Darwinian dilemma

CLECs play their own game of `Survivor' When Leo Hindery announced his departure from Global Crossing last week, attention almost immediately turned to his personal windfall that resulted from the sale of the company's hosting arm. With options from the sale of GlobalCenter to Exodus Communications, which could put up to $247.5 million in Hindery's pocket, it is one example of how profitable the non-incumbent market can be (see story on page 9).

Hindery is the exception to the rule, though. More typical is Christopher Resavy, chief operating officer of e.spire Communications. According to SEC filings from the last two years, Resavy has directly and indirectly accumulated 31,200 shares of the company at prices ranging from $4.19 to $6 per share. At mid-week last week, those combined shares were languishing at about $2.50.

And though e.spire is just one of the many competitive local exchange carriers (CLECs) to suffer in the current market, it is emblematic of a market segment that is now questioning the entire business model. Less than a year ago, those same CLECs had everything a fledgling industry could ask for: Regulatory backing for more open local competition, an image as the place to be for up-and-coming executives and a money stream that seemed endless. In the interim, virtually every facilities-based provider has seen a tougher regulatory environment, an exodus of talent at the highest level and a financial community that is more tight-fisted.

In the CLEC version of "Survivor," GST Communications, CapRock Communications and Intermedia Communications already have been voted off the island, ICG Communications and e.spire have targets on their chests, while Time Warner, McLeod USA and XO Communications (formerly Nextel) could be in some sort of voting cabal.

Many are left asking what went wrong and whether the market is permanently damaged or is playing out a Darwinian scenario in which only the fittest survive. Pinpointing a single cause of the CLEC freefall is difficult, though many point to a lack of support from the financial community.

"I think the number one issue is the ability to generate capital from Wall Street," said John Windhausen, president of the Association for Local Telecommunications Services. "An awful lot of our companies have spent a lot of money building out their network, and some of the companies are going to be running out of money next year."

Indeed, a lack of cash already is taking its toll. ICG said last month that it will cut capital expenditures for the remainder of this year to about $450 million and reduce 2001 spending by more than 50%. And CapRock, which already cut back operations, agreed to be acquired by McLeod earlier this month.

More than cash problems, what ties many of the same companies together is a lack of focus and execution of the business plan, according to analysts and executives. In fact, while CLECs as a whole are out of favor with investors, many industry observers believe that the CLEC business model remains solid, blaming the current situation on those in the executive office.

"The part of the business that is a challenge right now is the execution," said Robert Taylor, CEO of Focal Communications. "Customers are buying the service, so if you look at it from where the business begins, it's doing great. The companies that are not making their numbers are not making them because of an execution deficiency rather than a market deficiency."

Craig Clausen, senior vice president of New Paradigm Resources Group, agreed. "When you have that kind of turmoil, you can't underestimate the effect the executive suite has on the company," he said. "They serve as the anchor of the company, and they serve as the keel. That's what happened to GST. They were well-funded, but the executive suite was in constant turmoil."

Others say technical issues play a large role.

"The market revelation has been that interconnection isn't easy," said Jim Boyer, executive director of interconnection solutions for Telcordia Technologies.

However, not everyone agrees that the current CLEC model works.

"Most CLECs were trying to be all things to all people," said Greg Tennant, who has held executive positions at both Intermedia and Convergent Communications. "A single-stop shop is a very difficult thing to pull off. It really begins to stress the available skill sets in the market."

The economics for CLECs - particularly those buying Class 5 switches - just don't work, Tennant said.

"They're deploying an identical service as the incumbents. They have a high capital cost to re-coup, and they're buying the raw copper or fiber at higher rates. And they're still completely dependent on incumbent bottlenecks."

Tennant, who now works with Argus, a security software vendor, also places some of the blame on the financial players, which fed the market with cash, regardless of the validity of its business plans.

"Wall Street fueled the growth spurt, and Wall Street never understood the model themselves," he said. "They were interested in making money off the company, not the company making money. With that attitude, they were tolerant of you missing your EBITDA for years. They knew exactly what was happening. They funded it, they fueled it and, when they realized it was a money pit, the funding began to dry up."

Not all CLECs are falling into the money pit, though. A number, including McLeod and Focal, are funded through next year and are generating sufficient cash flow to survive the current shakeout. Others remain afloat - or at least take on less water - because of their narrow focus. Analysts almost universally point to Focal as one of the success stories because it didn't attempt to cover more markets than it could handle - ironically, something analysts chided it about early on.

"We use the Southwest Airlines analogy. I'm sure they've got people that can fly to Tokyo, they can feed you along the way, and they can get your luggage there fast," Taylor said. "But all of those things detract from their product and service. I don't think you find anybody who does everything well."

Just over two weeks after sealing a $6.5 billion deal between GlobalCenter and Exodus Communications, Leo Hindery, CEO of Global Crossing and chairman and CEO for GlobalCenter, resigned from both posts.

While Hindery's departure may have come as a surprise to shareholders, it did not seem to surprise the company.

Stepping up to the CEO plate is Thomas Casey, vice chairman of Global Crossing, who's been working closely with Hindery during Hindery's seven-month tenure, which followed former CEO Robert Annunziata's surprise resignation. Hindery said he accomplished what he planned to do at Global Crossing, including overseeing the sale of his charge, GlobalCenter, on Sept. 28.

"This company has been in transition since its formation three-and-a-half years ago, and that's no surprise. It's a very young company," Hindery said. "It's not something I take exception to in any stretch of the imagination, nor do I feel that we are leaving the shareholders or the company in a difficult situation."

The transition from Hindery to Casey seems logical for the company now that GlobalCenter has been sold, said Courtney Munroe, vice president for telecom and IP services at IDC.

"I was kind of surprised that they tapped [Hindery] for the position in the first place. He is more cable-oriented. They needed more of a mainstream person," he said.

While Hindery did not directly address concerns over the company's stock price, which has fallen 57% since he became CEO, he said, "We'd be irresponsible to suggest that it's not a difficult time as companies throughout the sector try to figure out what they want to be when they grow up."

To drive revenue and cash flow during the next year, the company will rely on its 101,000-mile global IP network, which should be completed by 2001, and its data services, Casey said. "We expect to meet or exceed our recently increased projections for the third quarter and the full year," he said.

The company has good prospects with its global network and the demand for bandwidth, Munroe said.

Hindery will remain chairman and CEO of GlobalCenter until the acquisition is complete. According to published reports, he stands to make $247.5 million in stock from the sale.