About two weeks ago, Level 3 announced plans to acquire Global Crossing and we blogged on the enormous size and scope of the new entity, which we called Level Crossing. This week, CenturyLink, a regional US phone company, agreed to acquire Savvis. Since CenturyLink also owns Qwest, we are seeing another merger of two Tier-1 Internet providers, a pairing which we’ll label Qwavvis. In what follows, we examine the possible business considerations behind the move, as well as the impact on Internet transit customers and Renesys Market Intelligence rankings.
Renesys rankings of Internet service providers are based entirely on the quantity of IP space ultimately transited by each provider. While a crude measure, it is an objective one, and it is the ranking trends, rather than any absolute number, that are the most revealing. As noted in our last blog, if #1-ranked Level 3 succeeded in merging with #2-ranked Global Crossing today, the rankings of the top global providers would have the following form. The newly combined entity would dominate the global provider market.
Assuming regulatory approval of the merger, the battle is now for second place. It would seem that NTT is in a relatively comfortable position here, as Sprint has done nothing but decline in our rankings over the years, after aggressively competing for the #1 spot with Level 3 throughout 2008. However, if Qwest and Savvis succeed in merging, NTT will find the combined entity nipping at their heels as shown below. Assuming the traditional US carriers continue to prioritize product lines other than IP transit, another very tight race will ensue for the #4 position, between Tinet, Telia and Tata.
Investor reaction to the Qwavvis deal has been generally positive and discussed mainly in terms of EBITDA and return on investment. But there are other ways to look at this. First, Qwest is focused on traditional telecommunications services, while Savvis is more aligned with data center services — cloud computing if you will. In a buyout, it makes little sense to spend money to acquire your same customers again. And since Qwest and Savvis are so different, they have almost no customer overlap — one of the more dubious aspects of the Level Crossing deal. In fact, only 12 networks (i.e., prefixes) will suddenly find themselves single-homed behind Qwavvis and might need to go shopping to regain provider redundancy. These include such “powerhouses” as Allen’s TV Cable Service with three locations in South Central Louisiana and AAA Internet, a dial-up Internet provider.
As a result, with respect to our rankings, Qwavvis is essentially the sum of its two parts, i.e., the Renesys score for Qwavvis is over 99% of the sum of the individual scores for Qwest and Savvis. Compare this to Level Crossing. As noted in our last blog there is considerable overlap between Global Crossing and Level 3. While they have tended to focus on different geographic areas, their merger will still leave around 3,500 networks (prefixes) relying on a single provider. This overlap is reflected in our scoring. Level Crossing’s score is only 75% of the sum of the individual scores for Level 3 and Global Crossing. Such a dilution of value is largely unavoidable for competitors with a global footprint and maybe the best you can expect in a such a situation, although we haven’t run the numbers for all such possible pairings.
Rather than look at existing customers, another way to consider such mergers is by the potential for future sales. While divining the future is never easy, there is one certainty in this market: the raw material of the current Internet is extremely limited and becoming more so all the time. I’m talking about IPv4 addresses. Before much longer, there will be only one place to get them, namely, existing service providers. The lack of this raw material will undoubtedly curtail the growth of some providers and limit new entrants into the market.
In fact, if the Microsoft purchase of Nortel address space for $7.5 million is any indication, corporations are starting to wake up to the impending resource scarcity. While we will have a lot more to say on the value of IPv4 space in future blogs, we’ll briefly consider the issue here for the proposed mergers. Taking into account the various Level 3 and Global Crossing acquisitions over the years, the newly formed Level Crossing will control nearly 50 million IPv4 addresses or over 1% of all available address space. In contrast, Qwavvis will control about half as much space. For both companies, much of this space is currently unused. As consolidation in the industry continues, not only will customers have fewer choices, they might also need to consider if their potential vendors will have the IP resources available to accommodate their future growth. Stay tuned for more on this important topic!