Wholesale Channel: Window Shopping
Posted: 2/2002
Wholesale Channel
Window Shopping
Resellers Eye Small Competitors
By Josh Long
few years back, Greg Hahn knew about 15 resellers in Houston — now he knows one.
“They were either acquired or … went out of business due to the billing problems our industry faced,” says Hahn, CEO of Pasadena, Texas-based TelOne Telecommunications Inc., a switchless reseller that also owns an enhanced services platform to provide forward fax and personal 800 numbers among other features.
Hahn says several companies have approached him, seeking to purchase his base of roughly 100,000 residential customers. But he says the “offers didn’t really pay us money for our trouble.”
While Hahn has room to negotiate a fair price, many of his peers don’t. Thus, resellers quietly have engaged in a buying spree, growing their customer bases and acquiring assets to help them carve a niche in other areas of telecommunications and information technology. It’s not so much a case of the big fish gobbling up the small, as it is the small fish gobbling up the smaller.
Columbus Capital Co. LLC managing director Peter Nesvold anticipates telecom companies will continue to pick up select assets during the next three to five years. He says the mergers and acquisitions will be multimillion-dollar bargains, not the over-inflated, multibillion-dollar deals signed during the ’90s Internet boom.
Strategy consultant Casey Freymuth, president of Group IV .Inc. and publisher of The Telecom Service Provider: How Much is It Worth?, says it is common for companies to pursue acquisitions — particularly horizontal or “like company” targets — in a down market because the “buying is good.”
“While the buy low-sell high rule makes sense in terms of overall strategy, buying a company just because it’s cheap rarely works out,” Freymuth says. “Companies always underestimate transition costs, shock attrition, cultural mismatches and a host of other issues that, in fairness, are not easily measured in advance.
“If the combined company does not generate real synergy, or ‘new value’ for shareholders, the deal will probably not work out in the long run,” he adds.
Telecom resellers say they wouldn’t buy a customer base or asset unless they could turn a profit shortly thereafter, ranging from six months to two years later.
RFC Capital president Richard C. Rudek says a long-
distance reseller probably will sell assets for between one and three times their monthly revenue. He says a business that purchases assets — including a customer base — should be able to turn a profit within two to four months.
He adds that setting guidelines to reach profitability within 24 months is way too long, partly because attrition is likely to eat away at revenue even if the customers are corporate users.
Buyer’s Market
PowerNet Global Communications, a Cincinnati, Ohio-based long-distance reseller focusing mostly in the residential market, scooped up roughly 100,000 customers in 2001, says Christopher Bradish, vice president of corporate development.
“We look primarily at acquiring customer bases unless there happens to be a strategic fit,” Bradish says. He declined to say how much PowerNet Global has paid for customers, but explained, “Our payback has to be within six months and I try hard to get it within three.
“I would say all of them have been losing money but obviously through buy rates and our economies we can make them profitable instantly,” he added.
Bradish says buying a customer base is tricky because it is never known how many customers will take their long-distance needs elsewhere: “You never know how much attrition you are going to get when you take the base over.”
A number of companies earning $50,000-$100,000 per month has approached PowerNet Global seeking to make a deal. PowerNet Global, which serves approximately 400,000 customers, typically passes on such offers.
“The time and effort to integrate a $100,000 base is the same time and effort it takes to integrate a $1 million base,” Bradish says.
PowerNet Global, which plans to incorporate local and long-distance services, Internet access and unified messaging during the first quarter, analyzes attrition and the strength of a company’s distribution channel in determining the value of a potential acquisition. The company would consider picking up a struggling competitor with no marketing channel if it possessed other assets strategic to its business, Bradish says.
In roughly half of the acquisitions, Bradish says, PowerNet Global gives the reseller some type of recurring payment. A switchless reseller frequently morphs into a master agent, effectively handing over the back-office duties to PowerNet Global while retaining a marketing team to grow the business, Bradish added.
In a similar vein, a switchless reseller approached Alliance Group Services Inc., a Westport, Conn.-based company that provides back-office and network services on behalf of communications companies. Alliance Group Services has agreed to handle provisioning, customer service and billing on the reseller’s behalf, says Bill VanderPloeg, executive vice president of Alliance Group Services. The reseller is paid a monthly fee based on billing.
Capsule Communications Inc. offers switchless resellers similar options: The Bensalem, Pa.-based company offers switchless resale customers “exceptionally competitive” international long-distance rates as a result of a merger agreement with Little Falls, N.J.-based Covista Communications Inc., says Capsule president David Hurwitz. Capsule assumes responsibility for billing, provisioning and customer service. “All the reseller has to do is focus on selling.”
During the last several months, the company has forged six significant relationships with resellers, which have resulted in thousands of new accounts, Hurwitz said during a December interview. The companies included a switchless reseller, a master agent, which became a reseller, and several entrepreneurs that have reentered the telecommunications industry.
Meanwhile, other switchless resellers have pursued an aggressive acquisition strategy much like PowerNet Global. Connect America, based in Naperville, Ill., 30 miles west of Chicago, picked up more than 10,000 business customers through its largest acquisition to date, increasing its customer base to 26,000, says Connect America president Brian Sledz, who declines to say how much Connect America paid venture capitalists on behalf of a Wisconsin-based switchless reseller, for the customers.
Connect America is not finished buying customers. The company is interested in picking up commercial accounts from switchless resellers that bill less than $1 million a month. “Those are deals we can do for cash quickly, fairly,” Sledz says.
In determining the value of a company, Sledz evaluates a company’s margin, customer size, attrition, bad debt and when he expects to break even. He says he aims to break even on acquisitions within 24 months or less.
Chris Barton, CEO of Wholesale Carrier Services Inc., says his company acquired 80 corporate customers through one deal last year and 30 conference calling and three broadcast fax customers through a separate agreement.
In the latter agreement, the company paid the reseller three times the monthly revenue to acquire the customers.
Wholesale Carrier Services is not “acquisition happy” but would consider acquiring corporate customers that purchase T1 access and additional bundled services, he says. The company also would entertain the notion of purchasing corporate circuit-switched customers if a business had long distance needs in a number of locations.
Long-distance reseller Univance Tele-communications Inc., based in Englewood, Colo., has purchased roughly 2,000 teleconferencing and long distance customers from Fusion Telecommunications International and about 500 long distance and data jcustomers from Convergent Communications Services Inc., which filed last April for Chapter 11 bankruptcy protection. As of late last year, the company was in discussions with two switchless resellers to purchase their long distance customer bases.
Broader Horizons
In tandem with its acquisitions, Univance Telecommunications is morphing from a switchless reseller into a facilities-based provider using voice over Internet protocol (VoIP) technology over a private network, underscoring the movement among many switchless resellers to ratchet up their service offerings and purchase facilities in order to sustain a profit.
In December, the company introduced gateway switches in Los Angeles, San Diego, San Francisco and Las Vegas to provide voice and data services through partnerships carriers such as Level 3 Communications Inc. and WorldCom Inc., among others.
“The resale industry is for the most part dying,” Univance spokeswoman Tara Krull says, justifying her company’s strategy.
That assessment is debatable, but certainly the number of companies selling 1+ has dwindled. Even veteran resellers that value the long distance resale market are pursuing acquisition strategies outside of 1+ in order to provide customers more comprehensive services.
For example, CIMCO Communications co-founder and CEO Bill Capraro Jr., says his company is open to purchasing a business that will expand the scope of his company’s IT and telecom expertise. One possibility includes buying a systems integrator that could manage local area networks, he says.
CIMCO, which has provided telecom services to medium-sized and large businesses since the late ’80s, purchased an applications development company in 2000. Through the deal, CIMCO was able to develop a web-based billing platform that simplifies invoice management.
Capraro says CIMCO has learned how to service a business customer’s telecom needs effectively, but he adds that he strongly believes the company must extend into a new area: Applications development.
“But personally I believe the applications side is really where the future is because much of what we do from a network perspective is very commodity-driven,” Capraro says. “When you are really helping companies be efficient with applications I think you are really benefiting them … .”
Shakeout Inevitable
While analysts say the price of long distance minutes is eroding at a slower rate than in recent years, many switchless resellers have failed to retain viable margins in the face of attrition, billing delays and other problems.
Many upstarts had no idea what they were getting into. On paper, it seems like a simple — and profitable — business arrangement: Buy a minute for two cents; sell it for five cents. But the carrier agreements are the easy part, resellers explain.
The tough part: Complying with tariffs and other regulations; persuading consumers and businesses to switch long distance providers; curbing attrition, getting the correct bill out the door on time; maintaining adequate customer service; and ultimately, making sure customers are paying their bills before an underlying carrier’s invoice taps cash reserves.
Consultant Freymuth says weak companies will go under as a normal part of market cycles but many viable companies sell out before they achieve success.
“This is not a phenomenon unique to telecoms. If you look at value migration in general, entrepreneurs and investors jump into markets that seem to have no ceiling and are completely shocked when the floor falls out from under them,” Freymuth says.
He adds that selling is unavoidable, in some cases. In those situations needs to be thinking in the same terms as the buyer about generating new value.
“Seventy five percent of mergers fail to meet their financial target, and they are all executed by smart, experienced people,” Freymuth says.
Analysts and industry observers say the shakeout will help stabilize long distance rates. “I think as we see more competitors being weeded out that will help in terms of stabilization of the price,” says Atlantic-ACM analyst Jennifer Lee.
Switchless resellers hope she’s right.
