In January, US LEC Corp. executives had a reason to be energized.
Two Wall Street firms had initiated coverage of the Charlotte, N.C., company, recommending investors buy its shares, which have more than tripled in value in the course of one year.
US LEC, according to the Association for Local Telecommunications Services (ALTS), is partly responsible for a spike in the market value of publicly traded CLECs. Wall Street analysts dropped coverage on the competitive industry a few years ago as scores of upstarts grappled with cutthroat competition and huge debt obligations.
While many large brokerage firms still haven’t reinitiated coverage of CLECs, and it’s not all smooth sailing yet, the group has seen some good news.
The Good News
The combined market value of 16 public CLECs, including US LEC, has grown to approximately $4.1 billion, up from $1.25 billion a year ago, according to ALTS. Of course, that is a paltry sum compared to the year 2000 — since which the telecom market has lost an estimated $2 trillion in market value, to which the CLEC industry made a key contribution — but it signals fundamental improvements in the CLEC industry.
Covad Communications Group Inc., US LEC and Z-Tel Communications Inc. are among the CLECs that have seen their stock prices surge. But not all CLECs have had this relative good fortune. Shares of Allegiance Telecom Inc. and ATX Communications Inc., for example, have declined. Both companies are operating under bankruptcy protection.
Z-Tel spokeswoman Sarah Bohne attributes the company’s success to the fact that it is living up to the metrics it promised investors and to its expansion into hot areas such as VoIP.
In January, Z-Tel Chairman, President and CEO Gregg Smith said the company expected to generate about $290 million in 2003 revenue, up from $235.3 million the previous year, and record positive operating income for the seventh consecutive quarter. On Jan. 23, shares of Z-Tel closed at $4 on the Nasdaq National Market, compared to a 52-week low of 60 cents.
As for its VoIP activities, Z-Tel plans to launch a broadband and voice service to small and medium businesses and multitenant residential dwellings next quarter in select markets, Bohne says. The plan is to eventually offer the package to consumers.
Vik Grover, a former analyst with Kaufman Bros. LP., had predicted a recovery in the competitive wireline sector a year ago. In a research report in January 2003, Grover said the sector was poised to outperform consumer-focused carriers, including the RBOCs. “We do not believe that sentiment towards the sector can get lower, and yet fundamentals appear to be improving with many players now generating free cash flow or poised to hit free cash flow inflection within 12 to 18 months,” wrote Grover, now an analyst with Needham & Co. Currently, Grover says his “thesis is only gaining momentum.”
During the last few years, many national CLECs have reorganized under bankruptcy protection, reversed a trend of deep losses and demonstrated consistent revenue growth. In the third quarter, US LEC recorded net revenue of $79.7 million, up 25 percent from the period a year ago. The company grew its earnings before interest and other expenses to $10.4 million and shrunk its net loss attributable to shareholders.
Mike Robinson, CFO of US LEC, says rising stock values indicate new capital is becoming available to CLECs. In November, US LEC raised $10 million in equity in a private placement through institutional investors.
“I think there will be some companies in the sector that will be able to access the capital markets in a meaningful way,” Robinson says. “I think now there is appetite for new [money] to come into healthy companies.”
The Bad News
Of course, not all competitive service providers and industry watchers see it that way.
Bill Lenahan, CEO of KMC Telecom, says it is still tough to access capital. “The only companies able to access capital are the companies that are cash-positive,” he says. “I do think we will see some consolidation this year in order to improve economics. This could bring new capital into these type of deals. Most CLECs are in discussions and trying to figure out the right combinations.”
Jay Pultz, research vice president of Gartner Inc., says there hasn’t been much to cheer about in the CLEC industry. The analyst sees some funding to support consolidation, but he is, for the most part, bearish on the space. “It’s very tough because venture capitalists aren’t investing in this space. They have gotten pretty shy about CLECs in general,” Pultz says. “The outlook in not good for them to ... raise capital.”
Indeed, VC investment is nowhere near its $106 billion peak in 2000 ($21 billion in 2002), and investors remain hesitant to fund telecom companies for the first time. However, VC firms are putting fresh rounds of money into companies within their portfolios. Many remaining upstarts have shown they are on the path to building a solid business and posting profits.
“Those companies continuing to receive funding have solid management teams, blue-chip customers, distribution partnerships, solidly competitive products and a path to operating profitability,” Edward Olkkola, a general partner with Austin Ventures, told xchange in an interview last year.
Some CLECs, like US LEC, say they have moved into a new phase of the business, adding to revenue and EBITDA.
Now, some CLECs say they are focused on building scale and developing innovative products and services. That combination may be the recipe needed to move the stock prices in a direction that would placate shareholders — up.
