Is Telecom (Un)Dead?
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About Matt NiehausAreas of Interest: Current Investments and Boards Include:Matt is currently on the board of Telecom Transport Management and is a board observer at Zayo Bandwidth. |
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EmailFour years ago, telecommunications was widely viewed as a “dead” industry, having been in free fall for three straight years. 655 telecom companies filed for bankruptcy during this period, carriers slashed their capital budgets, and $2 trillion (yes, trillion with a T) of telecom market value seemed to evaporate overnight. Venture investment in telecom dried up, plummeting from a high of $13 billion in 2000 to a mere $1 billion in 2003. Pundits opined that it would take the telecom industry many years to recover from the euphoric over-investment and subsequent over-supply of network capacity that put the industry six feet under. Headlines blared “Telecom, R.I.P.”
Funny thing, though. I’m not sure about you, but during those dark times, my own consumption of telecom services continued to grow. I used my mobile phone more, craved higher speed Internet connections, and enjoyed network-based software applications that weren’t available in the years before. More recently, applications like online video (exemplified by YouTube) have emerged and quickly taken over the Internet, proving once again that compelling applications allow bandwidth demand to catch up to and eventually exceed supply. YouTube consumes as much network bandwidth today as the entire Internet consumed five years ago.
Waiting for eventually, however, was a pretty trying time to live through. We at Battery were certainly caught in the investment run up to 2000, with the result that we became over-invested in Telecom. As the market dried up, we were forced to look really hard at our portfolio companies — in particular their burn rates, performance and chances for success — and make some tough choices, leaving only 9 out of 26 investments operating. Our renewed focus on those survivors combined with the hard work of their management teams through the dead years have proven that Telecom, like the Monty Python and the Holy Grail character, is “not dead yet.” And while the sector is not entirely out of the woods, we can point to some recent success and some macro market factors that have us believing that new opportunities for investment exist.
In the past two years, we have seen successful IPOs of portfolio companies Cbeyond (CBEY) and MetroPCS (PCS). Less than a handful of other telecom companies have gone public in the U.S. during this period, suggesting that market skepticism of the industry remains. Public investor Telecom scars run deep, and greed has not fully replaced fear as the motivator of investment.
What explains Cbeyond’s and MetroPCS’s success, in contrast to the many failures out there? In short, both boast tried and true investment models—differentiated businesses, strong management execution, and disciplined capital investment. As evidence, Cbeyond and Metro both enjoy ~50% EBITDA margins in mature markets, impressive by any industry’s standards.
Cbeyond, founded in 1999, provides “big business” communications services — voice, data, mobile, messaging, security, and other hosted applications — to underserved small and medium-sized business (SMB) customers. The Company is differentiated by its
- broad yet simplified, bundled product set
- 100% IP Managed Services platform
- target customer segment (12 employee/customer average)
- capital-efficient market entry model and
- focused, sales driven culture
From inception, Cbeyond had the discipline to test and perfect its business model in one market before expanding, avoiding the perennial pressure to expand faster than its team is comfortable.
MetroPCS, founded in 1994, was a relatively late entrant to the crowded U.S. wireless market when it launched in 2002. Rather than follow the competitive herd that required subscriber contracts, minute buckets, and billing surprises, the Company differentiated itself by offering simple, unlimited usage, no-contract wireless service to targeted consumers in major U.S. metros. In order to profitably offer more for less, Metro focused on building high-capacity, low-cost networks, giving it a compelling cost advantage over legacy wireless networks.
But enough celebrating our past success. In a recently dead industry, what is Battery doing to find compelling, differentiated investment opportunities?
In the past six months, we have made two new telecom investments: ZAYO Bandwidth and Telecom Transport Management (TTM). Both investments are in differentiated businesses with highly-experienced management teams and a disciplined capital deployment strategy. ZAYO and TTM, while pursuing different go-to-market strategies, are both working to expand the bandwidth capacity of communications networks, exploiting the ever-expanding demand for Telecom services.
ZAYO Bandwidth is “rolling up” U.S. metro fiber assets that remain under-valued due to the over-investment hangover of the late 1990s. Post-acquisition, ZAYO is restructuring and refocusing these assets for maximum profitability. The Company was founded in 2006 by Dan Caruso and John Scarano, experienced industry executives with successful histories in the metro fiber market and wholesale communications businesses.
After the Telecom “dead” years of 2001-2003, the dynamics of the metro fiber market have improved. Demand for bandwidth has grown considerably, driven chiefly by the proliferation of back-up and business continuity services, online video, and wireless backhaul applications. Simultaneously, the market has experienced vendor consolidation, limited new fiber construction, and high umbrella pricing from local exchange carriers. ZAYO Bandwidth believes current metro fiber asset pricing does not reflect these improving market conditions and has developed a long list of possible acquisition targets with which to implement its strategy. Armed with a capital base north of $300 million, ZAYO has completed three fiber acquisitions to date, has two more under LOI, and several more in its gun sites.
Our second recent investment, TTM, provides cost-effective, high-capacity, high-performance “backhaul services” to wireless carriers over its hybrid microwave/fiber network. Backhaul services are the transport of voice and data from wireless carriers’ cell sites to the carriers’ mobile switching centers. As carriers deploy higher capacity 3G and 4G networks, wireless demand continues to grow, particularly demand for high bandwidth data services. Legacy, copper T1-based backhaul services cannot scale to meet this demand, creating chokepoints in wireless networks.
TTM was started in 2003 by wireless industry veterans from McCaw Cellular to address this problem. The Company has a disciplined growth strategy, only deploying capital where a carrier makes an anchor tenant commitment over several years. With nearly 90% of U.S. cell sites served by copper T-1s today, TTM has a significant market opportunity.
With a couple of IPOs, some well-performing portfolio companies (such as Tejas Networks, a Bangalore-based innovator in carrier-grade optical transport equipment), and a few recent bets, we believe that the Telecom industry is less dead than four years ago. But it is not entirely out of the woods. Competition remains fierce, with 6+ wireless carriers in major markets and multiple competitive carriers providing voice and data services to business customers. The ILECs are now in full competition with cable MSOs, as the monthly “triple play” solicitations in our mailboxes attest. Despite this challenging competitive landscape, we are confident that attractive investment opportunities exist. We see opportunities to solve network chokepoints, to acquire undervalued assets, and to deliver advanced services that are not widely available. In every case, we will favor business models with differentiated strategies, highly-experienced management teams, and disciplined capital deployment plans.
So don’t “bring out your dead” quite yet!
Email me to discuss this article or investments in telecom.
© 2007 Battery Ventures. All rights reserved.