There has never been a better time to finance a new network build. But you'd better have your story straight before you approach the financial markets.

cover story

IT'S RAINING MONEY

There has never been a better time to finance a new network build. But you'd better have your story straight before you approach the financial markets.

BY STEPHEN HARDY

Nothing rivals the explosion in Internet-driven bandwidth demand-unless it's the amount of money chasing it. The market euphoria that has propelled Internet stocks to astronomical heights has spread to the networks that will deliver Internet-protocol (IP)-based services. Bankers and venture capitalists have become fixtures at telecommunications conferences, and it appears that if you can use "fiber" and "Internet" in the same sentence, you'll find someone willing to bankroll your next project.

Or will you? While money indeed seems to grow on trees these days (or perhaps telephone poles), representatives from the financial community say they'll apply the same strict standards in the telecommunications arena that they do in less high-profile markets. So both emerging and established carriers had better tell a good story when they make the financial rounds. These carriers also should ready themselves for a potentially bewildering array of capital resources, from venture capitalists to banks to public offerings to equipment suppliers. As veterans of this monetary merry-go-round report, the choice of funding strategy can prove crucial to a company's long-term success. Any funding isn't necessarily better than no funding at all.

Choices, choices

Finding the right option for funding frequently depends on the carrier's stage of evolution and what its management wants to do with the money.

"For actually building fiber-optic networks, putting fiber into the ground, venture [capital] is a poor route to go," advises Roland Van der Meer, co-founder of the venture-capital firm ComVentures. "Initial capital, yes-venture can now speak not just to $5 million to $10 million but $50 million to $100 million of financing. But that does not make a dent in building the infrastructure if you're really going to put fiber in the ground, either in a metro area or in more of a long-haul capacity."

Fortunately, carri ers ready to roll the backhoes have elsewhere to turn. "The financial markets have been very friendly to infrastructure plays because of the capacity issues that we see coming," Van der Meer continues. "So what you do is you get an initial funding round if you need to, but some bypass that and just go right to some sort of private equity that's not venture based but more institutional and layer a big piece of debt, or they do that in combination [with other financing options]. And the debt would be kind of a high-yield debt situation. And that can range from $100 million to $500 million."

Bankroll the build

If $500 million won't get the job done, then carriers can go to the public markets. Several carriers have floated an initial public offering (or an additional offering, if they already have stock on the market) to bankroll new builds. Telecommunications stocks in general continue to do well, particularly in the United States, so this option can prove very successful for carriers with an established track record and an existing revenue stream.

But for newcomers with little more than a dream and some expertise, venture capital represents an attractive option to get started. Because they frequently have other clients in the same area, venture capitalists also can help neophytes network with suppliers or recruit executives for management positions. What they won't do is fund anyone off the street.

"You very much need a distinct, unique services model to be able to go out to these markets and raise the capital. You can't just go out and say, 'I'm putting fiber into the ground, thank you very much,'" Van der Meer says. "The guys who come here have usually a pretty damn good idea of what they're going to build-in this space particularly, because it is so competitive and you better understand what a carrier means and how to run one."

Venture capitalists can be very helpful for those who have never created a company before-but that assistance comes with a price. "Our capital is the most expensive capital out there, because we take big slugs of equity versus public financial markets or higher institutional or strategic partner kind of equity," Van der Meer warns. "So when the concept has to be fleshed out, when the team has to be fleshed out, when it is an inkling of an idea or the beginnings of a new business model, that is the best time for a next-generation carrier or a facilities-based carrier to come out to the [venture-capital] community."

My vendor, my bank

For established carriers or new companies with money already in the bank, equipment vendors represent a well-established source of funding. Most, if not all, of the large telecommunications equipment suppliers will offer funding to carriers looking to buy their equipment.

Traditionally, such agreements have locked carriers into an exclusive relationship with the equipment vendor. But tradition isn't what it used to be. "Those kinds of arrangements are being changed quite a bit, where today if you finance your equipment deal through a large company, very often they'll have a huge percentage of it open to buy other vendors' equipment," reports Doug Green, vice president of marketing at Chromatis Networks, a startup equipment vendor. "So only some percentage of the deal that they finance has to come from that one vendor."

Why have vendors become so liberal? "There are very few cases right now where any of the large companies have everything that's needed to build one of these optical networks. Nobody has all the pieces," Green claims. The lending vendor still gets the benefit of a captured market for at least some of its equipment, he says. It also gets exposure to new technologies through working with other suppliers. Green predicts that smaller companies like his will create partnerships with the larger vendors to fill gaps in the big company's product lines.

"I think the larger vendors are having a tough time predicting where the market is going," Green explains. "And there are two ways they can fill those gaps. First of all, they can just buy a company outright. But for some of the markets that they don't necessarily understand as well, they may choose an OEM deal or some kind of distribution arrangement until they can really themselves get a better understanding of whether this is a technology they should buy or whether it's a technology [for which] they should just continue to have a tactical relationship with companies." Green points to Lucent's announcement that it will distribute Tellium's optical-crossconnect equipment as an example of this trend.

Green sees vendor funding as a supplement to other forms of capital. "Even if you get the venture capital and you have a lot of money, you still probably want to finance [equipment purchases] through one of the big vendors in some cases anyway because you want to control the cash flow," he says. "In my view, as long as you have a viable business plan, that the venture market sees that you're not doing something that's totally unproven, then you can get venture capital to finance the equipment. And then once you have enough money you can go off to one of these bigger equipment companies and say, 'I'd like you to finance my deal. It's not really high risk because I've got money. And I also want you to finance not only your equipment, but also finance some percentage of it to some of these other companies that I want to get equipment from.'"

However, vendor financing can have its pitfalls-particularly if funding proves to be about the only thing the vendor delivers. Van der Meer points out that a funding agreement that ties a carrier to a vendor can prove disastrous if the vendor's product line doesn't keep up with the carrier's expanding network requirements. Such carriers may have to go back into the market for alternative funding to buy equipment from other sources.

Roland Van der Meer -- ComVentures

The relationship between vendor selection and the financial markets has become more intricate as the competitive stakes have risen, Green believes. Carriers have used technology as a market-differentiation point ever since Sprint touted its "crystal-clear fiber-optic network" when it first entered the market. However, Green says today's carriers use technology as much to gain attention from the financial community as they do to win customers.

"One of the interesting angles about going to the [venture-capital] market and going public is that they start to choose their equipment not necessarily based on its technical strengths but how much hype does it give," Green asserts. "Some of it is kind of [shoddy]. But they still use their technology choices as a way to hype their company to increase their valuation both for venture capital and for going public."

Van der Meer says the financial community tries to ignore the hype when evaluating potential investments, but that equipment choice can have an influence on a company's attractiveness. "Our decision is usually based on the business model, and we look at technologies that are suitable to address the unique opportunity," he reports. "So do we look at the technology that they're going to use and how smart they are in what they can do? Yes."

Part of being smart with technology involves making sure that the fortunes of the carrier aren't solely dependent on an unproven equipment supplier. "How do we hedge our bet?" Van der Meer explains. "Is there another potential equipment provider out there? Can we get by with the existing carrier-equipment vendor, a Nortel or Lucent solution, or are we solely dependent on this emerging technology? And usually if the answer is that if you're solely dependent on this new emerging technology that's a year out-good luck."

Undersea not undervalued

Equipment vendors are less of a source of financing for submarine-cable networks than their terrestrial counterparts, according to Robert Stuart, managing director, Global Telecom Investment Banking Group at CIBC World Markets. Thus, venture capital, then institutional and public resources have provided most of the funding for the current spate of undersea cable networks.

Speaking at the recent Submarine Fiber-Optic Cables Summit 2000 sponsored by SMI Conferences in London, Stuart described the general process for submarine-cable financing. (CIBC was one of the initial investors in Global Crossing.) As with terrestrial networks, a unique business plan backed by a strong management team represent essential elements for a new venture. For investors such as CIBC, the ability to distribute their risk in a new venture to secondary investors (frequently banks) is an important consideration. So too is the successful completion of an independent capacity study-to ensure that there's adequate bandwidth demand on the proposed route to make the venture a success-and a technical report.

The presale of capacity-signing on customers before the network is built-is a favorite strategy among undersea-network entrepreneurs for raising cash. However, Stuart recommends that carriers not expect to travel too far down this avenue; he recommends that such sales be considered gravy as opposed to meat.

Stuart reported that the recent financing success enjoyed by the FLAG Atlantic-1 cable system illustrates several important lessons for others hoping to raise money in this market. First, banks and other generally conservative financial resources have educated themselves on the optical-network arena and recognize its potential. The fact that FLAG already had a cable in the water that was bringing in revenue also strengthened their case. As a result of these factors, FLAG Atlantic-1 could put together what Stuart termed an "aggressive financing structure" with access to high-yield financial markets.

In looking forward, Stuart told attendees that there is a strong backlog of financing activity in the submarine-cable market and that the loan syndication market was becoming deeper. These factors bode well for future undersea-network construction.

Of course, that doesn't mean that undersea-network developers will necessarily share this largesse with their customers. Analysts report that submarine-network companies are just beginning to consider providing direct financing (see Fiber Exchange, November 1999, page 8) to their potential clients. However, the lack of cash on the submarine network providers' tables may have more to do with the market than any inherent reluctance to open their wallets. Jane Windsor, director of communications at FLAG Telecom (London, UK), reports that only a minority of FLAG's customers request financial assistance, a market characteristic that hasn't changed significantly in the past two years. FLAG Telecom will help arrange financing through third parties and has occasionally granted deferred payment terms, she says. Generally, however, FLAG Telecom's customers turn to equity, high-yield, or bank-debt financing for their bandwidth purchases.

Fill your pail

The convergence of a hot application and a media that can make it ubiquitous-in other words, the Internet and fiber-has created not only a hunger for bandwidth, but a craving to invest. "I would bet that any forecast you make in terms of capacity and bandwidth will be met or beat in the next 10 years-provided the financial markets are there to fund it all," says Van der Meer. "So we're pretty excited. We think it's a wonderful place to be investing in."

While such sentiments are music to the ears of entrepreneurs looking to break into the telecommunications business via optical networks, financial institutions won't sing for just anyone. The right business plan must be coupled with a supporting technology choice before the cash starts to flow.