XO TAKES LEAP OF FAITH WITH BACKBONE UPGRADE

While most service providers have significantly slowed spending to conserve capital and appease investors, XO Communications is upgrading its network to OC-192 in a commitment to cutting-edge technology that ultimately may put the carrier on the chopping block.

When completed at the end of the year, the upgrade means XO will be one of the few carriers that can serve customers with a 10 Gb/s connection within its eight-city core network. But the cost has analysts puzzled. “I don't understand what they're doing,” said David Gross, senior analyst for CIR. “They have $5 billion in debt and a four times debt-to-revenue [ratio].”

Last week, the company said third quarter revenue increased to $331.5 million, a 48% increase over the same quarter last year and an 8% boost over the second quarter of this year. XO's net loss shrank to $50.8 million or 12¢ per share, compared with $436.5 million or $1.20 a share last year.

“This was a good solid quarter, and we were able to execute and grow revenue,” said Dan Akerson, XO chairman and CEO, who declined to provide fourth quarter guidance.

More concerning, though, is the company's cash position. XO has a cash balance of more than $1 billion, which is supposed to fund it through the second half of 2002. XO used $288.4 million in cash to repurchase $547.3 million in the principal amount of senior notes. It also bought $472.6 million in liquidation preference in the third quarter. Still, the plight is grave enough that XO hired investment banking firm Houlihan Lokey Howard & Zukin to find alternatives regarding restructuring and additional funding. Standard and Poor's recently downgraded XO's debt deeper into junk status.

Last month, the company laid off 8% of its work force and canceled a European expansion project. Although the company's stock buoyed slightly from the quarter news, it is still struggling to stay above $1 per share.

That aside, XO is going ahead with migrating existing customers from its OC-12 network to the new facilities-based OC-192 network using Juniper Networks' M160 and M40 routers. “We migrated the core of our network onto XO facilities [from leased facilities],” said Henry Clark, senior network architect for XO Communications.

XO's upgrade involves Atlanta, Chicago, Dallas, Denver, Los Angeles, New York, San Jose and Washington. The rest of the provider's markets will be linked to those IP core locations through dual OC-12c circuits. The old leased OC-12 links will be disconnected, and the network's Cisco Systems 12000 series routers will be reused in other areas. So far, the project is about 75% complete, according to Clark, and it will be finished by year-end.

By making the upgrade, XO expects to reap the benefits of delivering end-to-end data. “XO will definitely see a cost benefit from spending the money on the upgrade,” said Adam Stein, director of corporate marketing for Juniper.

Still, others aren't convinced the upgrade will pay for itself soon enough. XO doesn't have the benefit of long-standing data revenue such as WorldCom or a parent company willing to support it.

XO is likely caught in the old mentality of needing to have the biggest and largest capacity network, Gross said. “They want to have as big of a network as possible so their sales people can say they own their network, and they have OC-192,” he said.