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 The recovery is leading to a number of acquisitions as the largest
telecom companies duke it out with cable operators and telecom
providers such as Level 3 Communications Inc to serve corporate
customers.
Companies like Level 3 have been successful in shifting their focus
to the industry's sweet spot - the "last mile" of fiber which is
typically the most expensive to develop. They connect business
clients to larger networks, allowing data and Internet traffic to be
transmitted at ultra-fast speeds through thin filaments of glass.
Level 3, a Colorado-based company which narrowly avoided bankruptcy
in the early 2000s, put an exclamation point on its long climb back
from near death with the $5.65 billion acquisition last week of tw
telecom Inc - a merger which will connect 35,000 commercial
buildings nationwide to its fiber network. Analysts expect Level 3
to report an annual profit this year for the first time in 16 years.
The acquisition of tw telecom, a joint venture between US West and
Time Warner founded in 1993, wasn't the first such fiber oriented
deal and won't be the last, analysts and industry bankers said.
The market for corporate customers' voice and data services has been
estimated by analysts to be worth anywhere from $57 billion to $100
billion in revenue per year.
"There's an unstoppable demand for bandwidth so that's behind this
and there's been a lot of consolidation. It's a business that works
on scale," said IDC analyst Mark Winther.
Fiber network provider Zayo, a company that Reuters previously
reported is pursuing an initial public offering, says it has bought
25 companies – including AboveNet in 2012 for $2.2 billion - since
it was founded in 2007, according to its website.
And Zach Nebergall, the vice president of Dark Fiber Strategic
Product Group at Zayo said he expects Zayo to keep acquiring
companies as long as they aren't overpriced.
Among other private companies, Fibertech, owned by Court Square
Capital, could be a candidate for sale, industry bankers said.
Lightower, which buyout shop Berkshire Partners bought in 2012, is
another sale or IPO candidate, the people said.
Representatives from Court Square Capital, which owns Fibertech, and
Berkshire Capital, which owns Lightower declined to comment on their
exit plans, while Zayo declined to comment on IPO plans.
Cable and telecom companies could also become bigger buyers for
fiber assets. Time Warner Cable spent $600 million in cash on
DukeNet, a regional fiber optic network in the Carolinas co-owned by
Duke Energy in October.
Winther said so-called enterprise clients, which are the biggest
corporate customers and include everything from financial
institutions to hospitals, are tough negotiators on price, so the
way providers can maintain margins is by getting bigger.
Sunit Patel, chief financial officer of Level 3, said it could cost
between roughly $50,000 to $150,000 to connect a large client, with
the investment paid off quickly - within six months to two years,
depending on the length of the contract.
"We essentially have transformed from being a largely wholesale
player 10-15 years ago to one that is predominately an enterprise
player today. All of the growth is coming from enterprise
customers," Patel said in an interview.
COMEBACK
Demand for fiber services wasn't always so strong. In the early
2000s, the industry was in turmoil, with a glut of fiber being built
across the U.S. Before its collapse amid an accounting scandal,
Enron Corp dabbled in fiber routes, while WorldCom was losing money
on its fiber networks before its top executives committed fraud and
the company went bankrupt.
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Prices for fiber-optic cable plummeted, a big chunk of what had been
a plethora of start-ups went under and miles of fiber networks built
to carry Internet traffic over long distances lay fallow, or dark.
Level 3 struggled during the downturn but got a cash infusion of
$500 million in 2002 from investors including Warren Buffett. In the
decade that followed, Level 3 consolidated at a rapid clip and
picked off the remains of the most desirable U.S. fiber networks.
Global Crossing, a telecom company once worth billions, went
bankrupt and was later acquired by Level 3 in 2011. Level 3 now has
a market value of $10.5 billion, compared to about $1 billion in
2001.
The fastest growing area of the market is in local fiber routes that
connect directly to buildings, in stark contrast to the long haul
routes that were built out during the telecom boom more than a
decade ago.
Constructing fiber routes to the "last mile" to local buildings and
offices is very expensive because in densely populated areas,
companies have to get permits and often have to be built underground
around electricity and gas lines. The companies that drove the boom
about 15 years ago ran out of money before they could build out
these local routes, said D.A. Davidson & Co telecom analyst Donna
Jaegers. Now, fiber networks in cities are in demand and their
services sell for a premium.
Market leaders in the local fiber space are AT&T, Verizon and
CenturyLink, which have a combined 60 percent market share of the
business enterprise market, Jaegers said. Cable companies have about
10-12 percent while Level 3 had 4.5-5 percent and tw telecom 2-3
percent, Jaegars added.
The threat from cable companies provides another reason for smaller
players to consolidate. Comcast, which is focused on wiring up small
businesses, has been rounding out its fiber networks and plans to
expand aggressively after its proposed merger with Time Warner Cable
is approved by regulators.
Telecom companies also got more strategic about where they were
installing fiber. Nebergall, the Zayo executive who also worked at
Level 3, said the mantra 12 or 15 years ago was "if you built it,
they will come." Now that's changed.
"There's a known set of demand for locations to which we're building
so it's not like we're putting fiber in the ground and hoping that
there will be demand," he said.
(Reporting by Liana B. Baker; Editing by Christian Plumb and Martin
Howell)
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