Yes, I have been preaching the virtues of owning your own local fiber optic network and/or carriers to be on anyone elses’ network except the ILEC’s … well; the crows are coming home to roost. I’m just a simple man of the earth … so what would I know?

Qwest announced today that they are launching – get this – a referral program targeted to small businesses. As I like to say, the T1/IAD, DOCSIS, special access and xDSL end of the market. They are offering cash (not bill credits) incentives between $50 -$150 per referral for one small business to refer another small business to switch to Qwest. Just the thought of this brings back the long distance price wars of the 1990’s where such marketing further commoditized and devalued the long distance service industry and value propositions. As a result, we saw rapid consolidation and the bankruptcies of “asset light” resellers virtually over night. And if you care to remember, the last of the dying warriors ended up somewhere between Bernie Ebbers cooking the books at WorldCom and Joe Nacchio allegedly conducting inside trading as former CEO of Qwest.

What’s that crazy saying about if you don’t pay attention to history, history has a tendency to repeat itself? I think that’s the saying. Thus my thesis is: if a carrier does not have a low cost platform to lever from as organic bandwidth demand continues to accelerate and cash referral marketing evolves — history may not be as nice this go around!

I have no idea if Qwest has started a fire and if AT&T and Verizon will put on a similar squeeze in-territory also. No matter how you cut it though, this does not bode well for the CLECs who have built their fortunes, dreams and investors’ cash on renting pieces and parts from the ILEC. Most CLECs can’t afford to even match this cash offer, let alone any marketing “gotcha” in response – it’s a pure cash incentive play. Bare knuckle stuff… he with the most cash wins.

So what’s the multiple of an asset-light CLEC under these circumstances versus, say an AboveNet? Cogent Communications? TW Telecom? Level 3? You know, those idiots and their local fiber infrastructure…what do they know after all? Bunch of dummies …

I hear something in the distance; it’s a fine whine just developing. Yes, it’s coming from the Beltway … it’s a protest against Qwest for doing this … “It’s not fair!” After all, the CLECs only had 14-years to figure out how not to be dependent upon the ILEC – Qwest should now be required to slash their loops, special access and T1 prices for making such a bold move and to make the shareowners of asset-light CLECs viable.

Analysts–what will they say? I pity the CEO’s quarterly call reporting excessive churn in Qwest’s territory … I can hear it now … “… due to continued downward economic pressures and aggressive promotions by competitors …” will be the cry. But the reality is, like in the story of the three little pigs; when you build your house out of sticks or hay, eventually the big winds of reality arrive. It may be too late to build that brick platform that has been ignored for years. Equally culpable, deemed acceptable to ignore as of value for doing so are the Wall Street analysts. (All my public brick-owning, fiber-bigot CEO friends just smiled because they can’t write stuff like this but I can).

As the analysts say on Wall Street, what have you done for me lately (this quarter)? The winds are a blowing with Qwest firing the first salvo, maybe a cable company will follow as well … meanwhile the AboveNet’s, Cogent’s , Level 3’s and TW Telecom’s of the world are happily nestled inside their brick fortresses which they built (and/or bought), brick-by-brick, slowly over many, many years–when it was not popular to think beyond next quarter and securing their future by spending capital on bricks (local fiber optic infrastructure)! To this day, capital expended for unique local fiber is yet to be understood in value, multiples, strategic or sustainability as a business model by Wall Street.

Caw! Caw! Caw! I hear the crows and they are getting closer. (Editorial Note: Based upon my Native American ancestry, the crows arriving are a good thing for my tribe).

I own a brick platform and I intend to make money off of Qwest – so can you. I am going to submit some referrals into Qwest under this small business referral program to make some cash. I am going to obtain all the local Yellow Page books in Qwest territory and staple it to a referral application and just wait for the cash to flow in …

Amazing how things can change so quickly if you are not prepared or constantly scanning the horizon.

You know that I really hate repeating myself but it is time to put copper to bed. Good night, copper!

I say to those of you who freely chose a copper-dependent diet, “Type 2” business model. You did so under your own free will with your eyes wide open. Physics now has you in a tough place.

It’s been 14 years since the Communications Act of 1996, and based upon a report by Vertical Systems Group, I (your favorite fiber bigot) have been vindicated once again.

After 14 years, based upon VSG research, they estimate that 22% of business buildings in America now have fiber—not necessarily two fiber providers for network diversity in an IP world—but 22% nonetheless (after 14 years).

The good news? We are outpacing Europe. Let’s have a party!

Given the last 14 years, it looks like we can reach 40% of buildings with fiber, possibly by 2024. By that time, the 17 or so countries ahead of us will probably have 100 gigabit access working but we’ll still have that copper plant!

It is high time to put a sunset provision on copper loops, special access, T1, DSL, etc. and leave the advancement of networks to open markets. If policy is clarified, private capital will invest in Telecom infrastructure such as fiber which will further enable wireless—and in that order. So long as the drip feeding death of America vis-à-vis copper exists with no clarity of policy, there is little or no incentive for private-only investment. I believe that we should be trying to avoid placing the burden on the taxpayer.

# # #

On a side note, if you caught my recent post about Google entering the Fiber-To-The-Home sector and all the hysteria they are creating, I have coined (and now want to copyright) a new term. It’s called the GLEC and stands for the Google Local Exchange Carrier. If you read my post, this new acronym for our industry makes great sense. Don’t get GLEC’d…

# # #

A lightening-round, quick quiz:

Question: Who is making money on Cloud Computing today?

[Hum Jeopardy theme song for 30 seconds]

Answer: Companies holding seminars and conferences about what they think Cloud Computing is! We have no standards for Cloud Computing except for Larry Ellison (of Oracle fame) claiming that Oracle has been a de facto Cloud Computing provider for twenty years. Cloud Computing … in business cycle terms that you learn at MBA School, we are only at the seminar stage.

“Why do I make these predictions?” you ask.

The most significant reason is that Google (and a few others companies) has a competitive advantage today with tens of billions in distributed computing across local markets in America. If you can get the law to regulate a distributed access architecture, you get a built-in barrier to entry against competition given the billions it would cost to replicate Google’s footprint. Come to think of it, maybe Google’s distributed servers should be regulated for open access, not the network but I digress.

Please don your strategic cap for a moment. If you were the CEO of Google would you really announce that you are going to run super-secret applications that require gigabit speeds? What company in their right mind would signal competition to this possibility? The answer is none.

Google’s authority/expertise effort is designed to penetrate and influence government communications policy and win media coverage. Google the White Knight is here to save America from those big bad ILECs, Cable Companies and the Mighty Mice (CLECs). I can think of at least 20 companies that Google could have gone to without having to build out one inch of fiber and quietly conduct their scam (I mean application/experiment/R&D). They could have easily formed some LLC under another name to buy the fiber or capacity and no one would have known the difference. Come to think of it, with Google’s cash, they could have bought a city of 50,000 people and experimented to their heart’s delight. Or, if this play was really about new applications to blow away the competition, Google could have quietly gone to another country and experimented.

The publicity machine makes it is very smart for Google to position themselves in this visible manner, even though they have no interest in owning and operating FTTH networks. Infrastructure costs a lot of money and they want to figure out how to get that free ride. Again, that word free bugs me. Please observe the politicians coming out of the woodwork when Google announced a request for information (RFI) from communities who would like a Google FTTH laboratory. A RFI—what is the next step—asking for a RFP?

To all of the politicians out there who are chasing this bird, please let me assure you this service will not be free—you will pay for this sooner or later. Make sure Google posts a bond or two especially when they pull the plug on the experiment. Mr. Mayor, you don’t want to be caught as a “partner” holding the bag. Make sure Mr. Google has the proper licenses to operate a network, to gain access to the public right of way and be sure to charge them as you do any other carrier—permits, restoration, relocates, percent of revenue, real estate taxes, sales taxes, etc. No value-in-kind for the RFI consideration—that would be discriminatory. Don’t forget the performance bonds if they are only running an experiment.

As a final point, Google is quietly investing in another G-area and the strategy makes sense if they can get government policy to regulate distributed internet access architecture. This G stands for Geothermal. Yes, that is correct! Those crazy guys at Google have cash spread across various geothermal companies. Why not wind and solar? At the end of the day, it is all about heating and cooling. Much like global warming, wind and solar may not be a good bet.

I can remember my first Blog post, back when I was a Blogging virgin. One of the many things I shared with you is that I don’t believe in global warming—rather, I believe in science. It appears I was right.

Global warming—it starts with the letter G, doesn’t it? Just like Gore as in Al Gore.

It seems to me as though “G” is the letter of the new decade so far!

Back to Google—sure enough, those crazy guys that brought you satellite pictures of your neighborhood (while getting chased by the police because they were filming the same neighborhoods at ground level) keep the mystique going and going.

Yes, that Google. The Beltway folks who backdoor Telecom under the guise and alleged expertise of “Cyber Security” and advise President Obama. Yes, the same Google that wanted net neutrality and then changed their minds. The same crazy guys that played the last spectrum auction scenario and—get this—tried to get free spectrum access by advocating for public safety. That worked out well!

Hey Google, here’s a sure-fire tip to get your free spectrum. The next time, you should link it with education. No one inside the Beltway has the gonads to vote against something that is “for the children.” Hell, teachers’ unions do it all the time and you might as well steal it from their playbook—it has worked for decades for them. I call it the “No-teacher-left-behind” strategy.” Go ahead and try it. After all, “It’s for the children.”

Google is now buried inside the FCC, trying to influence future Broadband Policy, and win over the FCC Chairman with their recent announcement that they will pursue a Fiber-To-The-Home (FTTH) initiative in order to “experiment” with new applications that require up to a gigabit of bandwidth. Please note Mr. FCC Chairman – gigabit speeds not 768 fiery kilobits like we measure today. However, only 500,000 people will be involved in the “experiment.” How about introducing a “No home left behind initiative?”

Mr. FCC Chairman, I have been advocating a one gigabit policy long before Google showed up and my middle name starts with the letter G. Does that count for anything?
Does anyone really believe that Google is committed to being in the FTTH business? If you do, I have a really affordable bridge to nowhere that I’m looking to sell.

First, the media believes this initiative is based on spurring competition. Great spin by Google but incorrect! That pony left the barn years ago—we have a duopoly in residential services that mirror one another in market behavior as expected. Additionally, the economics of triple play are tough unless you already have a head start by owning a network. I do applaud, however (like the fiber bigot I am), that Google recognizes that fiber optics is the answer. As an aside, how is that free Wi-Fi Google thing going for those of you in California? I can see you turning towards fiber…you can’t resist that temptation of bandwidth can you? Keep coming towards the light, go to the light, the laser light, my friend. Personally, I have never liked a business model that included the name free.

Please join Dave later in the week as he contemplates why Google is interested in the FTTH business and thinks about some other noteworthy names that begin with the letter G.

1. Top line growth is struggling, and in some cases, moving backwards except for metro fiber owners. There is lots of single digit growth for metro fiber owners.
2. There is a general movement away from T1/IAD/DSL customers as price pressures and organic bandwidth needs are outgrowing the capability of copper. This movement is churning out low-end, low margin and slow growth customers. “We would rather give them back to the ILEC or someone else.”
3. The focus is on the quality of customer, not quantity.
4. Another emphasis is to improve gross and EBITDA margins.
5. Companies are grateful to have financed further debt given the above reasoning. (But will they squander the gift of time?)
6. There is a general shift toward upper middle and large enterprise market.
7. Usage billing is proving to be unreliable and necessitating the need to move to an IP platform.
8. Companies need to lower costs and the ILEC is not the answer.
9. Companies need M&A to improve margins or add applications. (Issue: how do they pay for M&A? In the current marketplace, there is nothing left except healthy firms performing in double-digit metrics.)
10. There is increased discussion about self-reliance with less emphasis on regulatory reliance.

I am looking forward to Data IP, fiber-based/focused AboveNet and Cogent Communications to report and deliver comparative growth metrics. I submit you may hear all about double-digit growth metrics!

If certain companies elect to run a process or auction, expect the Private Equity sector to outbid the strategic buyers for the companies and their assets. You may be asking, “Why?”

The logic is as follows:

1. A strategic buyer cannot get past their low multiple (4x-7x) and possibly offer a premium for a better performing company or assets.
2. A strategic buyer can’t look down the road any further than a year, especially if they are a public company.
3. A strategic buyer gets painted with the same brush and color of the last consolidation round where integration competency was called into question.
4. Investment bankers give advice to strategic buyers. For example, how can someone keep a straight face and approach a company with 80% of MRR booked for the following business year yet only value that company on trailing twelve months? By June of any given year, infrastructure companies have that year’s EBITDA budget met and are looking forward as opposed to backwards.
5. PE firms like to speak directly to the infrastructure companies without an Investment Banker in sight. Stealthy!
6. PE firms, after studying the space for years and visiting local infrastructure companies, reviewed their historical year over year performance become very comfortable with the future.
7. PE firms are not looking at next quarter or next year. They are looking 3-4 years down the road at companies who are on a steep growth trajectory with real demand. Companies that, even if you own them and do nothing, will continue to grow at double digit rates. Add some capital and the demand is there.
8. PE firms want to consolidate local infrastructure platform companies but not change the model. Historical organic performance is a good indicator of future organic performance. An initial acquisition or two to serve as an M&A platform to further consolidate the short supply of local fiber assets seems to be the vision.
9. PE firms are more active in approaching infrastructure companies while strategic buyers are nowhere to be seen as drivers of the consolidation effort – 2010 is the year as rumored.

As an example, examine how a PE firm looks at valuation per input it received at Metro Connect. Let’s say you have a local infrastructure company for which you can easily examine performance for the last 3-4 years. The PE firms are inquiring because they like hard assets, especially unique assets (even analysts are starting to see a difference). Organic growth for the company for the past years has been double digits and will continue so long as the local infrastructure company continues to do the same things it has been doing previously.

The PE firm recognizes that the high fixed capital costs the company incurred have created a barrier to entry; thus the capital invested to grow any of these infrastructure businesses will generate significant returns in the future and high IRRs due to the sunken costs of the fiber optic infrastructure being levered. The PE firm looks at the sales funnel demand and recognizes that real demand exists and that companies with limited capital are rationing the capital to customers who produce the best margins and long term contracts. The PE firm considers, if they add a little more customer capital to the rationing, maybe triple digit growth is possible. The PE firm looks at two things—the business and the fiber assets—for their investment purposes. Fiber assets are distinguishable and in limited supply. In contrast, most IBs that are advising strategic clients do not distinguish between a company with local fiber infrastructure advantages and one without.

The debt markets are open.

So, given the aforementioned profile, Company A is producing annual EBITDA of $10 million at a 40% margin. AboveNet shows a category trade in the 9-10x range—in a simplistic valuation, an enterprise value of roughly $100 million. Given historical performance, and let’s be conservative, without funding from customer capital (the company is self-funded), the company grows EBITDA at 30% per year and in typical PE fashion, you plan about four years out. At that growth rate, the EBITDA will be approximately $30 million. Given our example, based on the 10x multiple today, the PE firm has bought a company at a 3-4x EBITDA rate— and that math is based on adding zero customer capex or consolidating as a platform for even greater returns. Play with the numbers—12-15x makes sense for local infrastructure companies when you look towards the future based on historical performance and the fact local fiber infrastructure is in short supply and organic bandwidth demand is growing. You are not faced with a price war problem if your assets are unique and located in markets with limited competition (but not markets that are too small with limited upside).

So, this theory explains why PE expectations are considered relevant if a 2010 consolidation trend emerges among local fiber optic infrastructure M&A—and why strategic buyers may play second fiddle.

PE firms have been talking about this segment for years and are active with various platform companies. Meanwhile, strategic buyers are asking the IBs, “What are you hearing?”

First mover advantage? Auctions driving multiples if you are not first or last? A nice PE multiple theory—there is no reason why a strategic buyer can’t view it the same way. Debt is cheap (at least for PE firms).

Two facts are certain:

1) The local infrastructure companies are operating in good health, and
2) Who knows what 2010 is going to bring in M&A.

I guess we’ll wait and see. The analysts and industry media think this year is going to be an interesting one. In the meantime, I’ll just stick to my knitting and start planning for 2011 around July!

I am bullish on AboveNet and recommend the stock for these two reasons: they have great leadership and management and I know the business model works. From a multiple perspective, they trade 9-10x EBITDA depending upon the market fluctuations. I view this multiple as a floor.

Bill LaPerch and I usually get together at Metro Connect and exchange barbs, compare notes and ask each other questions about the state of all things Telecom. Both of us were so busy at this Metro Connect that we could not spend our quality time together so we just passed each other in the halls with a wink and a nod.

So why am I bullish on the metropolitan fiber optic infrastructure model? I’ll share my experience. Most of us (if not all) are experiencing double digit growth rates, ILEC-like gross margins and EBITDA margins climbing through the 30’s and into the 40’s. A 40-50% increase in EBITDA growth year-over-year is common and historical. Why? It’s what infrastructure owners sell—data IP connectivity—everyone needs it and the organic growth rate of demand is 50% a year.

At AFS, by calendar year’s end, we typically have 80-85% of the next operating plan year of MRR in backlog. By May or June, we have filled out the MRR order rate for the remainder of the billable year and we can begin to focus on the next year. This pattern has been a constant, predictable cycle. Moreover, we have a churn rate of 0.7% due to our services and customers. We could not do this planning and execution year-in and year-out without owning the local fiber optic infrastructure.

I am certain that if you dissect AboveNet’s cycle or talk to the remaining companies on the same metropolitan data IP non-legacy infrastructure ownership model you will hear similar performance and predictability. We are often asked about offering applications and we politely decline. Why? Applications will dilute our growth rates and margins. 90% of business buildings still don’t have another physical network provider serving them (outside of Ma Bell) and why should we change something that is working well and lacks the complexity of balancing between a legacy, regulatory and IP world?

These points are the perfect segue to sharing the Consolidation Theory bounced around at Metro Connect 2010 this year. Disclaimer: this theory is not necessarily my theory but one I heard many times.

Tune in on Monday when Dave concludes his Metro Connect posts by unveiling his 2010 Consolidation theory.

The underlying tone has been, a strategist behaves as a bottom feeder (perhaps due to past lessons) without recognizing the limited supply—or my favorite, a buyer can’t possibly pay more than what the going multiple may be! As you see, lots of ego comes with strategic buyers.

Before I disclose the Consolidation Theory of 2010 supported by various CEOs and analysts, let’s talk about limits of multiples. I’ll keep it simple, “If my company is trading at 6x and I can’t possibly pay more than that for yours, even though you have a history of double digit growth in all categories, you have lower costs (because you own fiber), you have more demand than capital to lever and have better operating performance.”

In summary, “If I am paying a premium, how do I explain that to my Board and/or Wall Street?”

The IBs should excel at explaining the premium, but instead, the only explanation they provide is to run the same numbers of valuation ranges and come out with the same answer. However, there is a vast difference and growth security in the valuation between a company that has no infrastructure (they rent) and one that does. Moreover, the value and competitive advantage is even higher if the local fiber routes are unique. The IBs’ logic seems to be valuations are based on the average of Telecom companies although no two may be alike. Additionally, such valuations are based upon EBITDA and cash flows and place zero value on the strategic importance of metropolitan fiber optic infrastructure physical assets.

Let’s look at valuation and multiples in the context of childhood parable. Suppose a company was smart, like the smartest of the 3 Little Pigs, and built their business of bricks (owning infrastructure). They are valued the same as the other Little Pigs that built their business out of straw or sticks (renting, collocating, UNE-L, Big Iron switches, etc). The Big Bad Wolf (ILECs or Cable Companies) blows on the straw or stick businesses, the advice is to go to the FCC and whine. Or to buy that brick house which is impervious to the Big Bad Wolf, but tell the owner that their brick infrastructure is not greater in value than the straw or stick built business. Meanwhile, the Big Bad Wolf is squeezing you in the market on price and costs, and ever so slowly, bleeding certain pigs to death.

Join Dave on Friday as he moves from a childhood story to the very real example of AboveNet. Don’t worry—these points will all connect as Dave outlines his Consolidation theory.

Let’s focus on consolidation: If the trend of consolidation is as dynamic as reported at Metro Connect and in analyst reports, there are two types of buyers interested in consolidation. The first category is referred to as strategic buyers—these can be wire line operating companies (CLECs), wireless companies, ILECs, and cable companies. Also in the mix are international PTTs and, as some speculate, a crazy move by Google or Microsoft to have unimpeded access to unlimited bandwidth via local fiber.

There are many potential reasons why a strategic buyer would purchase a metropolitan fiber infrastructure company including present day margin squeeze where fiber can lower costs, competitive differentiation, overlap, network extension, ILEC independence, regulatory independence, the ability to increase gross, operating, EBITDA margins by not being capped by ILEC rental fees, control over strategic assets (to cut off others from using it while forcing competition to build or exit a market)…there are plenty of other reasons—these were the first ones that came to mind. Allegedly, a strategic buyer should be willing to pay a higher multiple than a financial buyer because the recurring operating synergies are included in the value.

What is a financial buyer? A financial buyer, for example, may be any one of several PE firms with billions of dollars looking to invest those dollars in well-established businesses depending upon sector focus. Typically, this type of buyer is unwilling to pay a premium unless there is some type of market imbalance. Moreover, a financial buyer typically has an exit strategy of 3-4 years, either by sale or IPO. In most cases, a financial buyer will invest capital to make the returns 3-4 years in the future even more lucrative if presented with the right opportunity, market cycle and supply imbalance.

I would not lie to you, my loyal readers. Additionally, what I am about to write is not unique because I network with other CEOs in our industry. Various PE firms have been eying the metro infrastructure segment for several years and conducted lots of phone calls of interest and meetings with the same vision—there is an opportunity to roll up these remaining metropolitan infrastructure companies into a nice package and take advantage of the limited supply of local fiber optic infrastructure. The recurring theme is the consolidation of local metropolitan fiber optic platforms to create greater value at a future date.

The last round of consolidation was a few years ago, driven by large strategists. In my opinion, most of those transactions came with a lot of warts—it is not a secret that the integration and performance issues post-acquisition have been documented and followed quite closely by analysts. That particular generation of consolidation was driven by distressed assets or distressed investors. Moreover, the last round of consolidation had investment banker-syndrome written all over it. The prevailing advice to strategic buyers was to purchase large companies and drive quick contribution to top line revenue. As we know in some cases, revenue growth by M&A was realized but margin growth suffered, organic growth struggled, and overall, many of these buyers found themselves growing at single-digit rates for a variety of reasons.

The reason for this quick history lesson is that I am teeing you up for the consolidation theory of 2010. I could continue writing about the last consolidation period and its impact to shareholder value, but rather, I am trying to establish the context. The last time around, you couldn’t get an IB or strategist to look at anything “small” although the vast majority of buyers in the last consolidating round were small themselves when compared to the ILEC (and remain so by today’s comparison). The last consolidating round was quantity over quality.

Join Dave for his next post where he jumps headlong into his thoughts and opinions on the 2010 consolidation buzz.

Dear Richard:

Thank you for reading and especially for asking a question.

Level(3) has an interesting history and you do have to give them credit. On the one hand, they are survivalists. On the other hand, for shareholders, it is an entirely different matter. In hindsight, Jim Crowe must have had a crystal ball when they started by loading up with tons of debt, enabling him to anticipate the 2001-2003 Internet meltdown, the ILEC dominance in the Federal Courts v. the Communications Act of 1996 (with whiny CLECs) and our latest banking crisis.

Level(3) is still with us but it is always given a hard time because of its debt. I would guess that if Jim Crowe decided upon the inception of Level 3 to incrementally obtain debt, the company would have gone bankrupt when banks pulled back on the sector in 2001-2003—much like the 1200+ bankruptcies back then. Call Crowe what you want—genius, psychic or mad man, but Level(3) is still in the game while 1200+ others are not.

I am having difficulty writing this response today because I have been laughing so hard that my ribs actually hurt over Google’s big FTTH announcement yesterday. Google is playing politics – calling it an experiment. I discount the announcement altogether and so will anyone who owns fiber optic infrastructure. I’ll elaborate more on this announcement in a future post. But my ribs do hurt so much from laughing that typing is almost painful.

I digress—back to Level(3). Level(3) met God a few years back—fortunately, they met in the marketplace and not prison (unlike many white collar Telecom convicts). Whenever I am asked about finding God, I reply, “I think God is in prison.” In my opinion, once a white collar crook finally has criminal charges filed against him and goes to the Big House, he finds God there. So follows my theory, just like regular criminals, it seems if you can’t find God and a moral compass on your own, you can always find God in prison as so many do. God is definitely in prison.

Pipes—a word that I both like and dislike. When Level(3) found God, they finally understood what I have known for years—all applications will originate and terminate in a metropolitan market with local access along with their associated revenues. Long haul pipes are in vast quantity with plenty of inventory buried in the ground. In all fairness, however, if you are going to build a long haul network, you don’t undergo the expense to put only one pipe in the ground. Many critics of Level(3) don’t understand this fundamental aspect of building any network, and when I hear the illogical point and criticism of installing multiple pipes, I discount the critics. If your favorite broker or analyst provides this logic, I suggest finding a new broker or following a different analyst.

All of the money is made in the local markets by origination and termination of services. With data IP and Ethernet dominating installations, there is an agnostic aspect of what applications run over the local pipes. In addition, customers can’t figure out why a 100 meg connection in a metro market may be priced 3-4x more than the same 100 meg between Washington, DC and Miami. It’s an apples and oranges type of answer. Metropolitan markets are 10x more expensive to build, operate and install than a long haul network. You actually require more fiber to be deployed in a metro setting in order to support stuffed, long haul dumb pipes from long haul networks dumping packets at a carrier hotel for metro distribution or third party interconnection facilities. Think about it—it makes perfect sense.

When Level(3) found God a few years ago, they went on a buying spree of metro assets because they realized they need a local and a deeper presence as opposed to just a co-lo interconnection point. So I characterize the last round of consolidation as a blessing because the larger CLECs such as Level(3), who are still puny compared to the ILECs, bought larger holders of metro assets and removed a lot of junk, bad investments, poorly run companies, and in some cases, inept CEOs.. I think they acquired eight companies and TW Telecom bought one after bottom-feeding for so long that it lost the first eight opportunities. Due to Level(3) and TW Telecom buying up some of the junk, my business (as well as others) improved immensely because the low price champions were removed from the game. Rational behavior relative to staying in business has prevailed in for the most part (although a few occasions you get a nutty CEO that thinks the low, low price/volume play will work).

The integration struggles have been well-documented and disclosed—and were not unexpected to me. The good news is Level(3) found God and is trying to find success by focusing its efforts in metropolitan networks. In fairness on their last call, TW Telecom spoke about the M&A deal they did with Xspedius Communications. Out of 18,000 customers they acquired, they have purposely churned out 14,000. A lesson for Level(3) and all carriers—it is about the quality and loyalty of customers as opposed to the top line growth. And yes, owning the local infrastructure is the key to margin growth. I’d rather grow margins and profitability than acquire marginal customers or unprofitable customers to please some analyst. Level(3) really needs to take this lesson to hear—it’s not about low price but about selling reliability and saying no to business that is not profitable. A stringent credit check is crucial to avoid churn. Finding and retaining salespeople that can say, “No” to bad deals and move on to better opportunities will also help Level(3).

Level(3) has its focus on the right target–metropolitan access—but the junk customers, systems and processes make it hard to clean up.

In my opinion, Level(3) needs to position itself better as a solutions company and not a network company. Customers buy solutions that are reliable! Selling them on the fact you own infrastructure is a confidence-builder but the true consideration is that you deliver on-time, on-budget, reliable service.

Regarding prices, Level(3) doesn’t need to increase them or decrease them—keep prices at the same level as the ILEC and just outperform them on quoting, on-time delivery, speed and reliability. That’s our focus and I’ll give you a few internal AFS data points to illustrate that this formula works:

• On-time delivery success rate to customers over 10 years of 98.5%
• On-budget success rate over 10 years to customers of 98%
• All-all optical customer service affecting failure rate less than 1% over 10 years
• Customers than have never experienced a service affecting outage in 10 years
• Margins continue to grow at double-digit rates annually for 10 years (quality top line by double digit growth annually excluding business we turn away for not meeting our disciplined financial hurdles)
• A churn of 0.7% per month.

How or why does this model work for us? It begins with hiring the right talent, having a culture of customer inclusion and focusing on constant improvement in all areas of the business with an emphasis on efficiency (without going overboard).

If Level(3) tries the same formula, given what they now have (and cleaned up to a certain extent) I think they will be on the road to riches. Simplicity, less layers of management, decision-making tools for those closest to the customer are required.

Did I answer your question? Oh, my painful ribs!!!!