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BUNDLING FOR DOLLARS Start-Ups Pitch Telecom Combo

When former MSO chief James Vaughn wanted backing for hisnew enterprise, he knew who to call. Vaughn, the ex-FrontierVision Partners L.P.president, rang up J.P. Morgan & Co., which backed FrontierVision.

The new venture was a different animal than FrontierVision,though: Western Integrated Networks, a competitive telecommunications provider with plansto offer voice, video and data over its own network in Sacramento, Calif., and Austin,Texas.

It took just two days for Vaughn and J.P. Morgan to line upfive other investors and secure $453 million in private equity financing, with another $25million waiting in the wings.

"[Vaughn] didn't have to leave Denver to raisethe money," said Western Integrated chief financial officer Jake Kane, a formerAdelphia Communications Corp. executive. "It was basically done in two days over thephone."

Vaughn's experience is becoming typical amongcompanies once derided as "overbuilders," attempting to scrape a return out ofbuilding costly new networks that would compete against entrenched incumbents inresidential video or phone service.

Now it seems that investment bankers and venturecapitalists are lining up to back the next big thing in communications -- bundling thoseservices along with the Internet and offering them to consumers.

Digital Access Inc., a California-based competitivelocal-exchange carrier, recently started life with $450 million in equity backing. AndWideOpenWest LLC, a CLEC started by former RCN Corp. executives, raised $50 million fromAbry Partners and Oak Hill Capital Partners, an investment vehicle of Texas oilbillionaire Robert M. Bass.

One reason why overbuilding has gained favor in theinvestment community is the size of the bundle -- tacking phone and data services onto thecable bill. In fact, the data piece is the most attractive of all, several investors said.

Also, newcomers have attracted seasoned executives withexperience in competitive markets, which appeals to backers.

Add a virtual explosion in venture capital -- investmentsin communications firms rose 42 percent, to $2.7 billion, in the first nine months of1999, and they should hit $4 billion over the full year -- and there has never been abetter time to be an overbuilder.

PricewaterhouseCoopers national director of venture-capitalresearch Kirk Walden cited phenomenal returns from existing venture-capital funds and theInternet.

"Venture-capital firms on average have had returns of25 percent to 35 percent per year for the past three years," Walden said. "Whenyou go out to raise money for a new fund, people are clamoring to get in. The other thingwe are seeing is that it's all interrelated to the Internet. It's all aboutcapacity and transmission."

Investors are almost pounding on the doors oftelecommunications companies, offering cash.

"The reception we're getting from the financialcommunity -- they are calling us, versus us calling them," Kane said. "The largetelecom private investors are all going to be involved in this."

Also, telecommunications companies that offer bundledpackages are apparently relatively low-risk investments. Once the infrastructure is built,the network has an asset that can be sold if the company's ultimate strategydoesn't work out.

Knology Holdings Inc. CFO Rob Mills said having theinfrastructure asset lessens the risk, but that's not the only reason why investorsare pouring into CLECs.

Knology operates cable systems in Columbus, Augusta andWest Point, Ga.; Montgomery and Huntsville, Ala.; Charleston, S.C.; and Panama City, Fla.-- a combination of acquired systems and overbuilds. It claims about 131,000 voice, videoand data customers and passes roughly 300,000 homes.

Last week, the company started the process of gettingfranchised in Knoxville, Tenn., planning a $75 million, 150,000-home network. And Knologyis close to landing $150 million in private-equity investment from AT&T Ventures, theventure-capital arm of AT&T Corp., and others, according to Mills.

Not including that infusion, Knology has attracted $250million in high-yield debt financing, $65 million in private equity and a $50 millionrevolving line of credit in about five years.

"The whole idea is that once you build the network andhave the fiber in the ground, it's worth more," Mills said. "But Idon't think investors are looking at it strictly from an asset-value perspective.It's the ability to build a customer base and create a return that attracts them toput their money in."

Leading the pack, of course, is RCN. The spinoff of formerMSO C-TEC Corp. landed a $1.65 billion investment from Paul Allen's Vulcan VenturesInc. late last year, capping a run that saw CEO David McCourt raise $6.25 billion inprivate-equity and debt financing in just two years.

The company has built voice, video and data networks insuch major East Coast cities as Boston and Washington, D.C., and it is extending its reachto the West Coast.

RCN has clearly thrived as an investment vehicle. Its stockprice rose over the past year from $18.50 to $65 last week. Once considered an annoyanceto the cable industry, RCN now has a market capitalization of more than $4.3 billion.

Prudential Securities Inc. analyst Christopher Larsen saidtoday's overbuilders aren't anything like their predecessors of a few years ago.Increased demand for high-speed Internet service is the driver, and video is almost anafterthought.

"People are looking at the whole package," Larsensaid. "That's the whole beauty of the offering -- the bundle is on theresidential side. These companies are not considered to be cable overbuilders --they're more along the lines of CLECs with multipronged strategies. Nobody wants tohear about the second cable company [in a market]."

RCN, the onetime spinoff, has a clone of its own inWideOpenWest, run by former RCN executive vice president Mark Haverkate.

Denver-based WideOpenWest plans to offer voice, video anddata services in Portland, Ore., and Denver, and it won its first franchise agreement lastweek, in Jefferson County, Colo. Haverkate said he has his eye on the Dallas-Fort Wortharea, adding that he needs about $750 million to build out Portland and Denver.

Haverkate credited RCN's track record and thedevelopment of experienced management for attracting capital. "I hate to saywe're experienced veterans, but we are," he said.

Jay Grossman of Abry Partners said the decision to investin WideOpenWest was based partly on the changing economics of the overbuilding industryand partly on confidence in WideOpenWest's management.

Abry had backed Avalon Cable Inc., which bought CableMichigan Inc. Haverkate was Cable Michigan's president before joining RCN.

"The overbuild economics with two or three revenuestreams has changed dramatically than when there is just one," Grossman said."If you can get a franchise in a high-density area, I think there's somereasonable economics to be had."

The $50 million in seed money from Abry and Oak Hill isjust that, Grossman said. "Obviously, there's a lot more money than that to beput in something like this. This is just to get the toe in the water. We are very bullishabout the opportunity."

Overbuilders certainly need all of the cash they can raise.According to Kane, Western Integrated will need about $6 billion over the next five yearsto build out its markets nationwide. Haverkate said WideOpenWest will need about $1billion to build out its systems in the next five years.

Given the health of the private financial markets and theprospect of raising more money through an initial public offering of stock or from bankdebt, Kane said he didn't think that would be a problem.

"The money is there. Why it's there, I don'tknow," he added.