“The Bear” on Business

Ike has had several posts recently on Vonage.  Mr. Blog (a blog new to me) challenged Ike’s assertion that Vonage needs to ramp up marketing spend.  Today, Ike responded to Mr. Blog. 

I agree with Mr. Blog’s point that ramping advertising is likely throwing good money after bad.  I also agree with Ike’s post today–Mr. Blog’s conclusion suggests that Vonage needs to answer the ”then what do we do?” question. 

Many companies make a huge mistake when they get into a situation where their main business thrust proves to be flawed.  These companies (assuming they have access to some cash) frantically ramp up spending in hopes an answer will emerge.  They panic.  They need an answer so bad that they hang their hopes on a questionable one because having none at all is far more frustrating.

In the end, they usually make the situation worse.  They consume their most valuable asset–cash–on activities that are unlikely to put a dent on the main problem.  They seal their own fate.

ICG was definitely in this mode when we bought them in 2004.  It is part of what made our turn-around plausible.  Level 3 was in this mode in 2005, when it plowed a tremendous amount of resource into VoIP/IP Centrex.  Earthlink was recently in this mode when it pursued municipal WiFi networks because its dial-up Internet business was hitting maturity and decline.    Many DSL and UNE-P CLEC businesses went through this stage.

So what do you do if (a) you have cash or cash flow (b) your core business is flawed or end-of-life and (c) you don’t have a new initiative to replace it?  The first thing you do is buy yourself time.  You do this by putting the core business into a harvest mode.  Make sure it is being run for maximum profitability and cash flow.   This includes maintaining spending to keep current customers happy, as you want churn to be lower, not higher.  But spending levels should be spent with a realistic expectation on the prospects of the core business–if it is in the mature stage, treat it as such and make sure cash is generated.

Next, consider the possibility that new material new initiative will be discovered to replace the core business.  Model the free cash flow of the business in this scenario.  How much cash can be squeezed from the business over time?  Does it cover paying off the debt?  Does it imply any equity value?   It is important to make this scenario as accurate as possible.  Inaccuracy on this scenario–whether to the positive or negative–will almost certainly lead to bad decision-making.  

This scenario should be considered the baseline against which alternatives are measured against.    This scenario also becomes the basis for setting budgets for the business, and bonus plans for the management team.  

With this baseline established, new initiatives can be considered.  New initiatives must be vetted every bit as carefully as if the company was in start-up mode.   On a stand-alone basis, is it a good initiative and do others outside the company agree?  Is there a reason (i.e., synergy) that this initiative should be pursued within the company?  Does the company’s challenges in its core business hurt or help the prospects of the new business?  It is hard to be candid in answering the last question–as the answer is usually “hurts”, not “helps”.  Hurts is not the answer the company is looking for but they most be open and honest about it.

If initiatives pass these screens, start slowly.  Allow time for feedback loops prior to committing major dollars.   Just because the company has cash or cash flow doesn’t entitle it to be careless in throwing money against new initiatives.   What if, because of problems in its core business, the company doesn’t have time to be patient?  See the previous paragraph.  Almost certainly this means that the new initiative shouldn’t be pursued.

I can write a ton more on this topic.  Perhaps I will pick it up in a future series.   Bottom line–companies who find themselves in Vonage-like situations are best off slowing down.  Get very good at running your core business for nearer-term profitability.   Understand what this means in terms of shareholder value.  Be very conservative on all discretionary spending until you are highly confident that you have something to invest in. 

In his Telecosm blog, Ike Elliott had a nicely-written assessment of Vonage’s 1st quarter results.  For those who follow the VoIP sector, it is worth a read.  Thanks Ike.

Ike Elliott had a good post on churn today, using Vonage’s 1Q08 results as a backdrop.

I started to post a comment, but began rambling.  I’ve been hanging around John Scarano too long I guess.  Anyway, I decided if I was going to poke away at the keyboard, I might as well drive some traffic to my blog instead of Ike’s.  So I will complete comment here.

Ike’s analysis is interesting and useful. I will add one more concept to it.  What is a reasonable expectation for steady-state churn?

A 1% churn rate implies a dollar of revenue will stay on the books 5 years.  Think of all the reasons a customer might churn–go out of business; move; out-grow the service; benefit from repricing; or switch to another service provider.  If, on average, only one of these events every five years would seem to be a a fantastic result for most recurring revenue businesses. Yet many telecom business tout 1% or lower rates and attribute it to their great service.  Eventually, it becomes clear that the churn rate is really higher–this is explained usually by citing external uncontrollable macro events such as a slowdown in the economy. 

What is really happening?  Newer companies should have low churn.  Why?  –the maturity of their customer base is low.  If you have been in business only three years, your average customer has been with you less than 1.5 years.  Your churn better be very low!   Else, you have bigger problems such as bad service or an unsticky product.

Rapidly growing companies have a similar dynamic.  When Cbeyond was in its rapid geographic expansion phase, it’s average customer life was unnaturally low.  Churn, it follows, should be much lower than steady state.  Is this how they explained their low churn numbers in their early years?  I don’t think so.

Tracking and understanding churn is very important in recurring revenue businesses.  I wrote a series of posts on the topic.  For those in the telecom services business, they are worthwhile to read.  Look over at the categories on the left and click on Disconnect Inferno to read more.

My good friend Ike Elliott of Telecosm and I continue to entertain each other. I suspect the rest of you hope one of us concedes just to put our readers out of their misery. Please, spare us the references to the Hillary and Obama show.

Anyway, Eliot Soft-Spitzer (recall Ike + Softswitch + Bear Poking) is denying me dinner based on his crazy post yesterday. I have always been known as a great listener with an open mind—even in the year 2000, Maggie Lott—but even I have my limits. In a comment on his blog yesterday, I appealed to his Telecosm readers:

“Ike. Are you serious? Late in our debate, you changed your claim to be narrowly focused on “wholesale Internet Access”. I pointed out this Obama-ism (as your original claims were more far-reaching) but went along with it. Now you have further qualified it as “pay-per Mbps wholesale Internet Access” and “truly pure wholesale Internet access”. To top it off, you made up a hypothetical example to explain Cogent, which is as pure a play as there is in the wholesale Internet access market. Your example shows how it might be conceivable that despite its rapid growth and profitability, your assertion (using more tightly-defined definitions) might possibly still be true. O.J. had a better defense than that.

Even Eliot Spitzer knew when it was time to resign. Telecosm readers—help!!!! Is it time for Ike to buy dinner?”

Now, everyone join the chorus: “100 bottles of expensive red wine on Ike’s bill. 100 bottles of wine”.

It is time to settle the bet with Ike Elliott of Telecosm and softswitch fame. Elliott + softswitch + bear attacks = Eliot Soft-Spitzer. Over the weekend, I declared this post might be enough to sway Ike. The best part of this proof is I don’t have to write much. Here it is, Ike—how do you explain Cogent?

The only pure play public company that provides wholesale Internet access is Cogent. Here is a summary of their 2007 financial performance. Fantastic growth matched with rapidly growing EBITDA. If you look at their enterprise value, their investors seem to be thrilled with their performance. Cogent’s EBITDA multiple is 14.3x. Sound like resurgence is in full swing for them.

So Eliot Soft-Spitzer, are you ready to follow the path of your (nick)namesake and like the governor resign your post? I’ll check in with Frasca for a reservation. How many friends can I bring?

This post is one of my many responses to Ike Elliott’s challenge to me that the telecom resurgence is a figment of my colorful imagination. A dinner awaits me on Ike if I prove him wrong—yet he capped the wine to $80/bottle. He did not limit the number of bottles though.

Yesterday, I offered that Monday afternoon would be a post that might sway Ike to declare me the victor. It is not definitive I admit, but I believe it is far more meaningful than the “proof” he has offered up so far. I suspect it will take additional data points for Ike, but sometime before the baseball season ends in October—at Wrigley field with the home team celebrating—Ike will have nodded in agreement with me.

In this post, I challenge Ike to dig a bit deeper into his Level 3 analysis. What other revenue is captured in the IP and Data Services revenue line of Level 3? Perhaps a bit of retail VoIP—a product discontinued and burning off the revenue base? IP-VPN—a product that is not central to Level 3’s sales strategy? Perhaps some retail Internet access—legacy from the Broadwing, Telecove, etc. days—very high price per bit to be sure but now just being left alone to churn to Level 3’s enterprise-focused competitors? Anything else? My guess is some of this information is buried in annual reports and more can be whispered to Ike by his Level 3 brethren. Ike—if you redo your analysis while adjusting for this noise, what does this suggest about Level 3’s growth rate on wholesale Internet access?

Ike, it might take me a while to win a dinner from you, but my guess is that before long you will realize resurgence began in 2006 or 2007. At that point, you will declare you owe me a dinner. On Monday afternoon, however, I will put up a post that should sway you a bit.

Let me be clear though. I have no insight on growth rate of bits. Whether the growth rate is/has been 50-60% or something higher is not core to the discussion. Even if we find out it was in fact higher, I do not expect a dinner from you (though that was part of your offer).

It is the other part of your assertion that I quibble with. I need to first point out that you started out with a much broader conclusion than you are now stating. This is your Obama-ism. Your posts that sparked this friendly dialogue are Is an Internet Industry Resurgence Coming? and Triangulating Internet Growth. In a quick re-skimming, I saw many, many references to Internet bandwidth growth and several bandwidth growth references with no Internet as a qualifier. Here is an example of your broadly-worded conclusion:

“Internet backbone providers are hoping that a surge in demand for bandwidth, driven by Internet video distribution and other large file distribution services, will reduce the rate of price declines while creating a big surge in bandwidth utilization.”

To me, this sounds much broader than “wholesale Internet access“, though your dinner bet carefully narrowed the discussion to this term. In your two posts above, I only saw a single reference to wholesale Internet service. But that is okay.

On Monday, I will post something that might cause you to declare me the victor. Tomorrow, I will offer up a few tidbits that might make your rethink your Level 3 data point.

Ike answered my push-back with an aggressive smack my direction (see comment in this post). Nonetheless, I believe he sidestepped my major complaint. My Heisman to Ike is that he tried to “prove” revenue is barely growing as price compression fully (or near fully) offset bit growth. He used an analysis of Level 3’s IP and Data business unit as a proxy to argue this. I thought this single data point is not sufficient to draw any conclusion. One only needs to read Ike’s prior posts to know that Level 3 is dealing with challenges unique to itself. Generalizing their reported results in this one business unit with what might be happening in the industry as a whole is dangerous with a capital D. An additional point is bandwidth is a bigger bucket than Internet traffic–and with all that is happening in the arena of private networks for enterprises (e.g., hospital, banking, education), wireless carriers and content (e.g. CDNs, Internet companies like Google, and media companies), non-Internet bandwidth must be considered.

One thing was true during the bubble, meltdown and now–bits were growing at a hefty pace. Ike and others say 50-60%; others say higher. The reason why I call the 2006 through 2008+ period a resurgence is (a) revenue is growing at double digit rates and (b) bandwidth-focused companies are enjoying profitability. I believe there is still noise, with XO and Level 3 being two prime examples. Nonetheless, I am seeing first hand a ton of real-world data that makes me confident in the resurgence. 

Why is today better? One, supply is getting much more in line with demand. I will spend a lot of time on this topic in my upcoming Texas Hold’em series. Two, many telecom service providers are doing a better job at managing their businesses for financial results. During the bubble, management teams and their investors were undisciplined and inexperienced–in an Adam Smith survival of the fittest fashion, the meltdown painfully corrected this.

So Ike, I challenge you again–how do you back up your CONCLUSION that revenue is largely stagnant? How do you CONCLUDE price erosion is offsetting bit growth? Do you believe bandwidth companies are experiencing minimal revenue growth? Do you believe poor profitability? 

In two ways, I hope your answers to the last two questions are yes and yes…and I hope that most others agree with you. Why? One, Zayo will be able to buy a few more fiber-based properties for a good price. Two, the Zayo team will look pretty darn good to our investors–as our financial results will be in stark contrast the perceived performance of our competitors. 

Oh, and one more thing. It was me, not Ike, who coined the word “softswitch”.  (Okay, maybe not.)

Yesterday, Ike Elliott had a post on his Telecosm blog that postulated that bandwidth resurgence has not yet happened. I posted the following comment:

“Over the past year, I’ve personally spoken to the vast majority of the fiber-based suppliers of bandwidth in the U.S. Though there are a few exceptions, their bandwidth business is doing well. Growth rates of 15-20% are common and many are growing at far faster rates (30-40% in some cases). As you know, this was not the case in the 2002 through 2005 timeframe…but it began to change in late 2005. We are seeing this first-hand in our Zayo Bandwidth business. Though you show lots of numbers above, I don’t see anything in your ‘analysis’ that leads to the conclusion…you seem to be speculating…do you have any data?”

Ike had a follow-up post today. I follow Ike’s analysis and agree with his many caveats. His earlier “conclusion” of no resurgence, I would surmise, is based on speculation, not on a thorough and reliable analysis. That is, way too many holes can be poked into the extrapolation on his analysis of Level 3. Beyond the many holes he offered, a large one is that he looked only at the IP and Data Services business of Level 3, not the Transport business. I think (though have not verified) he would find that Level 3’s organic transport revenue is growing at a nice clip.

In the Exaflood graph, growth from 05 to 06 to 07 (based on Cisco’s data) appears much higher than the 50-60% cited by Ike.  It appears to be more like 250%.  Frankly, given the explosion of video in this timeframe, that would make sense to me.  Ike/Brett–what do you guys think of Cisco’s data?