Consolidation in an Unstable Economy
November 21, 2008
With an unstable economy, we’re going to see more consolidation. Who do I see partnering and conjoining in all this?
I am expecting more M&A to emanate from foreign entities such as Reliance Telecom, Deutsche Telecom, T-Mobile, etc. What you will see, given the financial mess the world is in, the consolidation will be driven and valued on hard fixed assets. Carriers of the rental or co-location genre will get heavily discounted as broadband demand continues to grow and outstrips the need for or carrying capacity limitations of copper loops, T1, DSL, coax and SONET/ATM.
So what does that mean for AFS? What are AFS’s plans in this arena?
I have come to find that those out looking to acquire travel like lemmings. For example, if all the EBITDA multiples are 7x, then everything must sell at 7x. I am sorry to point this out to public shareowners, but this is as sophisticated as due diligence gets with some Investment Bankers. So a company like AFS that is growing, profitable and has probably the lowest churn in our industry can afford to wait until the lemmings move back up the scale. Companies not similarly situated, you get what you can when you can get it.
AFS is somewhere between a number of options, and as I write this, the option I prefer is management buying AFS from our existing investors and moving forward from there. We have often received unsolicited offers or inquiries of interest on a regular basis. Any decisions made will always be made in the optimal value interests of all our shareowners. As I stated earlier, there is no compelling reason to sell for less than optimal value in our case.
More to come on all this…
What’s your take on consolidation and the state of the economy? Shoot Dave an email or post a comment below.
Guess Who’s Coming to the xchange magazine Blog?
November 14, 2008
You guessed it. This month I started a guest blog feature for xchange magazine on xchangemag.com. I posted my second xchange blog entry today entitled “Two Topics, One Conclusion” in which I wrote about how forbearance can help solve the fiber glut myth that exists. It also continues my commentary on the case for forbearance and answers a recent question I got:
“If all such forbearances were granted and the government stops watching, what will stop the ILECs from doubling prices where there isn’t competition and cutting prices in half where there is - thus ending the business case for anyone else to hook up more buildings with fiber? In other words, does granting forbearance necessarily lead to more choice?”
Here’s an excerpt from my post on the xchange blog:
Forbearance is the right tool to increase investment into local fiber optic infrastructure. This local fiber infrastructure is much needed to surpass today’s basic copper broadband to make the U.S. globally competitive in an array of industries.
As a result of being granted forbearance, ILECs will likely raise wholesale prices, as they should. This will generate profits for some, and for others, grant a timely death or consolidation. But as profits rise and regulatory certainty of forbearance manifests itself, then and only then will investment groups have an interest in entering the highly fixed cost business of local market competition on a fiber access platform. The worry that the ILECs will price everyone out of business is just a worry. Even the craziest of ILECs will recognize that if they get out of line, soon they would face regulatory scrutiny again. If anyone knows the touch point for monopolistic behavior, it is the ILEC. The last thing they want is more regulation when they have the control to avoid it. Control – understand that is what the ILEC is all about – from there, design your execution strategy.
Forbearance can also be a managed process. It does not necessarily represent a light switch. There can be safeguards and indices built into the process. But clearly, we need a sunset provision whereby all gloves are off the ILEC within five years. A five year sunset provision would mean that CLECs will have been given 17 years since CA 1996 to figure things out for themselves. Having such a sunset provision would clearly signal to investors that making high-cost investments in local fiber optic infrastructure is a value proposition and a long term advantage. Imagine if we had an eight-year sunset provision at the outset in 1996 – we would not be in the current mess. However, no one back then asked the non-celebrity types about regulatory policy – what could they possibly know? After all, they are from outside the beltway.
Is Dave right on or way off? Shoot Dave an email or post a comment below. You can also follow Dave’s xchange blog.
As Long As I Have Your Attention…
October 24, 2008
As long as I have your attention, let me address the broader economy relative to AFS. Here is what I have communicated to our team regarding the current financial conditions:
This economic downturn is much different from the Internet bubble of 2001-2003. Telecom is not at the center of this downturn. We are experiencing a combination of Congress, Wall Street, Hedge Funds and Financial “Banks” being caught up in a lending house of cards relative to the mortgage industry. If you want a life lesson out of what is going on today, just remember this: there is nothing immune from economic business cycles … nothing. Somehow the real smart guys (RSGs) believed housing prices were going to keep rising forever and people were afforded mortgages (Fannie Mae and Freddie Mac) on homes without having a job, address and/or a down payment. The RSGs in Congress, Wall Street, Hedge Funds and “Banks” in combination drove the collapse of our financial institutions.
Also please note, whenever there is a downturn based upon over exuberance, you will always find Wall Street’s finger prints all over it.
Compared to the Internet bubble, today AFS is a much different company and in a better position than most. Our constant drive for quality customers, high bandwidth customers and profitable customers is what has and will continue to sustain us. Yes our mantra – deliver on-time, on-budget, reliable services and proactive customer services, is what has sustained us and will continue to do so. We do not need to change a thing.
Those in telecom that I believe face great exposure are those firms serving the low end of the market via copper loops, T1, IADs, VOIP or special access. Because this segment of the market relies on the ILEC for network, as credit gets tightened, a number of these firms will start doing something real dumb to raise near term cash to pay the bills … they will start cutting prices. The problem with this strategy, outside of its lack of sophistication, is that their Cost of Sales via the ILEC is fixed. As they price war each other, it becomes a death spiral as every dollar in price dropped is a direct dollar in margin dropped. In addition, this segment of the market historically churns at a very high rate in a down business cycle as small businesses cope with declining demand or lack of capital. Thus, the situation is a one-two punch for those serving the SME segment via the ILEC infrastructure.
As you know, I constantly encourage everyone to be creative in our business dealings whether to increase sales, lower costs or streamline processes to the benefit of customers. If we had a conforming business model and culture like other telecom companies to the benefit Wall Street, we would not be in the growth position we have experienced. My opinion is Wall Street and investors look for conformity to gain comfort. This is often referred to as the lemming culture. Such conformance may provide a few relative data points, but in my opinion, diversity of ideas and talent gets stifled whenever it is okay to look and act like everyone else. It is fair to say, and it’s not hindsight, that our contrarian culture and demand-driven strategies have greatly benefited our investors, customers and employees. No one is here to satisfy me – we are all shareowners.
As we go forward, I encourage you now more than ever to get creative to streamline processes, increase sales or lower costs to the benefit of our customers.  This credit crisis is going to get butt ugly. Cash is king. The more cash we have on our balance sheet, the better we can serve customers, weather this storm or take advantage of opportunities that present themselves.
Do you have a take on the financial crisis? Post a comment below or shoot Dave an email.
Just for Grins
October 23, 2008
Just for grins, when I originally sought funding for American Fiber Systems in 1999, I had a business model that was purely demand driven. The model was based on a fundamental premise that in the long run, if you do not own and operate your own local fiber optic infrastructure but rather rely upon your largest competitor to stay in business, well, it is simply not a smart idea.
Once again, it’s 1999 – my view based on experience, you cannot rent or lease your way to sustainable economic success through the ILEC. The more you depended upon the ILEC pieces and parts, your ability to innovate, time-to-market, provision and compete is limited. When your largest competitor, the ILEC, basically controls your costs and has expertise in regulatory and judicial matters, I don’t see this as a win-win formula … but I could be wrong.
Anyhow, the reason I bring this up is purely for grins. In 1999 I pitched many investment banks, a/k/a “experts,” for funding, Lehman Brothers and Bear Stearns amongst them. Across the board, I was told by the Wall Street experts that my demand-driven, slow role, metropolitan fiber based business model was not attractive and not fast enough. They were critical because I had an incremental, success-based funding model. I was told that unless I was raising $500 million equity and $300mm in high yield debt (heroin), I had no idea what I was doing.
Thank god I had experience, common sense and thick skin. I ignored them and eventually went the venture capital route. So as I watch Lehman Brothers and Bear Stearns fade from our memories … with more to follow … I guess I will let the record speak for itself alongside the business moral values of some CEO from upstate New York who had no idea in 1999 how to build a business according to the big Wall Street firms.
Shoot Dave an email or include your insights and questions below.
The Tortoise & The Hare: A Telecom Parable
October 3, 2008
Great article the other day on xchangemag.com by Kelly Teal on the current economic conditions and the impact on telecom. The piece, Recession Expected to Hit Telecom in Second Half, looks at how telcos stand to fare given the actions of Congress, peppering in perspectives from various industry analysts. This projection I found of particular note:
Ed Vilandrie, co-founder and director of business and technology consultancy Altman Vilandrie & Co., added that fiber providers, carriers with their own transport and even entities such as data centers, stand to feel less pain than other industry players. That’s because they have infrastructure that clients need, and they can help customers reduce costs by making better use of the Internet and IP. “Middlemen,” on the other hand, such as resellers without their own facilities, are likely to struggle, Vilandrie said.
Economic uncertainty? No credit available? Economic downturn? Common sense and third party analysts alike validate the importance of owning and operating your own fiber optic infrastructure in this article. If this thing gets as bad as the Wall Street “experts” claim (I use quotes because I don’t want to say the word I’m really thinking — “idiots”), my vision in building AFS for the long run in 1999 is coming to fruition. It’s been a big race – the Tortoises against the Hares – with Wall Street “real smart guys” betting on the Hares since 1996. Credit crunch, downturn … this Tortoise is seeing the finish line … the Hares, well… they’re seeing the “finished” line.
What’s your take? Shoot Dave an email or post a comment below.
What America Needs is Choice (and I’m not talking about the election)
September 18, 2008
We have not experienced in 12-years a migration from ILEC dependency by CLECs. The CA 96 was designed to create competition – it has failed. So, do we need other 12-years of status quo? Absolutely not!
What America needs is choice. Choice in true facilities based competition and not the holographic companies that claim they “own” a network.
How will you get true choice? Real competition? You don’t do it by continuing regulations that have not worked. You do not do it by relying on Governments that are only interested in sapping fees from users of any operator’s customers plus the operator. It is time to wake up – you need to do what you need to do and stop relying on the Beltway Broadband Bandits. You do this by leadership and not whining how unfair it is if I don’t get 12 more years of renting. You realize the government is NOT on your side and you figure out your destiny. Prolonging the inevitable only provides the ILECs and cable Companies more opportunity to penetrate with facilities which lock you out of competition.
The Global bandwidth driven economy is passing America up and bandwidth is fast becoming the oil of the 21st century. So let’s keep arguing for the status quo so we can fall behind further.
Yes, the ILECs do not have to share fiber, it’s the law. So why do we sit around and whine about it? A lot of CLECs do whine which is a waste of time and lawyer/lobbyist money. Get over the anger and denial and stop counting on the government. Also, by law, cable companies do not share networks or even rent out pieces like the ILEC is required. I don’t hear too much pissing in the wind about this fact!
Yes, granting forbearance will drive prices up in the short term, as it should. This is called an open market finding competitive equilibrium. The reason we hear; “Oh my costs will go up and my prices will go up” is because the weak CLECs that only compete on price have no value add to offer customers. They don’t have sales people whom are sophisticated enough to sell up the value chain on value and a profitable return. They believe telecom is homogenous and it is all about low price elasticity. Bottom line: being on the ILEC dole so long, some CLECs have become plain lazy. Exactly what the ILEC wants.
As competitive equilibrium is reached in a post-forbearance market and profits realized, then and only then will private investment occur into more local fiber optic infrastructure and access. When investors clearly realize that they can get a return on the capital deployed in this high fixed cost business under a forbearance-granted market, the investment flows. Profits create competition, not the continuance of the telecom welfare state as we know it.
Over 90% of business buildings in this country still do not have cable #2 into their building from a true facilities competitor. It is estimated it would take $125 billion in investment to bring needed fiber to every home and business as entry stakes for Global broadband access. We will not attract new infrastructure investment as long as government regulations make earning a profit a risky undertaking in what is and always has been and will always be, a high fixed cost business for participants of stamina.
Weren’t those 12-years enough time to figure things out?
Shoot me an email or add a comment below.
Opportunity Abound for XO Despite NOL’s
September 16, 2008
I recently received the following comment in response to What Frontier Means on a Resume:
The viability for PAETEC will be integrating the McLeodUSA fiber into the PAETEC environment.
I have been challenging tax assessments on this industry specifically focusing on CLEC’s and IXC’s back to 2000. Because of the NOL’s, property tax was a major part of the CLEC operating expense. A CLEC without fiber going forward will soon see the end. I am sure if the credit markets would allow and the PAETEC stock price would rise, Arunas would be after more fiber…possibly XO.
XO is next. Question is who is the buyer.
Thanks Brian.
I believe if anything reasonable were in M&A play, XO is in a better position to go on an acquisition spree. Mr. Icahn recently cleaned up their balance sheet and they are now debt light. The owners of metro fiber like an XO can benefit by adding customers and applications to their local fiber infrastructure at a reasonable valuation. The net effect of doing this is the acquired customers’ margin contribution to the fiber-based entity can increase as much as an incremental 40%.
The converse, an asset-light company buying a metro fiber based company with its customers, is a different animal altogether. The same 40% in margin increase can be had by the acquirer as it comes with the fiber platform, however, the valuation profile of such a local fiber-based company will be much higher than an asset-light company. The thinking behind such a scenario isn’t as much about the local the cost of acquiring the metro fiber business but the value of its metro fiber; it quickly becomes a valuation of “what does it cost me if I don’t have access to the metro fiber M&A play and get locked out by a competitor?” It is not an industry secret that there is a shortage of metro fiber and having to build it if you can’t buy it is a costly proposition. It costs 60% more today for the same metro fiber build than what it cost to build 5 short years ago.
In an acquisition or merger, NOL’s get fractionalized to such an extent by the IRS, they are of marginal value. Whether you agree with Mr. Icahn or not, he restructured XO in such a manner within his holdings that he can take advantage of the lion’s share of XO’s NOL’s.
Shoot me an email or add a comment below.
Wisdom from the Street — High Margin is Bad
September 11, 2008
One of my readers, Mark Miller of Miller Capital Partners, wrote asking about my thoughts on an announcement by TWTC:
Any thoughts on the announcement today from TWTC (a big fiber owner), recent issues with CCOI [Cogent], while LVLT [Level 3] and GLBC [Global Crossing] say no slowdown in sight? Is it that TWTC have so much voice and CCOI sells basics, whereas LVLT and GLBC have a different revenue base? I guess we’ll see what LVLT and TWTC have to say later today.
First of all, thanks for writing, Mark. I really enjoy hearing from other professionals about telecom topics such as this.
For those not following the story, TWTC filed something with the SEC yesterday and said that they are experiencing churn from their very small customers who are not paying their bills. Well, as soon as the Chicken Littles got this news, the knee jerk reaction is to downgrade. I say upgrade TWTC; this is good news.
The Street reaction to the tw telecom filings, per usual, just demonstrates to me, again, a major disconnect between Wall Street and reality. Once again, Wall Street does the “the sky is falling” routine.
Want a stock tip: buy TWTC courtesy of Wall Street Analysts that are short sighted. Clue: You can’t find an analyst on Wall Street that has run a telecom firm that can distinguish between staying power and last night’s date.
Wall Street has some kind of Oedipus complex with top line revenues. Any disruption to revenue growth, well, that is not acceptable. When will Wall Street start realizing this game is about predictable margin and profitability growth?
If “small customers” (a/k/a Type 2 **) are churning out of TWTC, this is good. These marginal, no growth, financially strapped customers are leaving for another carrier. I say lets get a cake and have a party. TWTC margins will improve! Low end, low margins v. high end, high margin customers … what’s the problem? Rejoice!
I would be more concerned if TWTC were having a run on the on-net customers since these are high margin, high revenue customers. But they are not and will not because TWTC owns local fiber optic infrastructure. Metropolitan fiber allows you to play at the 70% - 85% gross margin level with on-net customers; it’s the type 2 customer that drags down margins. Type 2 customers – good riddance — have a piece of cake on the way out. Go back to Ma Bell where you belong.
So, in my simple way of thinking, since tw telecom does not make sub-prime mortgage loans, manufacture automobiles or build houses, I think they are a buy. Funny thing – the credibility of Wall Street firms – they create the bubbles and somehow want to be seen as credible. To Citicorp that provided a downgrade take note: people who live in glass houses should not be throwing any stones.
Do your homework, and jump on buying opportunities like this when the uninspired, inexperienced Wall Street spreadsheet jockeys hand you a gift like today’s.
** Type 2 describes when a provider like TWTC buys a circuit wholesale from the phone company (because they don’t have a particular building On-net), and they then resell this circuit to an end-user. AFS does Type 2 circuits less than 5% of the time. Paetec is 100% type 2.
Shoot me an email or add a comment below.
Two Cents on Paetec
August 28, 2008
I got an email from a reader that said, “I’m surprised I haven’t seen the Straight Shooter’s $0.02 on this topic: Who will buy McLeod’s fiber from Paetec?”
Here’s my take: What I heard on the conference call is that PAETEC is not selling fiber anymore, so analysts should not rely on said sales going forward.
I think it’s a smart move not enabling competitors. That said, previous management to Paetec, attempting to avoid bankruptcy, sold fiber on the cheap thus enabling low cost competitors on the same local fiber routes. I don’t believe Arunas was saying that they will divest and be a non-fiber participant. If this were the case, in my opinion, Paetec would not have bought McLeod. I believe Paetec management understands that fiber enables greater margin control/growth and service differentiation.
Paetec hit a bump in the road; they should be running to local fiber, not from it, regardless of the 90-day Wall Street view of matters. Local fiber creates a sustainable, competitive advantage.
Comment Response: Just how prevalent is Ma Bell?
August 13, 2008
The following comment was posted on the 8×8, Inc., Yahoo! Message Board late last evening citing one of my previous posts:
“90% of business buildings are still served by one providers infrastructure, that being Ma Bell. ”
http://www.telecomstraightshooter.com/20…
Still not sure I believe it. Comcast has spent plenty of money marketing to enterprise customers in my area. They must have sufficient cable in the right commercial zones.
Still, this is what Martin (CEO of 8×8, Inc.) has been telling stockholders, believe it or don’t.
See the comment posted on the 8×8, Inc., Yahoo! Message Board
My response: I believe in data … real data. The FCC collects data on competition by an honor system. The Federal Government Accountability Office (GAO) collected data for a report on competition by actually pulling circuit type data from 16 markets through a proprietary, highly confidential database that Telecordia keeps. This database identifies who has what circuits and where.
The GAO report was highly critical of how the FCC measures competition, as they released their findings on true, real, physical facility based competition. This November 2006 report stated that 94% of business buildings in the United States have only one true, real, physical facility based provider … Ma Bell. The FCC would identify 5-7 competitors in a building, however, all riding over the same Ma Bell infrastructure including Ma Bell.
The report may be found at the following location: www.gao.gov/cgi-bin/getrpt?GAO-07-80
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