Enron's Telecommunications Revolution[Fool on the Hill] February 9, 2000

An Investment Opinion

Enron's Telecommunications Revolution

By Bill Mann (TMF Otter)
February 9, 2000

Here's a juicy piece of trivia for you. Can you name the company with the largest amount of business derived from e-commerce?

If you managed to see the title you'd likely expect the answer to be Enron. And you'd be right.

Houston-based Enron Corp. (NYSE: ENE) processes online transactions with a notional value of $300-400 million per day. Enron's electricity and natural gas intermediation services manage a significant portion of the natural gas spot contracts in the United States and Canada, providing service via its own natural gas pipeline network as well as providing the information system to broker sales between suppliers and purchasers.

In effect, Enron has decided to leverage its network of pipelines by using the information about natural gas flow to help make a much more efficient system. The information is then what becomes valuable, with the network and the actual natural gas just being the commodity upon which the information exchange is built.

Enron has made some recent splashes here at The Motley Fool, starting with its inclusion as a NOW 50 Index company, which began on the first day of trading in 2000. In just the last two weeks Enron's CEO, Ken Lay, appeared with Tom and David Gardner on The Motley Fool Radio Show, and on Monday of this week, George Runkle (TMF Runkle) wrote about it as a part of the Pathfinder Series being undertaken in the Drip Port.

But what really catches my eye about Enron is its attempt to bring the same spot market efficiency to the bandwidth market as it has done with natural gas. This is something really bold -- a company with natural gas and electric utility backgrounds (Enron owns Portland General Electric, the incumbent utility in northwestern Oregon) moving into the telecommunications field, one of the most fiercely competitive on the planet. Are these people nuts?

Not at all. They're crazy like foxes, actually. Enron is part of a rare breed, a company that is perfectly willing to go out and compete for business anywhere, anytime. They seem to have no preconceived notions of what their business limitations are supposed to be, and have never seen any such thing as a sacred cow, to the point of selling off the operations that first brought them into commerce. These companies, to which I assign the highest regard, include Nokia (NYSE: NOK), CMGi (Nasdaq: CMGI), Reed Elsevier (NYSE: ENL), Cable & Wireless (NYSE: CWP) and Schlumberger (NYSE: SLB), operate in different industries, but they are in effect companies that trade primarily in intellectual capital. Enron fits this mold as well -- it trades in information, the commodities and services it provides are the manifestations of that information.

With this background in mind, I jumped at the opportunity this morning to attend an informational session that Enron held in Washington, D.C. to discuss its new initiative, Enron Broadband Services, presented by the CEO of EBS, Joe Hirko, and the Vice President of Bandwidth Trading, Tom Gros.

What Enron proposes to do, and is provisioning its network for, is to create a market by which Internet Service Providers (ISPs), carriers, brokers and end users can purchase high bandwidth capacity on a spot market. Enron is initially using its existing 14,000-mile fiber optic network in the U.S., along with pooling points and other points of presence, currently in 25 U.S. cities.

The concept is revolutionary. Currently high-bandwidth pipelines (DS-3 and higher) are provisioned on a long-term contract basis and can take up to 90 days to be brought into service. This means that it is very difficult for networks to do any dynamic load management because their networks must be built to handle peak usage times that, in some instances, can be 200 times as high as the low usage points.

Enron estimates as a result of this that even on the heaviest trafficked routes, such as New York-Los Angeles, that the load factor (amount of capacity that is actually used) for circuits is less than 5%. What Enron is proposing would provide a way for network managers to use as much bandwidth as they need during peak times, and sell it on the open market during their own lower traffic times. But how can companies do this given the long lead times required to bring up and tear down circuits?

Enter Enron. Enron has built its first two pooling points (one in New York, one in Los Angeles) to which ISPs, carriers and high-density end users can connect. These pooling points can then, using Enron's network optimization protocols, route the traffic from any number of customers across the same network. In so doing, Enron has provided its customers a solution that would otherwise be unavailable to them -- the ability to efficiently provision their own bandwidth needs, on a time-of-day, hourly, or one-time purchase basis.

So, for example, if Citigroup (NYSE: C) needed to send wiring information out from its New York clearinghouse once a day from 2-3am, Enron could provide them dedicated bandwidth for that transaction, selling the capacity to other clients during the other 23 hours of the day. Enron can even "hot roll" a data stream, matching supply and demand every 5 seconds, and move a customer from one dedicated circuit to another without any disruption of service to the customer.

There is a great deal of things that need to take place in the market before this vision becomes real, such as terms of service standards, legal efficiency (master contracts), and an increased level of interconnectivity between carriers. But more importantly, carriers need to be willing to change the rules of the game. At least one carrier has been dismissive of Enron's entrance into their sandbox, saying that there's nothing an Enron could teach them about their own business. This suits Joe Hirko just fine, as Enron is working to set up a liquid telecommunications market, and in the end, like anything else, the needs of the consumers will drive the market. Hirko expects that activity in a liquid bandwidth market will build through 2001. But already Enron Communications has some $160 million in streaming contracts.

Seeing as Akamai (Nasdaq: AKAM) -- whose Internet delivery service provides network flexibility is valued at $24 billion for $1.7 million in annual sales -- is it any wonder why some analysts believe that Enron Communications could be worth more than all of the rest of the company? If Enron succeeds in its drive to create an open broadband market, its $31 billion market cap could be a distant memory.

Be sure to check out our Valentine's Day treat, Stocks Fools Love, for a few love sonnets and other odes to some of our favorite companies! You might learn something, and you might be inspired to compose a ditty for your own beloved.

Fool on!

Bill Mann, TMFOtter on the boards

Related Sites:
Enron Message Board
Enron Corp website
Enron Broadband Services