Posted 12/2000
Business and Finance
When the Going Gets Tough
Stop Crying About CLEC Stock Values and Get Back to Work!
By Jonathan E. Canis
For almost a decade, venture capitalists (VCs) and investment banks focused on steadily increasing revenues. Valuations for CLECs were based on multiples of earnings, so earnings growth meant higher valuation. This valuation method favored business plans that focused on expansive growth, fueled by increasing debt.
Over the last two years, this valuation methodology degenerated into a cookie-cutter formula that was applied by VCs and investment banks alike: Get as big as you can (preferably a 50-state rollout) as fast as you can (go public in nine to 12 months). This formula was applied to just about every CLEC startup, regardless of markets targeted or technologies used--full-service CLECs, data LECs, ASPs, etc.
This model crashed and burned starting in March of this year, when IPOs stopped producing big pops for shareholders, and when banks started to get skittish about high debt levels. As the debt markets dried up, and the IPO boom faded, growth could only be financed by more private equity. Because this would only dilute original investors' equity, the rage for pro-growth turned to slow growth.
This year, a new model has developed--positive EBITDA within the first year, with actual profitability shortly thereafter. This has resulted in new CLEC business plans that focus on controlled growth, with regional--not national--coverage, and use of the most cost-effective new technologies available. There are a host of new CLECs using these scaled-down, positive EBITDA business plans, and they are still attracting high levels of investment.
The largest of the old-school CLECs, however, were mired in debt and were overly reliant on easy money from reciprocal compensation, which allowed them to avoid hard choices about cost-cutting and growing their traditional retail revenue base. As reciprocal compensation rates were reduced dramatically over the last two years, these CLECs' profitability declined, and they could not meet the new demands of the capital markets.
What's the prognosis? Equity investment is still widely available, and debt is available to companies showing they can meet their revenue projections. On the cost side, 2001 will see an obsessive focus on reducing network costs--especially through UNEs and enhanced extended links (EELs), creative uses of collocation, and a shift from ILECs to competitive providers of intracity transport. In addition, the new generation of softswitches and edge devices will help contain equipment costs. On the revenue side, we will see continued focus on deriving multiple revenue streams from value-added services, as well as basic services.
Jonathan E. Canis writes a monthly column on regulatory issues. He is an attorney at law with Kelley Drye & Warren LLP, and can be reached at canis@kelleydrye.com.
