Survival Instincts

One CLEC has the edge needed to succeed

Fat with capital, flush with ambition and happy with Congressional guarantees of a level battlefield on which to fight the regional Bells for local phone customers, competitive local exchange carriers shouldered their way onto Telecommunications Avenue five years ago.

They were ready to make money by building voice and data networks, by reselling Bell services to their own customers, and by unbundling and selling network elements. They convinced the financial markets that they would make it, and make it big.

But in the years since the Telecommunications Act of 1996 opened those competitive floodgates, some competitive carriers have begun to drown. The reality of competing with the mega-Bells that have consolidated their financial and political clout through multibillion-dollar mergers has frightened Miss Money away.

Covad Communications, one of the largest competitors, says it will cut back on build-outs and focus instead on selling its existing network. HarvardNet last fall gave up the Digital Subscriber Line business it worked so hard to obtain. ICG Communications fell into Chapter 11 bankruptcy protection, as did GST Telecommunications; the former expects to rehabilitate itself, the latter was acquired by Time Warner Telecom. Jato Communications laid off 650 workers after the third quarter of 2000, then closed its doors just after Christmas.

So when Cedar Rapids, Iowa-based competitive carrier McLeodUSA offered $450 million in senior notes two weeks ago to refinance debt, one would have expected the market to react with skepticism.

It didnt.

Even McCleod officials were surprised when investors fought their way to the offering like post-holiday bargain hunters, snapping up $750 million worth of the notes.

The reason: Not all competitive local exchange carriers (CLECs) were created equal.

And McLeodUSA, with what analysts agree has been a history of strong management, a facilities-based starting point and an ever-growing footprint through aggressive acquisition of smaller, successful operations, has gotten very positive reviews.

McLeodUSA started as a local phone company in Iowa, and has come through several incarnations. In 1991, it was incorporated as McLeod Telecommunications to provide fiber-optic maintenance services for the Iowa Communications Network.

In 1993, the company reinvented itself as McLeod Inc. and won regulatory approval for local and long-distance service in Iowa and Illinois. In 1996, after a successful initial public offering, it acquired a direct marketing and telemarketing firm and began publishing phone directories for cities nationwide.

In 1997, the company changed its name to McLeodUSA, and in the succeeding four years, it began a series of mergers with communications firms in Illinois, Minnesota, South Dakota and Texas. It now has 9,600 employees, and provides telecom services in all 50 states, describing itself as a "super-regional CLEC."

With fourth-quarter earnings exceeding expectations, analysts were charmed by the companys earnings before interest, taxes, depreciation and amortization, and gave it two thumbs up before its bond offering earlier this month. In its earnings call Jan. 31, McLeodUSA is expected to announce fourth-quarter EBITDA of $29 million — up 92 percent from the third quarter of 2000 — on revenue of $401 million, which is in line with Credit Suisse First Boston analysts estimates of $403 million.

LouAnn Newman, a consultant at TeleChoice, says the fact that McLeodUSA is running strong while others are running scared, is owed to the companys history as a former incumbent local exchange carrier that turned itself into a competitive carrier vying for regional Bell customers.

"People like McLeodUSA have survived because they are facilities-based and have their own network in place," Newman says. "They have done well by increasing the area they have competed in, and they, frankly, have good management. They also have telephone revenue."

Bryce Nemitz, vice president for communications at McLeodUSA, says he believes the company is strong in part because it has capitalized on "opportunity."

"Were in the best place we could be in right now," Nemitz says. "I think that all relates to strong management; our commitment to our business plan, which has been in place since 1994; and to our strong financial condition, which we see as a strategic asset."

Newman says competitors that began life as incumbent carriers — McLeodUSA and Dobson Communications among them — have grown because "customers like them, and they have a solid history."

Pitched Battle

On the other hand, analysts including Newman say that competitors trying to resell Bell services are failing because they cant compete on price alone — which many have tried to do.

"In public, the [regional Bells] say they are going to be fair, and are going to compete, but they really havent been either," Newman says. "Under the table, theyve been hard to work with. For the resellers, you cant get [access] cheaper than the people they are buying it from, so they are struggling."

McLeodUSA has had its own struggles with the regional Bells — evidenced by its aggressive anti-merger stance when Qwest Communications International was in the process of seeking regulatory approval for its merger with U S West.

But at least in that instance, the competitors found oil to pour on the troubled waters. Qwest rejected McLeodUSA as the company to which it ceded its long-distance business in the U S West region — a merger condition — prompting McLeodUSA to complain to regulators that Qwest was improperly looking for "friendly" partners, not competitors.

But later, in a three-year, $600 million deal, Qwest opened its arms to McLeodUSA, allowing the competitor to offer services ranging from high-speed Internet access to voice messaging over its 14-state network.