Bumpy Ride for CLEC Stocks

Posted: 02/1999

Bumpy Ride for CLEC Stocks
1998 Was Year of Ups, Downs ... and New Competitive Pressures
By Charlotte Wolter

When an industry segment's stock index shows gains of more than 45 percent for a year--as competitive local exchange carriers' (CLECs') have done in 1998, according to New York-based Bear Stearns & Co. Inc. figures--it would hardly seem to be the basis for a cautionary tale.

However, that is the circumstance in which the CLEC industry, in both the United States and abroad, found itself at the end of 1998. Stocks were up strongly, but other factors in the industry's performance have many investors disgruntled and critical.

The story of CLEC stocks in 1998 was volatile (see chart, below). The Bear Stearns CLEC Index of stock prices (see list, below) rose more than 50 percent by the end on the first quarter, falling back somewhat in the second quarter, then peaking at nearly 80 percent growth at the end of the second quarter.

The CLECs generally went south when the rest of the market took its dive in September, but the stock prices for the industry segment as a whole bounced back rather quickly to more than 45 percent above the beginning of the year (although prices undulated for the last two months of 1998). Some stocks never came back, such as that of Tampa, Fla.-based Intermedia Communications Inc., the revenue leader in the U.S. industry with estimated 1998 revenues of $711.8 million. After missing an earnings before interest, taxes, depreciation and amoritization (EBITDA) goal in the third quarter, the company's stock price lost ground even as other stocks were getting back on track, and ended the year 42 percent lower than at the beginning. Others, such as the stock of Englewood, Colo.-based ICG Communications Inc., did not begin to recover until the end of the year.

Despite the inconsistencies, analyst James Henry of Bear Stearns notes that, "in the face of all this Internet mania, we would hope that investors will recall that all Internet traffic travels over telecom networks and that increased Internet use will likely bode well for the underlying backbone providers and local network access providers."

Among the big stock price winners for the year were European CLEC COLT Telecom Group plc, London, up 454.3 percent near the end of the year; tiny Metromedia Fiber Network Inc., White Plains, N.Y., which enjoyed gains of 567.7 percent in its stock price; and Silicon Valley Internet-centric service provider Concentric Network Corp., Cupertino, Calif., up 176.1 percent.

Big losers besides Intermedia were Vancouver, Wash.-based GST Telecommuni-cations Inc., off 50.5 percent; another small player MGC Communications Inc., Las Vegas, off 68.4 percent; and Annapolis Junction, Md.-based e.spire Communications Inc., down 41.5 percent.

"What is interesting about the CLECs is that they are often viewed as a group and not yet viewed as individual companies," says Craig Claussen, senior vice president of Chicago-based research firm New Paradigm Resources Group. "When one misses a target, they all take an undue hit."

One current target, he says, is e.spire. Management performance has become a more critical issue than in earlier years, and Wall Street reacted negatively to changes in e.spire management. Under CEO Jack Reich, the company had good--though not spectacular--performance, but appeared on its way toward achieving its business plan. However, the financial performance saw a couple of flat quarters, and the stock took its lumps along with the rest of the industry in the fall market meltdown. At that point, Reich left the company and was replaced by former management figures--including CEO Anthony J. Pompliano--whose performance had been criticized on Wall Street the first time they were in charge.

After the company's teleconference to announce the management changes and describe its plans for the future, Wall Street voted with its feet. The stock dropped, and several brokerages changed recommendations on e.spire to be more negative. The stock continued to fall through the end of the year and was hovering near its 1998 low at the end of December.

The wireless broadband segment of the industry also saw mixed results. There are three operating companies offering broadband wireless CLEC services at this time--New York-based WinStar Communications Inc., Vienna, Va.-based Teligent and Bellevue, Wash.-based Advanced Radio Telecom Corp. (ART)--although many more are waiting in the wings, holding new local multipoint distribution service (LMDS) (28 gigahertz [GHz]) licenses and working to build infrastructure.

All three current broadband CLECs are newcomers and all are less than five years old. Although it could be said that both WinStar and Teligent had successful years, with stocks up 27.3 percent and 23.9 percent respectively, both have slid from their highs, says Bo Fifer, wireless analyst with BT Alex. Brown Inc., New York. At the end of the year, WinStar was down 70 percent while Teligent was off 32 percent from its year-to-date high.

ART was in worse shape, down 43 percent for the year and 85 percent from its high in 1998. ART changed its business plan in the first quarter of the year, switching from a pure bandwidth provider to a provider of wireless communication services. It also trimmed its launch plans to just three markets in the Pacific Northwest and the Southwest--Seattle; Portland, Ore.; and Phoenix. Despite a $25 million respite--in the form of vendor financing from Murray Hill, N.J.-based Lucent Technologies Inc.--it remains to be seen whether ART can be a viable entity in the future.

Single events can produce a strong response for related companies. For instance, on Dec. 18 WinStar announced a deal with Tulsa, Okla.-based Williams Communications Inc., a subsidiary of Williams, in which it paid $640 million over seven years for access to Williams' long distance networks (see related story, page 24). This allows the CLEC to be an end-to-end broadband network provider and very likely will produce considerable savings long-term in access charges, Fifer says. WinStar's stock immediately went up 2.5 points, to 37. Teligent was up $5 the same day and ART, which was hovering around $5, increased to $6.

Besides the market's overall slide in the third quarter, the main culprit in the failure of some CLEC stocks to perform is missed financial goals. These companies are not expected to be profitable yet, but they are expected to reach certain milestones in EDITDA and to begin to move toward positive performance on that critical measuring stick.

"I think the street in general has been very disappointed with the general EBITDA performance of the whole sector," says Richard Nespola, president and CEO of The Management Network Group Inc., Overland Park, Kan. "The break-even points have been protracted."

This could prove a long-term problem for the industry unless that performance improves, he says. For investors, "If you were expecting to see a higher stock price because of better earnings in three years and now they are projecting EBITDA-positive two years later than that, that presents a dilemma," Nespola says. "Can investors find another place to invest and have less risk in the near term?"

Being a new industry, the CLECs are highly susceptible to sharp short-term up-and-down moves in response to industry events. For instance, WinStar rose sharply on news of its $2 billion vendor financing deal with Lucent in November, although the agreement is dependent on year-to-year performance rather than being a one-time windfall.

Operations support systems (OSSs) also are becoming issues for many of the companies as they move beyond the first waves of customers. When CLECs were acquiring just a few thousand new customers per month, billing systems could be off-the-shelf and redundancy in switches and routers was less critical. Now as they scale up their networks, CLECs already are feeling the need for investment in large-scale proprietary systems to manage back-office functions as well as monitor systems. Finding capital and developing systems for OSS and other software support is expected to be a major concern in 1999.

WinStar, Williams Swap Capacity and Cash
By Ken Branson

New York-based WinStar Commun-ications Inc. and Tulsa, Okla.-based Williams Communications Inc. have started the new year by swapping capacity and cash in what they say is a mutual leveraging of assets in the service of complementary strategies.

The flow of money and capacity goes like this: WinStar gets $400 million from Williams in return for 2 percent of the capacity of WinStar's fixed wireless broadband network, the money to be paid to WinStar over four years. That means that 2 percent of the WinStar's network capacity is available to Williams, beginning with the 60 nodes WinStar has in operation now. Eventually, that 2 percent will be available from 270 projected WinStar nodes, distributed however Williams wishes, so long as Williams uses no more than 15 percent of any one node.

Williams receives $640 million from WinStar over seven years in return for a 25-year indefeasible right of use (IRU) of 60,000 miles of dark fiber on its network. Dark fiber is optical fiber that has been laid in the ground, but is not "lit" by optronics. WinStar will be responsible for lighting the optronics on its 60,000 miles. An IRU allows the purchaser to act as if it owns the capacity it has acquired the right to use, but without the headache of having to maintain the cable and the conduit in which it lies. WinStar's share of the dark fiber will consist of four fibers, each 15,000 route miles long.

"WinStar was seeking a strategic partner for a wide area network (WAN), an intercity network, and we met that need," says Gordon Martin, senior vice president, network services for Williams. "For us, the secondary question is: Why wireless local access? As a wholesale provider, we have a number of opportunities where we could supply wireless local access to our customers. It is well-known that we have relationships with RBOCs (regional Bell operating companies) that can potentially use that wireless local access out of region for their applications."

Martin says he has discussed the possibility already with some of his wholesale customers, but declines to say which ones.

"We always wanted to have our piece of the optical core that exists in this country, and by buying these four fibers, we get that," says William Rouhana, CEO of WinStar. "Our view has always been that what we have is a scarce resource ... and we did this transaction according to that view of the world."

Analysts believe this makes sense, considering that "bandwidth barons" such as Williams need fiber access to local markets. "We have long been proponents of the view that the next generation of long distance carriers will need to own or control the crucial local network assets--just as their forefathers have--in order to be competitive," writes James Henry, telecom analyst for Bear Stearns & Co. Inc. in New York.

When Rouhana and his colleagues announced the Williams deal at an investor's conference, the response was generally favorable, but there was some analytical murmuring at the news that the Williams deal may push out the date at which WinStar expects to be earnings before interest, taxes, depreciation and amoritization (EBITDA) break-even from the first half of 2000 to sometime in 2001. That this might happen is by no means certain, Rouhana says. It depends on whether Williams' $400 million is accounted for as it comes in, or at the rate of $16 million per year for the 25-year life of the deal.

Omaha-based Level 3 Communications Inc. has named Michael D. Jones its chief information officer. Jones, who will be responsible for Level 3's financial, billing, customer care, and network management systems, comes to Level 3 from Corporate Express Inc., Broomfield, Colo. His career also includes stints at Sprint Corp. and Accenture.

Denver-based Rocky Mountain Internet Inc. (RMI) has sold some of its preferred stock to an unnamed equity investor for $8 million. Douglas Hudson, RMI's CEO, says the investor has committed to provide RMI with another $5 million if RMI meets certain, undisclosed conditions.

Alltel Corp., Little Rock, Ark., has agreed to buy Aliant Communications Inc., Lincoln, Neb., for $1.5 billion. The deal is expected to close by mid-year. Alltel officials say the deal is part of their strategy of growing through the acquisition of smaller telecommunications companies in rural markets that are ignored by many other carriers. In another deal, Alltel has agreed to purchase the operations of Durango Cellular Telephone Co. in southwestern Colorado. Terms of the deal were not disclosed.

Sven-Christer Nilsson, CEO of Ericsson, the Stockholm-based international telecom equipment maker, says lower-than-expected earnings for 1998 will force his company to lay off some employees. Nilsson blamed the earnings shortfall on international market conditions, especially affecting public networks.

Clear Communications Corp., Chicago, says it will make its branding and marketing systems available to competitive local exchange carriers (CLECs). Clear's current customer base is among incumbent LECs (ILECs) and long distance carriers.

Brooktrout Technology Inc., Needham, Mass., has acquired the computer telephony products business of Lucent Technologies Inc., Murray Hill, N.J., for $29.4 million in cash. The 100 employees of the group, based in Los Gatos, Calif., will become employees of a wholly owned subsidiary of Brooktrout.

Pacific Bell has entered into a strategic partnership with Symantec Corp., Cupertino, Calif., under which Pacific Bell will market Symantec's telecommuting software and Symantec will market Pacific Bell's caller ID service.
Pacific Bell, San Ramon, Calif., is a subsidiary of SBC Communications Inc., San Antonio.

@Home Corp., the Cox Communications-based Internet service provider (ISP) from Redwood City, Calif., has agreed to acquire Narrative Communications Corp., Waltham, Mass., in a stock deal worth $89 million. Narrative provides Internet-based advertising. Also, @Home announced its intention to raise $200 million through convertible subordinated debt. The company didn't divulge the specific terms of the issue, but issued a statement saying it would use the proceeds for general corporate purposes, and possibly to acquire other companies.

Level 3 Communications Inc., Omaha, Neb., will lease 7,355 miles of capacity on the network of IXC Communications Inc., Austin, Texas. Kevin O'Hara, Level 3's chief operating officer, says demand for Internet protocol (IP)-based services has "outstripped our earlier estimates." Terms of the deal were not disclosed.

Networking vendor Newbridge Networks Inc., Kanata, Ontario, has entered into a collaborative agreement with Nokia Corp., Keilalahdentie, Finland, the telecommunications equipment maker. In a prepared statement, the companies say they will leverage each other's strengths to deliver Internet protocol (IP)-based solutions to businesses over broadband asynchronous transfer mode (ATM) wireless networks.

MDU Communications Inc., Vancouver, British Columbia, has been acquired by Alpha Beta Holdings, also of Vancouver, which has taken the name of the acquired company. MDU provides entertainment and security systems via satellite to multiple dwelling units (MDUs). Terms of the deal were not disclosed.