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Incumbents, Overbuilders Could Coexist

New York-Cable overbuilders are becoming an increasing threat to more "traditional" cable operators as they amass huge war chests to build out their networks.

But according to a group of panelists last week, the changing face of the market and the industry could allow both to thrive.

At a Kagan Seminars Inc. conference here last week, First Union Corp. senior vice president Mark Misenheimer said that while he was bullish on cable operators, overbuilders with hybrid fiber-coaxial cable architecture are attracting large sums of money from the private investment community.

So far, companies like Digital Access Inc., WideOpenWest LLC and Western Integrated Networks LLC have raised more than $2 billion in venture capital, and the flood of money doesn' t appear to be waning.

In the past six months, about 15 business plans from overbuilders have crossed his desk, Misenheimer said.

"Broadband overbuilders with hybrid fiber-coax plant, that business plan is second to none," he said. "There is nothing out there that can beat what that pipe can do."

Misenheimer stressed that he is still bullish on cable. But he added that the economics have changed to allow overbuilders to coexist with "traditional" cable operators in the same market.

Key to the overbuilder strategy is market density, he added. With one exception, none of the overbuilder business plans he has seen targets densities under 80 homes per mile, Misenheimer said.

"With revenue of between $100 and $150 per home, isn' t there room for more than one operator?" he asked.

Mike Cummings, managing director of GE Capital Commercial Finance' s Southern business group, said telecommunications infrastructure is becoming more compelling to investors. But he doubted that the capital for these companies would come from the banks. "Too many banks are still looking for earnings," he said.

However, the money from the private-equity market will continue to flow, he added, and it has already reached staggering proportions. "It wasn' t too long ago when a $500 million equity fund was a big deal," Cummings said. "Now they do it in the first run."

Part of the reason for the surge of capital being thrown at overbuilders is a feeling by many private investors that the telecommunications sector is just too hot to stay away from.

"People are dying to get into this," Salomon Smith Barney managing director John Reidy said. "The last cable equity deal-Mediacom Communications [Corp.]-hasn' t been a big success. But there is a huge demand if you have a good selling story, particularly if you are in Europe or Latin America. There is plenty of money out there if there is a good story."

The good news for cable operators is that the communications pie is growing rapidly, Daniels & Associates Inc. executive vice president Greg Ainsworth said. But investment dollars are migrating toward overbuilders, he added, because they are building state-of-the-art fiber networks.

"A newer mousetrap is a better mousetrap," Ainsworth said. "The pie is literally exploding, driven by Internet opportunities and the communications revolution."

And though Ainsworth believes most markets have room for two competitive voice, video and data providers, he said it gets a little trickier when additional players enter the fray.

"A first mover, if he executes half right, he' s going to make money," he said. "So will the second entrant. But how about the third provider and the fourth provider?"

Ainsworth noted that most overbuilders expect to gain 30 percent of the video market, 15 percent to 18 percent of the high-speed-data market and 15 percent of residential telephony business in five years. Obviously, the presence of a large number of players in a market makes those goals harder to achieve.

"The pie is growing, but I don' t know if it' s growing over the next five years by 300 percent to 400 percent," he said. "Will people literally fail? Perhaps not. Will a variety of venture firms be disappointed? I think they will."

Waller Capital Corp. senior vice president Townsend Devereux, though, believes the communications pie is large enough for three or four competitors in the residential market alone.

In the commercial market, he believes as many as six companies can compete for communications dollars successfully.

Devereux cited a market trial conducted by RCN Corp., one of the premier overbuilders, in Waltham, Mass. In that 20,000-home market test, RCN achieved about 35 percent penetration in residential telephony, and it is generating about $125 per month from each customer. "You don' t need anything near that to make the model work," he said.

Devereux added that from an investment perspective, overbuilders are less risky because even if they don' t achieve their goals, they still have infrastructure that is rising in value.

"To look at it as an ex-banker, if you build out a fiber network in a cherry-picked neighborhood, even if your business plan doesn' t work, someone will think it will," he said.