Net2Phone dialing back on long distance

Cheap Web calls are becoming a commidity business, so the company is changing strategy. Hello Cisco!

Net2Phone Inc., the aspiring Internet phone company, is switching strategies after concluding that long-distance calling is as much of a cutthroat business on the Internet as it is in the traditional off-line world.

In a major shift, the high-profile firm, whose biggest backer is AT&T Corp. (t), is planning to market software that will enable traditional carriers to route more of their traffic over the Internet -- though that new market is itself becoming a crowded one.

A significant partnership with networking leader Cisco Systems, Inc. (csco), and a spinoff of the new business unit, was announced Monday.

Net2Phone (ntop) made a splash three years ago by charging only pennies for long-distance phone calls made over the Internet. Today, it claims a 40% share of the small but growing market for Internet telephony, enough of a presence to have attracted a $1.4 billion, one-third stake from AT&T in March.

But the Internet telephony market is a crowded and unprofitable one, with 300 companies using price cuts to win customers and driving toll rates to as low as two cents a minute for domestic Internet calls. Net2Phone is expected to report a loss of $41.5 million for the fiscal year that ended July 31, on sales of $70 million.

While Internet toll charges now account for 95% of the company's business, Net2Phone executives hope to shrink that percentage to 50% within two years.

They also hope that 20% and 30% of their revenue by then will come from their new business line: telephone network management software for major carriers, like AT&T, which are moving more of their calling to the Internet. The software allows carriers to handle such common network management tasks as call routing and fraud detection.

A new-business unit, to be called Adir Technologies, will be formed with Cisco, and will be majority-owned by Net2Phone. It will sell the company's software along with Cisco's hardware.

Analysts said the move by Net2Phone was inevitable, considering that its earlier strategy, while attention-getting, wasn't sustainable.

"Every carrier in the world is reducing its rates," said Mark Winther, vice president of telecommunications services at International Data Corp., a Framingham, Mass., market-research firm.

Winther also warned that the move is a risky one. "It's a completely new business for them and there are a lot of companies offering this type of network management solution," he said.

AT&T is in line to be Net2Phone's first management software customer, and hopes to make the technology standard for voice over Internet protocol, said John Petrillo, AT&T's executive vice president of corporate strategy and business development.

The long-distance giant is building its own high-performance network and plans to use Net2Phone's software to help manage its calls and data streams as they move between the Internet and AT&T's private network.

"This is the way the industry is moving," said Petrillo. "We're going to put as many calls on our [network] as we can."

Net2Phone, which has more than a million customers, is a closely watched company that is seen as an indicator of the progress of the larger Internet telephony market. It has a number of other large investors besides AT&T, including America Online Inc. (aol) and Yahoo! Inc. (yhoo) Net2phone also has signed a string of strategic deals with such marquee players as Microsoft (msft), Sprint Corp. (fon) and Inc. (pcln).

Besides its new software business, the company said it is also planning a line of other Internet telephony products and services.

Net2Phone was founded in 1997 by IDT Corp., a Newark, N.J., long-distance company. After being spun off, Net2Phone went public in July 1999.

The first day of trading its shares soared 77% to $26.65 from an offering price of $15. After reaching a 52-week high of $83.75 later that summer, some of the air has been let out of its stock. The shares closed Friday at $33.81, up $1.94, in Nasdaq Stock Market trading.