Really?  Let's do a little math to see what that means.  How big is the entire Internet today?  Let's give Mr. Cicconi the benefit of the doubt and assume that he was speaking only about the US Internet, which was somewhere between 750 and 1250 Petabytes per month at the end of 2007, according to MINTS. (A Petabyte is a 1 with 15 zeros after it) Again, giving Mr. Cicconi the benefit of the doubt, we'll take the lower of these two numbers, and assume that in three years, 20 typical households will be generating more than 750 Petabytes per month, meaning each household will generate 37.5 Petabytes per month in traffic.  Multiplying by 8 to get to Petabits, then each of these twenty households would need to generate

300,000,000,000,000,000 bits per month.

That's a lot of bits.  Even if each of these households watched 8 hours of uncompressed streaming HD video on the Internet every day, 30 days each month, they would be generating only on the order of

125,000,000,000,000 bits per month

...or about 0.04% of Mr. Cicconi's predication. 

Given that there were about 238 million Internet users in North America at the end of 2007, in order for Mr. Cicconi's prediction to come true, even if you assume the number of Interent users remains constant at 238 million users through 2010, the Internet would have to grow at a compounded rate of 23,350% per year for the next three years.  That's just a smidgen higher than the more typical 60% compounded growth rate the Internet has recently seen. 

Of course, all of this begs the question: why did AT&T let somebody with the title of VP of legislative affairs talk about Internet growth?

As for Mr. Caruso, I'm glad we can both spot hype when we see it!  It's good to be back on the same page.

New Music: Pinback

Telecosm reader Chris Jensen commented on last week's New Music post on Le Loup with a few suggestions for my listening enjoyment, including The Mars Volta, Pinkback, and The Sim Redmond Band.  I've listened to all three this week, and really enjoyed exploring the music of these bands, but have to say that San Diego-based Pinback is the real standout among these three.

I was playing some Pinback on Pandora while writing this post (more on Pandora next week), and my fifteen-year-old son Ben says "It's kind of loud."  I smiled and said "Yeah!" (with relish), and he asked if I could turn it down and I refused, of course.  I think in most families this Dad-to-teenager relationship is usually reversed.

I don't mean that Pinback is headbangin' metal music...they are anything but that.  This band makes "some of the most complex, postmodern indie pop happening on the West Coast."  They do some fascinating things with song structure and melody that keep my ear from getting bored.  The innovation with song structure reminds me of some of cooler songs by The Shins, but they don't sound like The Shins, really.  A good mix of mostly mellow electric guitar, synth, drums, with punk influences, and a relaxed vocal duet sound. I haven't heard a Pinback song I don't like.

Some of the songs that have caught my ear: Tripoli, Charborg, The Yellow Ones, and Offcell. 

The band isn't exactly new, having been around for about ten years.  They're just new to me! 

Thanks, Chris, for the recommendation...I'm going to enjoy exploring the rest of Pinback's music.

How Level 3 Gets to Positive Cash Flow

Yesterday I posted about how Level 3's positive earnings report, and their forecast of positive cash flow before the end of the year, could be due to couple of things:

• Cost reductions in both capital expenditures and SG&A
• More rapid growth in wholesale Internet access utilization and revenue

Meanwhile, I've been picking through the posts from the "anonymous analysts" over on the Investor Village Level 3 message board, and have discovered some additional factors that should figure in to an outstanding year for Level 3.  You've got to hand it to this particular message board: it has a number of very talented and thoughtful posters, and they turn over a lot of rocks, and they share their findings.  I often learn from them.

• Gross margin improvement: The company forecast a slight improvement in gross margins this year, but since gross margins came down a little bit in the first quarter, the company must be counting on improving gross margins more in the remaining three quarters.  This margin improvement should come from additional transitioning of services to on-net fiber, and from slight increases in wholesale voice pricing.  This could add on the order of $20M or so per quarter in additional free cash flow.
• Lower interest expense:  Level 3's bond interest expenses are seasonally concentrated in the 1st, 2nd, and 3rd quarters.  Less interest expense in the 4th quarter equals more free cash flow at that time.

Add these factors to continued improvements in SG&A forecast by the company, and you could get enough cash flow improvement to meet or beat guidance even without increasing sales much at all.  Meanwhile, the company is adding 100 salespeople in the first half of this year, so we should see some of those new hires begin to hit their stride in the 4th quarter.

Many thanks to a certain members of the Investor Village gang for this info!

Level 3's Wholesale Internet Business Turning the Corner

Listening to the Level 3 Communications quarterly earnings conference call this morning, CEO Jim Crowe offered the following forecast for the company's IP business for 2008:

Bandwidth Growth: 75-80%
Pricing Decline: 25-30%

Taking these two data points and plotting them on the table I published last week in my post on "Is An Internet Industry Resurgence Coming?", we can now plot a range for Level 3's IP and Data Services revenue growth for 2008:

Industry Internet Year over Year Revenue Growth
	Rate of Price decline in price per Mbps
Rate of Bandwidth Growth	20%	22%	24%	26%	28%	30%	32%	34%	36%	38%	40%	42%	44%
50%	20%	17%	14%	11%	8%	5%	2%	-1%	-4%	-7%	-10%	-13%	-16%
55%	24%	21%	18%	15%	12%	9%	5%	2%	-1%	-4%	-7%	-10%	-13%
60%	28%	25%	22%	18%	15%	12%	9%	6%	2%	-1%	-4%	-7%	-10%
65%	32%	29%	25%	22%	19%	16%	12%	9%	6%	2%	-1%	-4%	-8%
70%	36%	33%	29%	26%	22%	19%	16%	12%	9%	5%	2%	-1%	-5%
75%	40%	37%	33%	30%	26%	23%	19%	16%	12%	9%	5%	1%	-2%
80%	44%	40%	37%	33%	30%	26%	22%	19%	15%	12%	8%	4%	1%
85%	48%	44%	41%	37%	33%	30%	26%	22%	18%	15%	11%	7%	4%
90%	52%	48%	44%	41%	37%	33%	29%	25%	22%	18%	14%	10%	6%
95%	56%	52%	48%	44%	40%	37%	33%	29%	25%	21%	17%	13%	9%
100%	60%	56%	52%	48%	44%	40%	36%	32%	28%	24%	20%	16%	12%
105%	64%	60%	56%	52%	48%	44%	39%	35%	31%	27%	23%	19%	15%
110%	68%	64%	60%	55%	51%	47%	43%	39%	34%	30%	26%	22%	18%
115%	72%	68%	63%	59%	55%	51%	46%	42%	38%	33%	29%	25%	20%

It looks like 23-33% revenue growth for Level 3's IP and Data Services Business this year, thanks to a small reduction in the rate of price compression, and an uptick in traffic growth at Level 3. This is much better than 2007, when the company's IP and Data Services revenue grew at about 8 or 9%.  A higher IP and Data Services growth rate could be a big part of why Level 3 is comfortable reiterating its forecast of 8-13% growth in Core Communications Services revenue for 2008. 

If Level 3 is representative of the Internet industry as a whole, then maybe we are seeing the beginning of a "resurgence," as Dan Caruso calls it, in the wholesale Internet industry, here in 2008, in revenue terms.  Does Level 3's traffic growth of 75-80% match the industry, or is Level 3 expecting to take market share and grow faster than the industry?  I suspect that Level 3 is growing faster than the industry, but that we may actually be seeing an uptick on overall industry growth rates from the 50-60% we saw last year.

Jim Crowe pointed to video delivery over the Internet as the big driver, citing a stat from Comscore that 10 billion videos were viewed over the Internet in February, a 65% year-over-year increase.  A continuation or acceleration of that growth rate in 2008 could nudge the overall Internet's traffic growth above 60%, since video files are so large.

It's going to use data from Level 3 to track this in the future, though, because Level 3 has stopped reporting revenue by product group and is now reporting revenue by customer segment instead. 

LVLT: Crowe Predicts CFBE For Remaining Three Quarters of 2008

Level 3 Communications released a promising earnings report this morning, with the highlight being this statement from CEO James Crowe:

"...we expect to be free cash flow breakeven for the remaining three quarters of this year."

That's big news, even though Crowe only meant that the next three quarters would cash flow breakeven on a cumulative basis.  Prior to today, the company had only predicted positive cash flow, on a run rate basis, by the end of 2008.   Today's statement accelerates the march to positive cash flow by at least one quarter, and maybe by two quarters three quarters.

It appears that the company is achieving this milestone by managing its SG&A and capital expenditures downward.  SG&A for 1Q08 was $418M, a cut of $21M from the $439M in 4Q07.  Capital expenditures were down to $113M in 1Q08, compared with $153M in 4Q07, a drop of $40M. 

Cost-cutting your way to profitability by itself would not inspire celebration, but there was other good news in the report:

• CFO Sunit Patel reaffirmed EBITDA guidance of $950M - $1.1B for 2008
• Patel also reaffirmed the company's projection "that Core Communications Services revenue will grow 8 to 13 percent for the full year 2008."

There had been speculation that the company would need to cut its sales forecast for 2008, due to a worsening economy and lack of demonstrated sales momentum, so a reaffirmation of revenue guidance is a very good sign.  Growing sales for the remainder of the year is key for Level 3.

The only dark lining on this silver cloud was that 1st quarter results in core network services revenue were sequentially lower than 4th quarter 2007.  This high-margin segment declined to $774M in 1Q08 from $783M in 4Q07.  The company telegraphed that revenue would be down a bit in the 1st quarter on their last quarterly earnings call.

Overall, though, things seem to be heading in the right direction, and the market likes the news, too.  The stock is trading at $2.69, up 13.5% on the day, so far.

I may post more after the conference call.

Full disclosure: I own Level 3 Communications stock.

Mr. Caruso: Don't Bother With Dinner Reservations

If you have been following this blog for the past week or two, you will know that there is a running dispute between my good friend Dan Caruso and myself over whether the wholesale Internet access business is growing quickly, in revenue terms.  I say it's not, Dan says it is. 

Dan thought he had me cornered with a post on Sunday about Cogent Communications, noting how the company is growing quickly in revenue terms.  However, Dan is stretching when he claims that Cogent's revenue is evidence of rapidly-growing wholesale Internet access revenue, because Cogent's revenue is not limited to pay-per Mbps wholesale Internet access.  The company also operates data centers and has colocation revenue, and they also sell local loops, and these revenue streams are likely to be growing faster than their wholesale Internet access revenue, masking weaker growth there, too.  Plus, Cogent could be growing faster than the market, meaning they are taking market share as they grow.

How could Cogent's local loop revenue be growing faster than their wholesale Internet acccess revenue?  Let's look at a sample network to show how this can happen:

Transport Annual Price Compression	10%
2007 DS3 Monthly Transport Price	$      2,000
Internet Annual Price Compression	30%
2007 Monthly Price Per Mbps	$           25
Sample Network
Number of Sites	1000
2007 Peak Internet Bandwidth Demand/Site	38	Mbps
Annual Growth in Bandwidth Demand	55%
	2007	2008	2009	2010
Bandwidth Demand Per Site (Mbps)	38	58.9	91.295	141.50725
Total Mbps needed	38000	58900	91295	141507.25
Number of DS3s needed	1000	2000	3000	4000
Price per DS3	$      2,000	$      1,800	$      1,620	$      1,458
Price per Mbps	$           25	$      17.50	$      12.25	$        8.58
Transport Revenue	$2,000,000	$3,600,000	$4,860,000	$5,832,000
Internet Revenue	$   950,000	$1,030,750	$1,118,364	$1,213,425
Total Revenue	$2,950,000	$4,630,750	$5,978,364	$7,045,425
Year over Year Growth, Total Revenue		57%	29%	18%
Year over Year Growth, Transport Revenue		80%	35%	20%
Year over Year Growth, Internet Revenue		9%	9%	9%

In this example, Internet bandwidth utilization is growing at 55% per year, but because wholesale Internet price compression is 30% per year, Internet revenue grows at only 9% per year.

Transport revenue (local loops, and in some cases long haul circuits sold in order to get to the Internet) grows much more quickly, thanks to a slower price compression rate of 10%. 

Indications from presentations from companies in the business indicate that transport price compression has indeed slowed down, and on some routes prices are even going up.  So, a 10% price compression rate on transport is may actually be more price compression than what is really happening in the transport market as a whole. 

From this example, you can see how Internet bandwidth demand can drive a boom in transport revenue at the same time as truly pure wholesale Internet access revenue is growing more slowly. 

That's part of what I think is going on with Cogent.  Rapid growth in transport and colocation revenues are masking weaker growth in per-Mbps Internet bandwidth fees.  Plus, Cogent may be seeing faster growth than the market. 

Nice try, Dan, but you will have to do better than that to get me to pay for dinner!

Skype Launches Aggressive International Unlimited Plan

eBay's Skype unit announced an aggressive unlimited international calling plan to 34 countries. The plan costs only $9.95 per month for unlimited calls from your Skype client on your computer to any phone in the 34 countries in the plan.  Or, you can pick a single country in Europe and make unlimited calls to it for $4.70 a month. 

I think this is part of a push to demonstrate that Skype's popularity as a free service can be converted into revenue before the end of 2008, when eBay's CEO John Donahoe says he will reassess Skype's fit within eBay and consider selling Skype if the fit isn't good.  In this case, I believe a "good fit" can be translated as "growing really fast and making a great profit." 

The unlimited international plan should create an uptick in revenue.  We will see if it is enough for eBay to want to keep Skype in its portfolio.

The Bear Strikes Back

Interesting post today from Dan Caruso over on the Bear on Business blog, regarding my contention that the wholesale Internet access business isn't growing quickly, at least in revenue terms, due to price compression.  I used data from Level 3's quarterly reports, and from Qwest's quarterly reports to support the hypothesis, showing that neither company's revenue line for the business grew much in 2007. 

Now Dan raises the possibility that Level 3's Internet and Data Services revenue line is sufficiently corrupted by other revenue items that it isn't a reliable indicator of the growth of the wholesale Internet access business.  Dan's hypothesis is that revenue from discontinued or de-emphasized businesses is included in the Internet and Data Services revenue line item...revenue from things like IP-VPN services.  He even speculates there might be some retail VoIP revenue in there.  Dan's hope is that these businesses are shrinking at a rate that offsets and masks the true growth rate of Level 3's wholesale Internet acccess business.

Dan might be right on this point (gasp!), Level 3 might have a bunch of other businesses cluttering up their IP and Data services revenue line item.  Even so, the burden of proof is still on Dan to show how much of that revenue isn't related to Level 3's wholesale Internet access business.  And, keep in mind, that it is not only Level 3 who is showing slow growth in wholesale Internet access.

I told Dan I'd buy him dinner if he can prove that the wholesale Internet access business grew quickly, in revenue terms, in 2007, and that is no small bet, given Dan's expensive taste in wine!  I'm ready to pay up, though, if I must, just for the joy of getting to tell Dan to go find a rock, for once in my life!

New Music: Le Loup

I'm starting a new feature on this blog, to follow a passion of mine: discovering new music.  I like to explore new artists and recent releases, and one of the coolest things about the Internet is that is makes it easier to do this exploration than ever. 

So, for the inaugural episode of the new music spotlight, I'm giving four thumbs up to Le Loup, a Washington D.C. based band that is making some waves.  They have an experimental, ethereal sound that is kind of a cross between Broken Social Scene and Robert Fripp.  I know, it sounds weird, but it works. 

Check out some of their songs on their Myspace page, here.  I particularly like Outside Of This Car, and you simply have to check out We Are Gods! We Are Wolves!

It's a refreshing and innovative new sound.  Kudos to Le Loup.

Another Example of Anemic Wholesale Internet Access Revenue Growth - Qwest

Dan Caruso recently asked me to provide more examples of how price compression is offsetting unit growth to create anemic revenue growth in wholesale Internet access.  I had provided revenue data for Level 3 Communications as one example, but Dan challenged me to find more data. 

It wasn't easy, because not every company in the wholesale Internet access business provides separate line items for their wholesale Internet businesses.  But Qwest does provide a separate line item for "Wholesale Data, Internet and Video", which is a pretty close approximation of what I was looking for:

Qwest	4Q06	1Q07	2Q07	3Q07	4Q07
Wholesale Data, Internet and Video Revenue ($MMs)	$     375	$     363	$     370	$     371	$     372

As you can see, Qwest's wholesale Internet access business has been pretty flat for the past five quarters.  The company did grow wholesale Internet access about 5%, year-over-year, from 2006 to 2007, but you can see that the trend lately has been pretty flat.  It looks eerily like Level 3's recent revenue performance in wholesale Internet access.

I suspect a simple explanation...despite 50-60% year-over-year increases in bandwidth utilization, price compression has curtailed revenue growth in this business unit at Qwest, just as it has in Level 3's wholesale Internet access business. 

Baitin' the Bear on the "Imaginary Resurgence"

Okay, I guess I have been challenged to an all-out cage-fight, blogging style, by my good friend, Dan Caruso, on this issue of if and when an Internet resurgence might or might not be happening.  Dan called me out on his blog yesterday, so I must respond to preserve my tattered honor.

Among Dan's rants were the following:

"Ike ... tried to “prove” revenue is barely growing as price compression fully (or near fully) offset bit growth.  He used an analysis of Level 3’s IP and Data business unit as a proxy to argue this.  I thought this single data point is not sufficient to draw any conclusion."

"So Ike, I challenge you again–how do you back up your CONCLUSION that revenue is largely stagnant?  How do you CONCLUDE price erosion is offsetting bit growth?  Do you believe bandwidth companies are experiencing minimal revenue growth?  Do you believe poor profitability?"

The gauntlet has been thown. 

First, a little history on this issue:

• I admit it, I started it, when I questioned an erroneous and mis-cited chart on Dan's blog that seemed to show something on the order of a 500% growth in Internet traffic between 2006 and 2007.  I pointed out that the chart was wrong, and a reader pointed out that the chart was also mis-attributed.  To Dan's credit, he pulled the chart down and posted an explanation of how the error was made.
• Dan was attempting to point to Internet traffic growth as a reason for the resurgence in the bandwidth business.   That could be true, but I found the assertion that Internet traffic growth is accelerating to be questionable, since the data involved did not show an acceleration in Internet growth.  I pointed out that Internet traffic growth was no faster in 2007 than it has been for several years.  NOTE: my posts have consistently been focused on Internet bandwidth growth, and have not been focused on other aspects of a bandwidth provider's business, such as growth in circuit orders and installation.  Internet bandwidth growth influences the business of circuits and transport, but Internet bandwidth growth is not the only predictor of growth in the tranport business. 
• As I questioned whether an Internet industry resurgence was really coming, I made an assertion that Dan found to be un-supported by data:
  
  "The problem for the wholesale Internet service provider industry, though, is that revenue is not growing at a corresponding rate, because wholesale Internet access service prices are compressing at a rate that very nearly offsets all of the bandwidth growth.  So, for the provider of Internet backbone services, you get little or no additional money for providing 50% more capacity every year."
• Dan challenged me to support the above statement with data.  I did that by pointing to Level 3's relatively flat Internet and Data services revenue in 2007. 
• Dan then countered with a post that raised some valid points, which I will paraphrase here:
  1. That Level 3 might not be representative of the industry (a point I already acknowledged in my post).
  2. That bandwidth is a bigger bucket than Internet traffic. (I agree - I never claimed that the the Bandwidth Market was not seeing a resurgence - I claimed that the wholesale Internet bandwidth market did not see a resurgence in 2007.  So, I won't argue against a point that I agree with, and won't argue in favor of a point I would not make).
  3. That supply is now much more in-line with demand, so that new demand must be met by creating new supply.  (I also agree with this point, and even made this point before Dan in my post from yesterday, showing a slide from Telegeography.  Again, I won't argue against something that I agree with).

Next:  A litte explanation about the difference between the Wholesale Internet Access Business and the Bandwidth Business.  The Wholesale Internet Access Business does not include revenue for the physical circuits that connect a customer's equipment to the Internet.  It only includes revenue for the the number of bits that travel over that pipe, to and from the Internet backbone.  Measurements of Internet bandwidth growth, such as the MINTS and Telegeography data, are measurements of the number of bits that travel over the Internet backbone. 

In contrast, the Bandwidth Business as a whole does include revenue for circuits that are used for any purpose, whether that be for Internet access or for any other purpose.  These circuits have a very different price compression rate than Wholesale Internet Access, and usually these circuits have a much slower rate of price compression than Wholesale Internet Access, and in some cases these circuits are actually experiencing price inflation.  So, it is completely possible that steady, unaccelerating Internet growth of 50-60% could be driving a very healthy 20% to 40% revenue growth in the Bandwidth Business, because circuits are not experiencing nearly the same degree of price compression as Wholesale Internet Access. 

So, where does that leave us?  Here is the scorecard, as I see it:

Dan's assertion, contested by Ike:  That Internet bandwidth growth is accelerating and is fueling a resurgence in the "Bandwidth Business."  Ike questioned that Internet bandwidth growth really accelerating, and supplied data from MINTS, Level 3, and Telegeography to support that point.  Ike is most definitely not claiming that the Bandwidth Business is not resurging...only claiming that Internet Bandwidth growth, as a whole, is not seeing an acceleration of growth.  Ike has supplied data to support this point, and has pointed out the potential flaws in the data he has supplied.  There is the possibility that we are both right...that there is a resurgence in the Bandwidth Business, at the same time that there is no acceleration in revenue or bandwidth growth in the Internet Business.   Dan has said "I am seeing first hand a ton of real-world data that makes me confident in the resurgence." I think we are talking past each other on this...Dan probably is seeing a resurgence in the Bandwidth Business, while the data shows no acceleration in 2007 in the Internet business.  If you really want to contest my point about no resurgence in the Internet business, then let's see your data, Dan!  Time for you to show your cards.  Until you do, I will assume I have won this point.

Ike's assertion, contested by Dan: That "the problem for the wholesale Internet service provider industry, though, is that revenue is not growing at the same rate as the 50-60% bandwidth growth, because wholesale Internet access service prices are compressing at a rate that very nearly offsets all of the bandwidth growth."  Since Dan asked, Ike has supplied data from Level 3 to support this point, and recognized that the Level 3 data is not conclusive.  Dan still complains that the data is not sufficient to support the point, so I'll hunt for some more data.  Nonetheless, I have at least supplied third-party data to support my point.  So far, Dan has not supplied any data to contest the point.  As a Level 3 shareholder, I would love to be proven wrong on this...so please show me the data!  Until you do, I will assume I have also won this point.  And don't show me data about the Bandwidth Industry as a whole, because my point was about the Wholesale Internet Service Provider industry. 

By my scorecard, I am ahead 2-0.  This could still change, though, and end up in a tie, if Dan makes a comeback and wins the second point.

As for Dan's new questions: "Do you believe bandwidth companies are experiencing minimal revenue growth?  Do you believe poor profitability?"  I shouldn't even bother to answer because I never made these claims, but I'll answer anyway, because I think it will show Dan that I am playing fair and am agreeing with him on these two points: my answers are no and no.  Remember that I wasn't talking about the broader Bandwidth Business...I was talking about the Wholesale Internet Access Business.  It is reasonable to believe that a Bandwidth Business can be profitable, surging, and growing at double-digit rates on the strength of its transport business, at the same time as Wholesale Internet Access businesses, in isolation, are not growing quickly, in revenue terms. 

Skype's Monetization Strategy Takes A Hit

eBay announced their quarterly earnings this afternoon, and with it, we got our quarterly glimpse into how Skype is doing.  Bottom line, Skype's user base is growing quickly, at a record pace, but Skype's strategy for monetizing that user base seems to be faltering.  Check out the following statistics:

SKYPE STATS	Q4 2007	Q1 2008
Borderless Communicator "Real Users"*	27,206,646	31,741,318
Quarterly Revenue ($millions)	$                115	$         126
Quarterly Revenue Per User	$               4.23	$        3.97

*NOTE: Borderless Communicator, a blog by Hudson Barton, closely tracks a Skype stat that Mr. Barton calls Skype "Real Users", which is an attempt to measure the number of registered Skype users who actually consistently use the product.   It is the most meaningful measurement I have found for the Skype user base.

Until the first quarter of 2008, Skype had been steadily increasing their quarterly revenue per real user for a while.  Now they have taken a step backwards, causing the company to miss my optimistic projection of $136M in first quarter revenue. 

If the monetization trend can't be turned around at Skype, I think it increases the chances that eBay will sell the Skype business unit.

Telegeography Agrees: Internet Growing At About 60% Per Year

Given the focus on figuring out Internet traffic growth over the past few days on this blog, there is a particularly timely post by Nate Anderson over on Ars Technica that pokes all kinds of holes in the theory that the Internet is growing at a rate that Internet backbones can't handle.  It's a big four-page thing, but worth the read if you have the time.  I'll excerpt a couple of interesting parts here for you over the next couple of days, including the following chart from Telegeography:

This chart can be a little bit confusing and counter-intuitive.  The red line, labeled "Internet bandwidth", represents year-over-year percentage change "Internet capacity growth."  So, basically, the chart is saying that Internet capacity grew at about 45% per year from 2004 through 2006, and then in 2007 Internet capacity grew 70%. 

The yellow and green lines on the chart are two different measures of Internet bandwidth utilization...the green line measures year-over-year percentage growth in peak Internet traffic utilization, while the yellow line measures year-over-year percentage growth in average Internet traffic utilization.  Since networks should be engineered to handle peak load, the green line is the best measure of demand, and the chart shows that peak offered load on the Internet has grown about 60% for three straight years.  This corroborates Andrew Odlyzko's data from the Minnesota Internet Traffic Studies, which has shown 50-60% growth in Internet traffic for several years.

A key takeaway from this chart is that from 2004 through 2006, investment in new Internet capacity lagged actual demand growth, implying that there was so much leftover capacity on the Internet, that providers were waiting for traffic levels to catch up with an oversupply situation.  Only in 2007 did service providers have to add more capacity than traffic growth demanded.  So, it looks like last year we finally finished eating a lot of the leftover supply that was built earlier this decade, and had to start building new capacity more aggressively.

Triangulating Internet Growth

In yesterday's post, we saw that the big Internet backbone providers like Level 3 Communications really want to see a boom in the rate of Internet bandwidth consumption, and would be thrilled if that boom was accompanied by a sudden reduction in the rate of bandwidth price declines.  More units sold for more money per unit equals bigger profits.

So, are we heading for a boom?  To get a read on that, I looked at Level 3's "IP and Data Services" revenue for 2007 to see if I could spot a trend.   Now, looking at a single company, like Level 3, is kind of dangerous when trying to extrapolate a trend for an entire industry, so take this analysis along with a disclaimer that, well, it could be wee bit speculative!

Here was Level 3's IP and Data Services revenue:

	1Q07	2Q07	3Q07	4Q07
Level 3 IP and Data Services Revenue ($millions)	$     144	$     143	$     144	$     153

You can see that revenue was really very flat until the fourth quarter, when it saw a 6% quarter-over-quarter jump.  You can interpret this data in one of two ways:

• Look at the entire year, which gives you an 8% annual revenue growth rate, supporting the hypothesis that price compression is eating most of the revenue you would otherwise achieve from bandwidth growth, or
• Look at just at the fourth quarter, and assume every quarter thereafter will grow just as much, and you get a much prettier 25% annual revenue growth rate.

Okay, assuming 2007 is a good guide for 2008, that gives us a range of 8-25% revenue growth in 2008.  So, how much bandwidth growth does that imply?  To find that, we need an assumption on how much prices will decline in 2008. 

Again, looking at 2007 as a guide, if you assume that Level 3's 2007 bandwidth growth matched the overall Internet's bandwidth growth, then you would have to assume that Level 3 grew 50-60% in bandwidth in 2007.  Some sources think that Level 3 officials have dropped hints that the actual bandwidth growth at Level 3 was more like 90% in 2007.  So, we have a range of 50% to 90% bandwidth growth in 2007.  This much bandwidth growth, combined with what we know about Level 3's Internet revenenue, results in a range of price compression between 28% (if bandwidth grew 50%) and 40% (if bandwidth grew 90%), year over year, for 2007.

What does all this mean for bandwidth growth in 2008?  Well, if 2008 is similar to 2007 in terms of revenue growth (8 to 25%) and price compression (28 to 40%), then you get a range of potential Level 3 bandwidth growth as follows:

Likely Level 3 2008 Internet Bandwidth Growth Range
	Price Compression
Revenue Growth	28%	40%
8%	50%	80%
25%	74%	108%

So, you're probably thinking "Thanks a lot, Ike.  So we know it should be somewhere between 50% and 108% bandwidth growth in 2008.  Thanks for narrowing it down!" 

I know this isn't much of a prediction, but I wanted to take you through the calculation of how you end up with this range of performance, because the analysis might indicate that an acceleration in Internet bandwidth growth is already underway, at least at Level 3, and it may have started in the 4th quarter of 2007, as shown by Level 3's revenue data.  In just one example, if you pick the midpoint of the 50% to 108% range, you get a 79% year-over-year bandwidth increase in 2008, which is certainly a better number than the standard 50-60% we have seen for a few years.  If that accelerated growth rate of roughly 79% sustains for a few years, I would certainly call that a resurgence!

Of course, to use this as a prediction for the whole industry, it helps to believe at least six things:

• That Level 3's revenue growth rate is a good proxy for the whole Internet bandwidth industry,
• That Level 3's price compression rate is a good proxy for the whole Internet bandwidth industry, and
• That Level 3's bandwidth growth rate is a good proxy for the whole Internet bandwidth industry.
• That Level 3's 4th quarter jump in Internet revenue was not just a one-time seasonal blip, and that some of that jump was an accelerated growth rate that the whole industry is experiencing, and that will extend into 2008 and beyond.
• That Level 3's 8% growth rate in Internet revenue in 2007 represents a floor for 2008 Internet revenue growth (after all, it could be lower, couldn't it?).
• That a slowdown in the US economy won't create too much of a drag on growth.

Any of these might be an erroneous assumption, so as always, use this little exercise at your own risk!

PS - click the continuation link to see the math that relates revenue growth to bandwidth growth and price compression.

Is an Internet Industry Resurgence Coming?

Last week found that the Internet is still growing at a brisk 50-60% rate, in terms of bandwidth utilization.  That is certainly not as good as the 250% to 500% rate predicted by some (as in a recent speech from John Chambers of Cisco), but it is still a rapid growth rate. 

The problem for the wholesale Internet service provider industry, though, is that revenue is not growing at a corresponding rate, because wholesale Internet access service prices are compressing at a rate that very nearly offsets all of the bandwidth growth.  So, for the provider of Internet backbone services, you get little or no additional money for providing 50% more capacity every year.

Backbone providers like Level 3 Communications are hoping for an Internet resurgence, but to achieve that, at least one of two things have to happen:

• The bandwidth growth rate needs to accelerate, or
• The rate of price declines needs to decelerate

The table below shows the combined effect of price declines and bandwith utilization increases on year-over-year revenue growth rates in the Internet industry:

Industry Internet Year over Year Revenue Growth
	Rate of Price decline in price per Mbps
Rate of Bandwidth Growth	20%	22%	24%	26%	28%	30%	32%	34%	36%	38%	40%
50%	20%	17%	14%	11%	8%	5%	2%	-1%	-4%	-7%	-10%
55%	24%	21%	18%	15%	12%	9%	5%	2%	-1%	-4%	-7%
60%	28%	25%	22%	18%	15%	12%	9%	6%	2%	-1%	-4%
65%	32%	29%	25%	22%	19%	16%	12%	9%	6%	2%	-1%
70%	36%	33%	29%	26%	22%	19%	16%	12%	9%	5%	2%
75%	40%	37%	33%	30%	26%	23%	19%	16%	12%	9%	5%
80%	44%	40%	37%	33%	30%	26%	22%	19%	15%	12%	8%
85%	48%	44%	41%	37%	33%	30%	26%	22%	18%	15%	11%
90%	52%	48%	44%	41%	37%	33%	29%	25%	22%	18%	14%
95%	56%	52%	48%	44%	40%	37%	33%	29%	25%	21%	17%
100%	60%	56%	52%	48%	44%	40%	36%	32%	28%	24%	20%

So, for example, if there is 50% growth in bandwidth utilization from 2007 to 2008, and if prices decline by 33%, then there will be no increase in revenue for sellers of Internet bandwidth.  However, if there is 100% year over year growth in bandwidth utilization, and only a 22% decline in prices, then there will be a 56% increase in overall revenue for the sellers of Internet bandwidth.

Internet backbone providers are hoping that a surge in demand for bandwidth, driven by Internet video distribution and other large file distribution services, will reduce the rate of price declines while creating a big surge in bandwidth utilization. 

So far, the big surge hasn't materialized.  Will 2008 be the year?

Postscript - A Trip to Given, West Virginia (by Fred Faber)

Dad mentioned at the start of his story that he thought that I had attempted to find Given, West Virginia, but I had not – I didn’t even know that that was his birthplace or that the family had lived there until I read his little piece.

This past weekend, Saturday March 14, 2007, was rainy and not too promising for any excitement around here, so Sue and I decided to put some miles on the car and drive to Given.  The road signs (to “Given") were lacking and the roads worse, but we did find it after several wrong turns.  I usually use the sun to orient myself and zero in on destinations, but there was no sun on Saturday to assist me in my quest.  The rain had been light and spotty until we reached the suburbs of that crossroads and then it really cut loose.  The post office used to be in a country store when Dad lived there and then visited the place in his later years.  We found the new building quite by accident while looking for a place to turn around and head back to the center of the little village.

The Real Internet Growth Rate

Yesterday, I posted a slide from Dan Caruso's blog a Gilder-Swanson study that claimed there was 5X to 6X growth in Internet traffic in 2007.  I couldn't believe what I was seeing, because the Internet usually grows about 50 or 60% annually, meaning a jump to 500% or 600% would be huge news, indeed. 

So, thanks to some pointers by my readers, I found the Minnesota Internet Traffic Studies web site, which is a wealth of information for those interested in real, measured Internet growth statistics.

What did I find?  The Internet is still growing at 50-60% per year.  Even in 2007, it grew at 50-60% per year, both in the US, and in the entire world.

So, that Gilder-Swanson Caruso chart is wrong, at least where 2007 is concerned.  The "big bump" in Internet traffic that Gilder and Swanson Mr. Caruso predicted hasn't happened...at least, not yet. 

Editor's Note: Bret Swanson has commented on this blog post, saying that the chart in question is not his, as I apparently incorrectly reported at first.  I have corrected the citations in the blog posts related to the chart accordingly.

How Fast Is The Internet Really Growing?

I was reading through Dan Caruso's excellent "Bear on Business" blog recently, when I ran across a post with an astonishinig growth forecast for the Internet:

Original Source: Estimating the Exaflood, Bret Swanson & George Gilder, January 2008, Discovery Institute, Seattle, Washington

This chart was originally attributed to Bret Swanson and George Gilder's January, 2008, report, Estimating the Exaflood, but Bret Swanson has commented on this blog that the chart is not from their work.  Bret also doesn't think it is derived from Cisco's January data, at least not in a clearly traceable way.  It seems to have been pieced together from another source. 

My first reaction to the chart was "That can't be right."  I mean, I know that video over the internet is driving massive growth in Internet bandwidth utilization,  but this chart indicates that a huge jump occurred in 2007.  Guessing at the values associated with the bars in the graph, it shows 500% to 600% bandwidth growth, year-over-year, in 2007. 

I don't dispute that the Internet is growing really fast, but I found myself doubting this forecast, and decided to do some checking around to see what really happened in 2007.   More to come...

Neutral Tandem Under The Microscope

Yesterday, Dan Caruso marveled at Neutral Tandem's revenue multiple of better than 4X revenue, over on his excellent "Bear on Business" blog.  That's especially impressive in the current telecom bear market.  By comparison, the once high-flying CBeyond is trading at about 1.6X revenue at the moment.

Neutral Tandem does look expensive right now.  Last week we saw a WSJ article saying that the cable stocks look cheap right now, because they are trading at an enterprise value to EBITDA ratio of about 6.  How do TNDM and CBEY stack up on similar metrics?

	In millions, except for ratios
	Market Cap	Long Term Debt	Cash	Enterprise Value	Estimated 2008 Revenue	Estimated 2008 EBITDA	Revenue Multiple	EV /EBITDA
Neutral Tandem	533	3.2	112	424.2	114	40	4.7	10.6
CBeyond	574	0	56	518	357	61	1.6	8.5

Note: this post has been updated to subtract cash from the calculated enterprise values of these companies, which I neglected to do in the first edition this morning.  Thanks, Parkite!

The cable stocks are looking like a much better value at an EV/EBITDA of 6, compared to TNDM's 10.4.  CBEY is looking a little more reasonable at 8.5 EV/EBITDA.  However, TNDM's valuation is helped by the company's rapid growth rate, and one could argue that the market is always right, and you get what you pay for. 

I'm not so sure about that.  Recently, CBeyond was also trading at better than 4 times revenue, and the market was spooked by the company's worsening churn rate and a small growth haircut, causing a rapid drop in stock price.  Could it be that Neutral Tandem's stock price is only temporarily helped by momentum investors, until the company hits its first bump in the road? 

I don't really know the answer to that.  For now, I'll just say that from the outside looking in, TNDM's wholesale business looks like it would be easier to scale than CBEY's retail enterprise business, so for the near future TNDM might have a smooth road ahead.

Editor's Note:  I don't own any securities of Neutral Tandem or CBeyond.

Neutral Tandem: A Smart VoIP Business

Regular readers of this blog will know that I am not so enthusiastic about certain VoIP business models, especially those that try to skirt regulations.  There are also a lot of low-margin or "high cost of customer acquisition" VoIP businesses out there that are struggling to survive right now, including Vonage.  However, that doesn't mean that all business models that leverage VoIP technology are necessarily bad.

Take Neutral Tandem for example.  The company flew under the radar for several years before making a splash with its public offering last fall.  The company uses Sonus VoIP equipment to create a nationwide, distributed tandem switch with deep interconnection into the local exchange carrier network, and now provides an alternative "neutral tandem" switch network that allows wireless carriers and cable companies to exchange voice traffic without sending it through the incumbent local exchange carriers. 

In the not-so-old days, the primary way for a CLEC to exhange traffic with another competitive carrier was to hand it to an ILEC, and the ILEC then would hand the traffic to the terminating CLEC.  Of course, the ILEC charges an arm and a leg to do that for you. 

Neutral Tandem used VoIP technology to find a cheaper way to provide that service, and has introduced a competing "voice traffic exchange" service that bypasses the ILEC.  They do have a little competition, as Level 3 Communications does much the same thing.  It's a good business, at about 64% gross margins for Neutral Tandem, and sustainable for at least a little while, until all that circuit switched traffic migrates to pure IP.   

It's a smart use of technology to solve a real problem.

Level 3: Is Brady Rafuse Out?

Big news:  The Level 3 web site now lists Grant Van Rooyen as President, Content Markets, in place of Brady Rafuse.  Rumors are flying that Rafuse has left the company.  I don't know if that's true, and hope it's not...stay tuned.

UPDATE: A reader comment confirms that there was an announcement last week to all employees that Brady Rafuse had left the company. 

Kindle Sightings Still Rare

With the launch of the Amazon Kindle electronic book reader last fall, there was a lot of excitement about the future of electronic books and speculation about the demise of book stores and libraries.  As is often the case, though, reality isn't measuring up to the hype. 

There was an AP story in the paper this morning about how the Kindle is sparking interest, but the article goes on to say that less than 1% of book sales are electronic books, and it is likely to remain that way for quite some time. 

While I am interested in the Kindle and would like to own one, I am mostly interested in using it for two things, neither of which have much to do with reading electronic books:

• I want ubiquitous wireless Internet access, through the Kindle's bundled Whispernet connection, from just about anywhere I go, without paying  a monthly fee.
• Since the Kindle has that Whispernet connection, I imagine using it to read and write blog entries while on the run, without lugging my laptop around and hoping for a free wifi connection.

I am probably not the kind of Kindle-buyer that Amazon is hoping for, since Amazon hopes to pay for the Whispernet fees through sharing book sales revenues.  I guess I might buy a few e-books once I have a Kindle, though. 

Still, there might be an opportunity in here.  A Kindle costs nearly $400, and some of the profit from that sale might pay for the Whispernet connection as well.  Maybe there is an ISP opportunity to sell lifetime basic internet access for a one-time, up-front fee.   Is the market ready for that?

Given, West Virginia (by Brooks H. Faber)

Brooks Faber, sitting on the stone bridge that he built across the “Little Creek”, as a teenager, from rock left over from the rebuilding of the stone root cellar.

It seems that there are always a few things in our lives it is impossible to forget. Some of these may be events that have taken place, or they may be things we have heard someone say, or they may be merely visions of the landscape or other very simple things.  The place where I was born is a very obscure community in Jackson County, West Virginia.  We moved away from there before I was four years old and I never had the opportunity to go back again until about four years ago: my wife and I decided to go see what the spot looked like, if we could find it.

I could recall very clearly in my mind many things about the place.  There was a creek nearby where my father used to take me with him to catch little sunfish about the size of a man’s hand; they were very delicious eating, indeed.  There was a swinging footbridge across that creek.  Beyond the bridge, there was a one-room schoolhouse where the children would play at recess time. When school was out, in the evening, they would stream out of the schoolhouse and run for home. From our front porch, from which I could see all this, there was also in view two dwelling houses and two store buildings. Near our home were two more houses with picket fences and gardens in between. Behind these houses was a barn where my father kept the horses.  On down the road a ways, but out of sight, was a post office and another store.  Just how such a community could support three country stores, I will never understand, but they all seemed to be prosperous enough.  I remember the name of the postmaster.  His name was Parsons.  He had a son about two years older than me: his name was Penumbrey.  One of the other stores was owned and operated by Louie Wolfe.  I remember hearing my mother speak of other families by the names of Skidmore, Sayre, Rankin, Kessell, Harrison and Raser (?).

Entertainment was scarce in those days and so such things as Sunday afternoon gatherings were very common.  One Sunday afternoon my family, and several of their friends and families, went for a hike through the countryside.  Someone in the gang had a camera and took some pictures.  In one of them, I happened to be prominently perched upon a rock along with some more of the gang.  I still have the picture to this day.

I can remember very clearly of seeing horse-drawn wagons turn the corner near our house, cross the creek near the swinging bridge, pass the schoolhouse and go on in the direction of the two stores.

My wife and I were successful in finding the place.  The schoolhouse was still there, but a larger building had been built beside it.  The two old store buildings and the two dwelling houses nearby were still there.  The footbridge was gone.  So were the barn, the house where we lived and the two neighboring houses with the picket fences.  The roadway, where I had watched the wagons cross the creek, was no more.  There was no sign of life in that immediate vicinity except a mobile home on the site where our house had stood.  In back, at a plain grassy meadow, where I could so vividly recall seeing these things years ago, makes one wonder.  Has my childhood memory been playing tricks on me?  Were they really there, or did I just imagine they were there?

We went on down the road and, low and behold, the post office was still there, store and all.  The postmaster was there to fill us in on the history of the place.  Mr. Parsons was long since deceased, but the post office never ceased to be.  I looked up on the hill across the road from the post office and there was the rock where I had my picture taken so many years earlier.

WSJ: Cable Might Be a Good Buy

There is an interesting article on C1 of the Wall Street Journal in Thursday's edition, speculating that it might be a good time to buy cable stocks.  Comcast, Time Warner Cable, and Cablevision stock prices are all down about 30% from a year ago, and Chris Marangi of Gabelli & Co. recommends buying the stocks now. 

The article say that both Comcast and Time Warner have enterprise value to EBITDA ratios of about six right now, which is about half of what is was for the past 10 years, so the stocks do look cheap by historical standards.  As a comparative example, Level 3's enterprise value to EBITDA ratio is over 10 at the moment. 

Cable stocks are beaten down in part because their service offerings are disadvantaged, in some ways, versus Verizon FiOS, as reported on this blog for the past couple of weeks.  However, even by the end of 2010 Verizon FiOS will only be available to 34% of Comcast's customers.

So, the point of the article is that despite the fact that cable's infrastructure has less capacity and has fewer years of life left in it versus FiOS, cable stocks are at historically low valuations and could perform better than telco stocks from here, in the near term. 

For the record, I don't own any cable stocks, but I have to admit the Journal article tempted me a little.

Google Looking To Buy Skype?

Rumors are flying again that Google might collaborate with, or buy, Skype:

• TechCrunch might have started it here, on April Fool's day.
• Henry Blodget at Silicon Alley Insider picked up the rumor early this morning, with lots of comment chatter.
• Dave Greenfield of ZDNet repeated the rumor, saying Skype could go for about $6B in a sale to Google.
• Techtree picked up on it, then SkypeNumerology's Jean Mercier voted in favor.
• Hudson Barton is one of the few to vote against a deal, on his Borderless Communicator Blog here.

This a resurrection of rumors from last November, originating with Jemima Kiss in the UK.  Kiss weighed in on the rumor again, today. 

Could a deal really be in the works?  I hope so.  eBay should be able to get a premium to part with Skype, because Skype is once again showing impressive subscriber and revenue growth.  If eBay can really double the money they invested in Skype be getting $6B from Google, they might just be relieved, after taking a write-down of nearly $1B on their Skype investment last October.  And Skype is just the kind of strategic property that Google could use:  a cost-advantaged peer-to-peer voice platform, the largest number of VoIP subscribers, and $600M or so in 2008 revenue, growing at 50-60% year over year.  Google would instantly be viewed as the VoIP leader...and they have the tech skillz to improve Skype's recently spotty service record.

It could be good news for Level 3, too, since Skype has been using Level 3 as an underlying carrier for SkypeOut for several years.  Google buying Skype could mean faster growth for Skype than if Skype remains with eBay...and therefore faster growth for Level 3 VoIP services.

Cable HFC Bandwidth Limits Are Hurting Video Services, Too

Last week I had a series of posts about how Cable Hybrid Fiber Coax is disadvantaged versus Fiber-to-the-Home systems like Verizon FiOS, especially in the long run.  I speculated that it might take Cable six years to bite the bullet and start replacing the coax parts of their system with Fiber-to-the-Home, due to competitive pressures to match the higher bandwidth rates available from all-fiber systems.  Meanwhile, Cable will be living with a disadvantage that will show up in both video services and internet access services.

While it might take six years (give or take a few) for Cable to cave, it is worth pointing out that Cable is being forced to compromise quality already in very visible ways, due to the bandwidth limitations on their HFC plant.  Nyquist Capital's blog pointed me to an excellent post on the Audio Visual Science Forum about how Comcast is starting to compress HD video channels in order to fit more channels into less bandwidth.  Basically, Comcast's video compression allows them to fit three HD channels in the space that two channels used to occupy. 

The quality difference between a compressed Comcast HD video channel and an uncompressed FiOS  HD video channel is pretty obvious when you view screen shots, side by side.   There are lots of good examples on the AV Science Forum post, but here is one example:

FiOS uncompressed HD screen shot from Discovery Channel:

Comcast compressed HD screen shot from Discovery Channel:

Cable companies are lucky that they don't compete against FiOS in very many places, yet.  Instead, Cable's main video competition is Satellite TV, which also compresses their MPEG-2 channels.  If cable companies were competing with FiOS in more places, it would harder to get away with selling an inferior product. 

The Trouble With Facebook

I've been a skeptic on social networking for a while now.  I was astonished at the $15B valuation Facebook got from Microsoft, and was even surprised when AOL bought Bebo for $850M, a much lower valuation, earlier this month.  It all smells like a new bubble to me, and now, The Economist has given voice to my nagging fears, with three primary complaints about social networking:

• Nobody has figured out a sustainable monetization scheme.  Ads aren't generating the expected revenue, and Facebook's Beacon project, which tried to share information about your online purchases with your social network, failed miserably over privacy concerns.
• History is not on the side of online walled gardens.  Early email systems were walled gardens and had to open up and interwork with other email systems over time.  The same is starting to happen with instant messaging.  Social networks will eventually follow suit.
• Social networking features are likely to migrate away from destination sites, and into multi-function communications client software, like email clients that incorporate address books and instant messaging. 

All of this spells lower valuations ahead for social networking as a standalone business.  Facebook and Bebo may never be worth more than they are right now.  Don't get me wrong - social networking features are here to stay...but standalone social networking destination sites should morph into something different over time.