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Dana Dana Blankenhorn has been a business journalist for over 25 years and has covered the online world professionally since 1985. He founded the "Interactive Age Daily" for CMP Media, and has written for the Chicago Tribune, Advertising Age, and dozens of other publications over the years.
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October 21, 2005

Walter Scott's Internet Power Play

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Posted by Dana Blankenhorn

walter scott jr.jpg A childhood friend of Warren Buffett is engaged in a power play that could raise your Internet bills.

NOTE: I have been informed by commenters, and confirmed, that Buffett's Berkshire Hathaway sold its Level 3 stake in November 2003. Level 3 founder Walter Scott, however, is a childhood friend of Buffett's, and a member of the Berkshire-Hathaway board. The correct headline should thus be "Walter Scott's Internet Power Play." I deeply regret the error.

He's doing it through Level 3. Buffett owns bought a big, quiet stake in Level 3, through secured notes bought by Berkshire- I Hathaway in 2002. Also, Level 3 chairman Walter Scott is on the Berkshire-Hathaway board.

Level 3, one of the largest Internet backbone operators not owned by a Bell company, is losing money. It's trying to change this by getting tough on peering, the linking of its network to other ISPs.

Specifically it cut connectons with Cogent Communications, a smaller backbone provider, early this month, and plans to do it again next month. The effect is to render 15% of the Internet invisible to Cogent customers, and vice versa.

The Internet is based on the idea that companies will exchange previous bodily fluids of information and worry about the money later. If there's an imbalance in flows between carriers, money changes hands, later. Level 3 and Cogent disagree on how much money should flow.

It all goes back to Cogent's purchase of PSINet, which didn't have an agreement on money flows, and Level 3's efforts to force such an agreement on its smaller rival. But the real issue is that Level 3 is highly leveraged (with Buffett's Berkshire Hathaway holding many notes) while Cogent has already gone through restructuring. As a result Cogent can undercut Level 3 prices.

The real danger is not whether Level 3 can force Cogent to knuckle-under. It is whether Bell companies might copy the move.

Remember, please. Verizon owns MCI. SBC owns AT&T. Verizon is buying MCI, and SBC is buying AT&T. Those deals should close before the end of the year. Between them, MCI and AT&T own more than half the Internet backbone capacity in the U.S. They are high-cost operators, highly leveraged, with owners who demand profits.

If Level 3's power play isn't put down, I guarantee SBC and Verizon are going to start playing the same game, turning backhaul capacity from cheap to expensive, destroying many folks' ability to linik to the entire Internet, and throwing the whole system into the crapper.

Just watch.

And thank Buffett Warren Buffett's childhood friend Walter Scott for it.

Comments (6) + TrackBacks (0) | Category: Business Strategy | Economics | Internet | Telecommunications


COMMENTS

1. Russell Shaw on October 20, 2005 03:28 PM writes...

Well, several things:

The SBC acquisition of AT&T has not officially taken place, nor has Verizon -MCI. So incorrect to say both are owned by...

From this week's issue of Multichannel News, cited at http://mediachannel.org/blog/node/1463:

In late October or November, the FCC is expected to approve, possibly with some minor conditions, SBC Communications Inc.’s takeover of AT&T Corp., pending since February, and Verizon Communications Inc.’s merger with MCI Inc., pending since March.

Also, Level 3 is a major, in fact, the major, routing infrastructure provider to most VoIP providers- whose services undercut traditional phone companies in pricing. So one read of Buffett's action here is that he is playing all sides...

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2. Rob on October 21, 2005 09:30 AM writes...

Actually, Buffett is known to have converted the stake you cite into stock back in June 2003, then sold every penny of that stock. Currently, Buffett is not known to own any portion of LVLT - bonds or stock - although rumors about the bonds do persist. The major players behind LVLT are Legg Mason and Southeastern Asset Management, I believe.

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3. bill on October 21, 2005 09:51 AM writes...

Article is a hoax. The debt was converted to equity and sold years ago. SEC filings by Berkshire confirm this key facct missing from the article.

Permalink to Comment

4. greg on October 21, 2005 10:36 AM writes...

You're out to lunch. Buffet converted the bonds to stock then sold. Cogent's customer base is porn sites. They're cheap because they rely on other people networks like LVLT to distribute, but carry very little of LVLT's traffic.

Listen, the only thing Cogent needs to do is to sign a reciprocal compensation agreement with LVLT. If the amount of traffic traveling in both directions is equal, then the dollars will offset and there is no impact to anyone. However, Cogent won't do that because they are screwing LVLT and can't afford to offer below cost prices and pay for the access as they should.

Try doing a little research before posting next time. Your few facts were wrong and your opinion shows little or no research.

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5. Someone in Chicago on October 21, 2005 10:48 AM writes...

As a consumer who knows something about telecoms and internet peering relationships AND sustainable business models in a service oriented industry, I have to hope that SBC and Verizon DO exactly this.

Permalink to Comment

6. Mike on October 23, 2005 10:31 PM writes...

Bad form by the author to so badly mis-state the fact that Berkshire Hathaway is long out of LVLT and then base an inflamatory article around false premise. A retraction is due.

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