Tuesday, November 9, 2010

Independent Phone Companies - Hosting Providers of the Future?

By David Gross

During last week's earnings announcements, Cincinnati Bell CFO Gary Wojtaszek stated that:

"The results from our recently acquired CyrusOne operations demonstrate great progress towards our goal of being the preferred provider of global data center colocation services to Fortune 1000 companies"

He made this statement the same day that Windstream announced its $310 million acquisition of Hosted Solutions, which had the same previous owner as CyrusOne, ABRY Partners.    But what's happening?  Have formerly conservative independent LECs suddenly become leading edge colo providers?

Independent telcos like Cincinnati Bell, Windstream, SureWest, and the 1,100 phone companies serving rural communities, are known for selling mature, established services like DSL, voice, and business T-1s.   But being boring no longer produces the cash flow it once did, and now telco executives are talking less like owners of 100 year old telephone exchanges, and more like providers who interconnect at Equinix exchanges.   But is this just PR gloss, or can they really succeed?

To date, many colo and hosting providers have succeeded by avoiding telecom services, while many telecom providers, notably Cogent and AboveNet, have focused on providing telecom services to data centers, not by selling the space inside of them.   The "end-to-end" provider has not fared well.   Level 3, in particular, received a delisting warning from NASDAQ last week, and has long struggled to compete against the multiple providers it faces across a variety of markets.   AT&T and Verizon Business have had some success in hosting, but much of their focus in the business market has been on high bandwidth and shared network services such as Transparent LANs and IP/VPNs.   However, independent telcos like Windstream and Cincinnati Bell have far fewer of these large corporate customers.

In the late 90s, Cincinnati Bell made an attempt at becoming a more exciting business provider when it acquired Texas-based IXC Communications and temporarily changed its name to Broadwing Communications.  When it re-branded back to Cincinnati Bell, the company mentioned the great tradition behind the name.   Now it is banking its future on another rapidly-growing Texas company, although this one is not in the midst of a crazy fiber optic building spree like IXC was.

Privately-held hosting and colo providers like i/o Data Centers and SoftLayer have had no trouble raising capital, and shortly before its acquisition, CyrusOne raised $150 million on its own.   While I can't say how much CyrusOne wanted to be acquired, ABRY Partners, not unlike GI Partners, clearly needed a "liquidity event" to maximize its IRR on its hosting investments, and in this case, getting 8x prior year revenue was far more than they would have gotten from an IPO, especially with CoreSite trading around 2x annualized revenue. 

While Cincinnati Bell unquestionably overpaid, I think it did the right thing operationally by keeping the Cyrus One brand, and not re-creating another "Broadwing" or oddly-branded provider.  But outside of CenturyLink/Qwest, which will stretch the definition of an "independent" phone company because of Qwest's RBOC operations, there are few other independents who can afford to spend $500 million on a hosting provider.

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