Tomorrow's traders

Bandwidth brokering is like the crazy uncle that everyone loves to talk about, but nobody wants to deal with. It’s sexy, bringing the aura of Wall Street trading floors and Gordon Gekko types barking buy and sell orders to the mundane task of filling network capacity; it’s in tune with the idea that telecom is deregulated and the supply of bandwidth is driving it toward commodity status; and it has precedent in the energy and gas markets, where spot markets allow utilities to manage risk and speculate on price fluctuations.

It’s also a ways from being realized. Worldwide, bandwidth exchanges carry less than 0.1% of global telecommunications traffic, according to Stephen Young, principal consultant at Ovum.

That’s because numerous barriers exist to the trading of bandwidth, including poor liquidity, nonstandard contracts, quality inconsistencies, provisioning delays and lack of price volatility, analysts say. “Anybody who is buying bandwidth is buying it to use it, not to do risk management on the price of bandwidth,” says Jeanne M. Schaff, analyst at Forrester Research. “We can’t envision the financial derivative markets.”

The other point that analysts agree on, however, is that it will happen, at least in some form. Buying and selling of excess network capacity has been going on for a long time, and the free fall in prices will force carriers to prepare for a time when bandwidth products have little differentiation and an open market controls the pricing.

The genesis of that market is happening with a class of providers termed “neutral physical exchanges.” These players provide price transparency, usually via a Web site; carry out financial settlement of the deal; and for most forms of bandwidth trading, deliver the goods by interconnecting carriers. They are providing the physical market that is the necessary precursor to the financial-based market everyone loves to talk about. And they are where bandwidth trading activity is happening now.

Wholesale minutemen

Arbinet-thexchange banks on a sure thing: voice

by Vincent Ryan

In fledgling, over-hyped markets such as bandwidth trading, the virtue of focusing on the here and now stands out. But it also can have its sacrifices if the market tectonically shifts and the early leader gets left behind. That’s the position that Arbinet-thexchange, a Web-based spot market for buyers and sellers of wholesale voice minutes, finds itself in.

While other firms sharpen their focus on trading and transactions, look ahead to a derivatives market and jettison their pooling points businesses, Arbinet moves in the opposite direction. Arbinet focuses on the only market with real liquidity today: the buying and selling of voice minutes for international and domestic long-distance voice and fax calls.

Here’s how Arbinet works: Paying members that have their gateways interconnected with

Arbinet’s New York-based switch anonymously submit bid and buy orders on a Web trading site. Arbinet’s transaction engine matches up a “limit order” that details maximum price and minimum quality of service with sell orders. Calls are then dynamically routed through the lowest price path that meets the buyer’s quality needs, and Arbinet handles the flow of money between parties.

“It operates like Nasdaq—the transaction happens when the call happens,” says Tony Craig, executive chairman of Arbinet.

Because carriers are looking to capitalize on excess bandwidth and find the cheapest path to terminate calls, Arbinet’s business is growing, says J. Curt Hockemeier, president and CEO of Arbinet.

About 138 Tier 1 to Tier 3 and voice-over-IP carriers trade voice minutes on Arbinet’s system, including seven of the 10 largest carriers worldwide. Minutes volume is at a run rate of about 3 million per day and 1.2 billion minutes annually, according to Arbinet.

Originally founded in 1993 by Alex Mashinsky, Arbinet evolved through several businesses before homing in on electronic exchange. Even then, it didn’t have the business model right at first. That’s because its revenues were based on a commission fee from buyers and sellers, and when the price per minute dropped, exchange revenues also fell unless volumes increased rapidly, says Stephen Young, a principal consultant at Ovum.

So Arbinet transitioned to more of an outsourced model that ties together negotiation, delivery, settlement and billing. In a model similar to packaged software, carriers pay an upfront license fee of $10,000 to join the exchange, and the capacity-based pricing model charges $750 per T-1 equivalent. The carrier is charged on lit capacity only.

As the price of wholesale minutes and bandwidth continues to drop, Arbinet sees itself benefiting because it replaces a carrier’s fixed costs. “Carriers will continue to outsource switched minutes to avoid capex [capital expenditure] costs,” Craig says. “We cut the cost of getting to the commodity.”

Of course, providing a robust physical delivery medium comes with some “sunk” costs for the exchange. Arbinet spent $30 million on a carrier-grade operations support system. The company’s New York switching center interconnects carriers, and Arbinet offers a PSTN+ product that enables carriers local access from any carrier hotel in New York through a FiberNet ring.

Although Arbinet is concentrating on building scale at its New York connection point, it is also doing a “smart build” in London, Hockemeier says. The company is establishing a virtual point of presence and leasing an STM-1 line to facilitate trans-Atlantic trading. Eventually, however, it hopes that members will provide the connectivity themselves. “We don’t ever want to be long on bandwidth,” Hockemeier says.

According to Arbinet officials, the company’s model presents advantages for carriers looking to end the one-to-one capacity trading processes that take place behind closed doors.

Besides being an alternative sales channel for sellers, Arbinet’s exchange mitigates their credit risk. A recent agreement with GE Capital enables Arbinet to take on the financial risk of dealing with anonymous buyers. GE Capital underwrites the large carriers that trade on the exchange, although smaller carriers are required to put up collateral to cover their net position. Sellers also get paid in 15 days rather than the industry average of 66 days, Hockemeier says.

In addition, Arbinet’s extensive code database protects buyers and sellers from having traffic moved at the wrong price, Hockemeier says, which is a problem worldwide as phone numbers proliferate. “If the codes don’t agree, the traffic doesn’t flow,” he says.

Despite its early lead in the market and a sophisticated trading platform, Arbinet does not expect to be cashflow-positive until the end of the year. The company has partly closed a Series E venture round that it expects will take it to that point, Hockemeier says.

According to an S-1 filed in March 2000, and pulled when the market soured, Arbinet posted a net loss of $14.1 million and negative net cash flow of $7.4 million for 1999. At that time, five service providers accounted for 85% of minutes traded through the exchange.

Bigger problems may lie ahead if, as Young predicts, the switched minutes market is overtaken by other forms of bandwidth trading. “The switched minutes market will become insignificant, and increasing liquidity will drive managed transmission to be the most important trading market,” he wrote in a recent report.

Arbinet, however, has not written a business plan to address the managed transmission services market. “It’s very popular to want to talk about the new, sexy stuff,” Hockemeier says. Arbinet is more likely to move next into trading of circuits, he said. IP packets trading is another possibility that is further out.

“We have been fanatical about staying at home and knowing the minutes business inside and out,” Hockemeier says.

Arbinet-thexchange

Headquarters: New York, N.Y.

Top officers: Anthony L. Craig, executive chairman; J. Curt Hockemeier, president and CEO; Robert S. Vaters, executive vice president and chief financial officer; Alex Mashinsky, founder and vice chairman

Number of employees: 106

Date founded: 1996

Focus: Minutes exchange providing automated trading, delivery and settlement

Venture funding raised to date: $81 million

Annual revenue: Not disclosed

URL: www.thexchange.com

 

From the ground up

RateXchange builds the market along with itself

by Toby Weber

Despite the predictions of recent years, the bandwidth exchange market is not, at this time, booming. This is partly because of carriers who have been hesitant to jump into the game, and partly because of the natural evolution of this new niche.

San Francisco-based RateXchange, however, is determined to help both move along.

The centerpiece of the company’s portfolio is RateXchange Trading System, a Web-based bandwidth exchange platform that allows for the exchange of time division multiplexing bandwidth and will soon accommodate IP-based bandwidth.

“The way we have approached setting up a bandwidth exchange is the model that has proved itself in a lot of other commodities,” says Nick Coill, senior vice president of trading operations with RateXchange. “They all approach credit with a pre-approved counterparty credit system….They all trade anonymously on a bid/ask market without any type of algorithms, so when you hit a bid and list an offer, you know exactly what you are getting. After the deal is made there’s a name give up and the parties find out who each other are.”

Through a deal with energy broker Amerex, RateXchange also accommodates those who do not want to trade bandwidth online.

A company using this service would call a brokerage desk and give information on the bandwidth it wants to buy or sell. That information is listed on RTS for others to view but cannot be acted upon via the Web. Instead, an interested party contacts the brokerage desk to begin the exchange process.

The relationship with Amerex can be used to transition companies into bandwidth trading, although the voice trading market will always exist because of the negotiations involved with larger transactions, says Jon Merriman, president and CEO of RateXchange. “The end game for the broker community and also the customer community is to migrate the smaller, more commodity-oriented transactions to the screen,” he says.

In the past, when a deal for bandwidth was cut, RateXchange provided for the physical handoff of traffic through one of its 12 pooling points. Feedback from potential bandwidth traders, however, convinced RateXchange that the company should exit pooling point business.

“The market is looking for neutrality across a variety of platforms,” Merriman says. “If we’re operating pooling points, we’re not going to be neutral.”

Seth Libby, an analyst with The Yankee Group, understands why carriers would desire such neutrality. “If I’m going to buy bandwidth from somebody, I would prefer to buy it from somebody who I was relatively certain didn’t have a stake in the game,” he says.

RateXchange, then, is selling its pooling points, at which time it will own no physical infrastructure and will have a purely transaction-driven business model.

This transition required changes at the top of RateXchange. In October, Merriman was brought on board as president and CEO, replacing Don Sledge. “There was a recognition that the model had to move to more transaction, more deal driven. My background is pretty much trade and deal-driven. [Sledge] came from a more traditional telco environment,” Merriman says.

This approach of neutrality is the bedrock for other major aspects of RateXchange’s portfolio such as consulting services. Approaching bandwidth as a commodity, the company provides asset valuation, hedging and trading strategies, market research and pricing strategies and policies.

The company also offers historical pricing information on some of the most liquid routes, such as New York to Los Angeles and Los Angeles to Tokyo.

These services are based on data RateXchange has taken primarily from RTS. “One of our objectives is to effectively market that information to the world because it’s valuable,” Merriman says.

To encourage the commoditization of bandwidth, the company is also working to establish a bandwidth futures market. In March, the company took a major step toward this goal with its acquisition of Xpit.com. Xpit has developed a Web-enabled trading and risk management system that offers traders, brokers and financial institutions access to trading pits and electronic exchanges throughout the world, and it provides real-time monitoring of accounts.

As with any futures market, carriers must first understand it. The education of potential customers is in fact one of the biggest tasks for bandwidth exchanges, according to Russ Matulich, senior vice president of sales for RateXchange.

“In the past few months [telcos have] figured out that exchanges have nothing to do with the price of bandwidth falling. Bandwidth prices are going to fall because there is as lot of dark fiber in the world,” Matulich says.

To educate carriers, RateXchange uses its consulting and market research information, which also serves as the “front of the arrow” for signing customers to their services.

“RateXchange has been educating us on the marketplace, putting everything in perspective for us as far as what’s going on in the industry, what are the trends,” says Bill Morrison, vice president of emerging markets for Teleglobe, which has been working with RateXchange since March.

The process of education has been slower than many had expected. For the fiscal year 2000, RateXchange posted a loss per share of $2.69, missing the $1.82 loss analysts’ had estimated at First Call/Thompson Financial.

In response to the slow growth, RateXchange has had to tighten its belt,  laying off some employees.

Things, however, may be turning around for the company. From September 1999 to September 2000, RateXchange signed up only one provider. Since then, 26 more have inked deals. “With the 20-plus telecoms we’ve signed up, when the market is ready to actively trade and move toward liquidity, then RateXchange is the first place that most of these telecoms will be turning to,” Matulich said.

RateXchange

Headquarters: San Francisco

Top officers: Jon Merriman, president and CEO; Nick Cioll, senior vice president of trading operations; Terry Ginn, vice president of software engineering; Stephen E. Kanaval, senior vice president of derivative products

Number of employees: 36

Focus: Provides Web-based trading system for TDM bandwidth; consultancy and market research

52 week high/low: $1.15–$23.00

Annual revenue: $91,000 (2000)

URL: www.ratexchange.com

Pushing pipes and packets

Band-X expands trading products

by Vincent Ryan

While other bandwidth exchanges stick to trading in voice minutes, London-based Band-X, the first spot market for switched voice, is testing the limits on how bandwidth can be traded with varying success.

Band-X describes itself as a business-to-business marketplace that offers four different trading floors: switched minutes and IP transit, which are facilities-based; and bandwidth and co-location space, for which it acts purely as a broker.

In the market for terminating international traffic or selling capacity in switched minutes, the process is much like other physical exchanges. Sellers submit bids, and buyers have Web-based access to pricing information. Band-X monitors the price and quality of circuits and provides daily reports showing traffic volumes, costs and answer seizure ratio quality per destination for buyers. However, Band-X does have scope, operating switched minutes platforms in New York; London; Frankfurt, Germany; and Hong Kong.

Bandwidth trading, or networks trading, consists of everything from point-to-point circuits, dark fiber, and submarine and terrestrial cable on a lease or indefeasible right-of-use basis. In October 2000, Band-X facilitated the first trade of a U.S. coast-to-coast optical wavelength capable of carrying 2.5 Gb/s.

These more complex trades operate on the old one-to-one model, and a lot of the work is done by Band-X employees manning phones, says Donald Noonan, vice president of networks. Account managers source the buyer’s requirements with the best supplier based on price, quality and availability, and once the parties agree in principle, Band-X introduces buyer and seller. A standard contract is available from Band-X, but it’s not mandatory.

“It really comes down to knowledge of the market and time,” Noonan says. “If you want to purchase an STM-4 from here to Paris, we know the pricing and the suppliers who have that capacity available now.”

On routes where competition is great or the buying needs are complex, carriers can perform a Band-X Tender, a reverse auction in which as many as eight suppliers bid for the deal over a two- to three-hour period. Typically large multimillion-dollar deals are traded this way, and Band-X did about $80 million in reverse auctions last year, Noonan says.

But Band-X is perhaps best known for pushing the concept of an IP-routed exchange, which other players believe is hard to manage because the technology to measure quality of service on the Internet does not exist, and traders require quality assurance for anonymity. In a patent-pending process, Band-X collects network performance information on packet loss, throughput, hop count and roundtrip time and plugs that into an algorithm to get a service quality index.

“We’ve created a solution to that barrier,” says Ilissa Mandelik, business development manager. “You can test an ISP’s network before you buy it, and if the network goes down, there are multiple sellers ready to pick up the down traffic.”

The company’s other agency business is co-location, which is touted as a “specialist commercial property agency for the trading of international telehousing.”

Band-X has about 90 suppliers in 400 locations worldwide, Noonan says. The emphasis is on introducing buyers and sellers and price discovery. “If you wanted to know about co-location in Buenos Aires, you could check out our Web site or call our people. It’s a good window on the market,” Noonan says.

Exactly how many carriers are trading Band-X’s different products is hard to verify. The company has more than 15,000 registered members, but that includes anyone who visits the Web site and inquires about how to connect, in addition to carriers that trade via the exchange.

Band-X trades about 1 million switched minutes a day and has about 100 customers physically interconnected worldwide, Noonan says.

If there is a potential weakness in Band-X’s business model, it is the wide number of products it offers while still relying on switched minutes for about 90% of revenue and a commission fee structure, according to analysts. Commissions vary in size by product line, from 1% to 2% on large-size bandwidth deals up to 15% on IP transit trades. Sometimes the supplier and buyer are taxed; other times it’s just the supplier.

That said, Band-X does have some big name backers, including Madison Dearborne Partners, Morgan Stanley and Goldman Sachs. And Jupiter Media Metrix named it one of the 10 business-to-business exchanges in Europe likely to survive the Internet shakeout.

Band-X estimates that its revenue will reach about $50 million in 2001 and $150 million in 2002. The company declined to comment on profitability, except to say that it is making money as an agency-based business.

“Every exchange has a different business model,” Noonan said. “We’re going in our own direction.”

Band-X

Company headquarters: London

Top officers: Marcus de Ferranti, co-founder and chairman; Stephen Beynon, CEO; Richard Elliot, co-founder and executive vice president, global trading development; Nigel Paner, executive vice president, global IP development; Paul Newnes, executive vice president, global switched development; Joseph C. Kiaer, executive vice president, USA.

Number of employees: 160

Date founded: 1997

Focus: Independent, transparent and neutral global marketplace for buying and selling wholesale telecommunication services including networks, co-location, minutes and IP transit

Venture funding raised to date: $51 million

Annual revenue: $16.5 million (2000)

URL: www.band-x.com