“The Bear” on Business

I thought this title would garner your attention.

One of my passions is theoretical physics. I’m not sure why and I don’t know if I should offer this up with pride or admit to it with embarrassment. Regardless, the topic fascinates me.

Star Trek, though only on TV for two seasons, left a lasting impression on our culture. The Saturday Night Live skit in which John Belushi played Captain Kirk is among my fondest SNL memories. “Beam me up, Scotty” is Star Trek’s most famous phase. Captain Kirk would be on the surface of some strange planet; just as the angry alien was about to zap Kirk, chief engineer Scotty would transport the captain to the ship. Kirk’s being would zap out of existence at the planet and instantly re-assemble in the ship. It is a nice form of transportation, even for those who have access to a corporate jet.

Teleportation seemed to be nothing more than a convenient invention of science fiction. How could something disappear in one location and immediately reappear at another?  This seems to violate all plausible laws of physics. Until recently, scientists never considered that this phenomenon was possible. But they were wrong.

It turns out we live in a strange universe, one in which teleportation is possible. You don’t believe me? Read tomorrow’s April 1, 2008, post.

The past few posts focused on the growth of bandwidth. Another dimension to the ongoing growth is the number of buildings that are served by fiber. This Vertical Systems article was circulated by Dave Rusin, CEO of American Fiber Systems and provides compelling figures.

BOSTON (March 17, 2008) -Business fiber availability increased 5% in the U.S. between 2003 and 2007, according to Vertical Systems Group’s latest research study. Fiber penetration now extends to 15.3% of U.S. commercial buildings with twenty or more employees, up from 10.2% in 2003. All remaining locations comprise the “Fiber Gap”, or business locations with no fiber access facilities. Optical fiber is a key enabler for the delivery of broadband network services at speeds up to Gigabit rates, including Business Ethernet, IP VPNs, VoIP and IP video.

“Service Providers cite fiber expansion as their top challenge to delivering business broadband offerings like Ethernet,” said Rosemary Cochran, Principal at Vertical Systems Group. “Fiber gaps are closing, but not rapidly enough to meet market demand across all customer segments. Fiber penetration rates are substantially higher for Large Enterprises than SMBs, and this disparity widened in 2007. A positive trend for SMBs is that residential fiber build outs are extending accessibility to adjacent business sites, which are predominately small and medium enterprise locations.”

Dave Rusin commented, “We are seeing bandwidth demand rising at a rate whereby last mile access business models that are dependent upon copper facilities or wireless eroding faster than most believe. As the ILEC drops fiber into small business locations along their video overbuilds, they remove the copper loop in sealing the deal. The end game to all homes and buildings is fiber with the exception of the most rural of areas.”

This word of caution was the first sentence of a Steve Lohr article that appeared in the March 13, 2008, New York Times. For a telecom guy like me, this gossip is more juicy than Elliot’s escort escapades.

YouTube, the article relayed, might have consumed as much bandwidth in 2007 as the entire industry did in 2000. The article quoted a few different estimates of the annual growth in Internet bandwidth. These quotes ranged from 50% to 100% annually—whether the low or high is accurate, the cumulative effect is dramatic.

I really enjoyed the characterization of Professor Odlyzko, a former AT&T Labs researcher. The growth ”basically corresponds to the improvements that technology is giving us,” he said. Step back and consider what this means. We know that technological advancements are driving down the cost of bandwidth. The pace of these suppy-side gains must match up with the nature of new bandwidth-intensive applications. The good professor suggests we shouldn’t think of demand outpacing supply, but namely the interplay between supply and demand. Silicon economics—a term that was coined by Jim Crowe, CEO of Level 3, focuses on this symbiotic relationship.   I will discuss silicon economics in a later post.

Rapid bandwidth growth, as far as the eye can see, is a fundamental principle behind Zayo Group’s investment thesis. Steve Lohr, I hope the title of your article—Video Road Hogs Stir Fear of Internet Traffic Jams—proves technically accurate.

The past two posts focused on the first pillar of Zayo’s investment thesis: The need for bandwidth is growing quickly and this rapid growth will persist. This appears to be a pretty safe bet. Zayo is also betting on a certain technology—namely fiber optic cables. Is this a safe bet? Will fiber optic networks be made obsolete by some technology change? 

Wireless technologies are what engineers think might someday make fiber obsolete. They are probably right…at some point, human-kind’s ability to manipulate airwaves might make any physical technology—copper, coax or fiber—an artifact of past civilizations. My guess though is this won’t happen for a very long time.

To date, wireless has driven demand for fiber-based bandwidth. Increasingly, cell sites feed video and content to handheld devices. Fiber, though, is by far the best medium for connecting the cell sites to the Internet. I doubt even the biggest wireless zealots would suggest that fiber is threatened by radios anytime in the next few decades. Beyond that, who knows. Some day, smart wireless engineers will figure out a way to manipulate wireless spectrum to avoid the need for any physcial medium. But this day is probably centuries away. For now, wireless and fiber are like peanut butter and jelly. 

Part of Zayo’s investment thesis is as follows: in a bandwidth hungry world, fiber is good for your diet. It will be the workhouse of bandwidth transport for as far as the eye can see.  

Illustration care of Peanut Butter And Jelly Wars

At the end of yesterday’s post, I ended with the words “and this will persist.” Certainly, bandwidth usage grew dramatically over the past 18 months. YouTube led the way. How do we know this wasn’t a one-time blip? Why do we believe that strong annual growth will continue for many years to come?

Below is another chart from the Discovery Institute report. Notice the yellow bar on the bottom. It represents the total amount of bandwidth in use today. It is small in comparison to the other bars, but we know today’s bandwidth is huge compared to a few years back.

If you cumulate all of the orange bars, the total would represent an estimate of 2015 bandwidth. Compare the total to the yellow bar and the implications are daunting. Each individual orange bar is a specific category of applications that will chew up bandwidth. Though forecasts are prone to error, it is a safe bet that most of these application categories flourish. Zayo’s Investment Thesis includes the notion that bandwidth growth will persist.

* Original Source: Estimating the Exaflood, Bret Swanson & George Gilder, January 2008, Discovery Institute, Seattle, Washington

Zayo’s Investment Thesis starts with a basic but critically important fact. Bandwidth is growing. It is not growing just a little bit, it is growing a whole lot. Exactly how much is hard to measure. Below is a chart that references data from 1997 through 2006 from a January 2008 report published by the Discovery Institute and uses the 50-60% growth rate as an estimate for  2007 to 2011 (The Minnesota Internet Traffic Studies showed year end 2007 growth at 50-60%).   It suggests the growth from 2006 to 2011 of ~800%.  

Note: this data in this post’s graph was incorrect.  2007 and beyond data was inconsistent with the data from 2006 and prior.  Please see this post for explanation.  Click here for the revised and corrected post. 

Zayo’s Investment Thesis starts with a basic but critically important fact. Bandwidth is growing. It is not growing just a little bit, it is growing a whole lot. Exactly how much is hard to measure. Below is a chart from a January 2008 report published by the Discovery Institute. It suggests the growth from 2006 to 2007 was 500-600%. This seems high, but think about how much has happened in the past 18 months with video.

*Original Source: Estimating the Exaflood, Bret Swanson & George Gilder, January 2008, Discovery Institute, Seattle, Washington

In the graph, bandwidth requirements in the years 1996 to 2006 look insigificant. This is misleading, of course, as the Internet went from nothing to everything in this timeframe. Bandwidth growth each year, even during the meltdown, was strong. The only reason these years look unexciting is because of the staggering growth in 2007 and beyond.

So that is the first part of Zayo Group’s Investment Thesis. Bandwidth is growing rapidly; and this will persist.

The expression “Investment Thesis” is an important one for private equity and venture capital investors.

The word thesis is defined as “a proposition put forward for consideration, especially one to be discussed and proved or to be maintained against objections.” Investment Thesis, by extention, means what an investor must believe for them to be comfortable that they are making a good investment.

Is Investment Thesis the same as Strategy? No. Strategy is a statement of what a company intends to accomplish. Investment Thesis is the rational that supports a belief that the Strategy is a good one and merits funding.

To launch Zayo Group, we needed to define our Investment Thesis. Investors certainly scrutinized it. If it didn’t hold up to this scrutiny, the company would not receive funding. On the next few posts, I will lay out our Investment Thesis.

(Continued from Friday’s post…)

I was having dinner with George Nazi. He was trying to impress me with his shots of Don Julio; I was trying to impress him with my Sambuca with flames. The conversation took a turn for the worse. He was probing into my claim to have grown up on the South Side of Chicago. George had just met Marty, my buddy from 4th grade and, incidently, still a Level 3 ops guy.

“Yeah, Marty’s Italian too,” cleverly I tried to change the topic. “How is that WDM upgrade between LA and San Fran going?”

George ignored the shop talk, “He said both of you are part Polish.” 

“He’s half. I’m only a quarter.” I felt it necessary to explain.

“He introduced me to your friends Mark and Michelle.”

Not good, I thought. ”High school friends of mine. Did you see that new router that Cisco just rolled out?”

“Did they know Al Capone too?” George chuckled.  

“I never said I met Big Al. I only said he drove through Chicago Heights, the town my parents grew up in.” 

“Drove through?” George sarcastically clarified. ”I thought he vacationed with your parents.” I looked over my shoulder, hoping to see the waitress with the bill. No luck. 

George continued his inquisition: “Michelle said she grew up in Flossmoor. She said she lived across the street from a country club.”

“Yeah. I caddied there. Often I schlepped four bags at a time.” This was true—though I only carried the four bags between the carport and the clubhouse. I switched gears, “How big did you say those rocks were that you threw at tanks?”

George ignored my question. ”Marty said you guys walked together to your 5th grade school. Was it dangerous?”

“It got better as we got older,” I replied, proud of the mis-direction.

“South Side of Chicago?” George yelped triumphly. “The Baddest Part of Town?”

“Well, technically it was the south suburbs of Chicago.” I muttered.

“Marty described your neighborhood as a nice middle-class suburb. He said the only thing you guys did in the street was play kick-the-can.” Now George was practically shouting. ”Marty said you had a two car garage.”

“The garage was unattached,” I defended myself. “We didn’t even have an automatic garage door opener until I was in college.”

I lit my Sambuca. He swallowed his worm.

Congratulations George on the success you are having in your career.

I have worked with Andy Sredojevic since he joined us at MFS in 1993. He has been part of our Level 3, ICG and Zayo teams. Over the years, I have gotten to know his family. Andy is an avid hockey player, as is his son Sean. Click the link below to see Sean’s penalty shot in the state championshp game.

This goal gave Sean’s team a 1-0 lead in a thrilling 8-1 loss. Congrats Sean on the goal and congrats to your team on a great season.