Overbuilders attracting the lending crowd

Call them what you wantoverbuilders, broadband or alternate service providers, even choice providersbut theyre kicking some serious assets into play as they prepare to take on cable and telephone companies in key markets across the country.

The expanding war chest for a growing stable of broadband service providers that intend to offer voice, video and data from state-of-the-art networks built from ground zero, is being filled by a cross-section of venture capitalists, individual investors, and most importantly, from several public and private equity funds at top lending institutions.

RCN, for example, has topped $5 billion in funding, while other providers such as WINfirst, which has secured nearly $1 billion, WideOpenWest, North Carolina Broadband, Everest Connec-tions and others are attracting impressive amounts of capital from lenders as they build their networks deeper into traditional cable and phone markets.

Top lenders such as J.P. Morgan, The Blackstone Group, First Union, Madison Dearborn, BofA Securities, Centennial Fund, Providence Equity and several others are investing significant dollars, some more than $100 million, in the second generation of overbuilders that is coming into play.

When the first generation of overbuilders like Ameritech and SNET dropped the business, it left some negative reactions to the term overbuilder. The new generation will offer services from day one, however, and customer demand, technological advances and regulatory changes are driving the new overbuilders, says Meredith Rosen-berg, director of the residential communications group for The Yankee Group.

Whats driving fund managers and venture capitalists to the overbuilders is the promise of enormous revenues from bundled cable, telephone and data services via new networks with no baggage attached. There are no revenues yet, so the investments are in the management, market selection and business plans. Weve torn apart several business plans, and most are very viable, and clearly the network architectures are critical, adds Rosenberg.

WINfirst, for example, has raised more than $850 million from six investors with each ponying up more than $100 million. Most of WINfirsts first round financing is from larger lending institutions such as J.P. Morgan and First Union, along with more traditional investors such as the Dolphin Fund.

WINfirst will turn its network on later next year and is projecting a 33 percent penetration rate in its first launches, which include Sacramento, Calif. Its financing, says Shiraz Moosajee, vice president of business development for WINfirst, is predicated on those numbers.

Fund managers are looking to either increase the number or the size of their deals. How many really good opportunities are there to invest in a company like WINfirst which will reach the ultimate goal of building a fiber-to-the-home network, and how many people can you trust with that large ($100 million) of an investment?, Moosajee asks.

The lack of investment in overbuilders from traditional venture capitalists, he adds, is simply a case of economics, or in WINfirsts case, the lack of it. In the capital intensive world of overbuilders, more rounds of financing are expected.  If you put up $125 million in any one investment, and that represents 10 percent of a fund, you need a fund pool of $1.25 billion. Those are adult dollars, and few have that kind of money today, Moosajee maintains.

WINfirsts business plan, he admits, is based on another overbuilders strategy, RCN. The market history from RCN and Knology is reflected in our model, which projects a 33 percent penetration rate, Moosajee says.

RCN generated its $5 billion war chest in just 30 months, says Bruce Godfrey, chief financial officer (CFO) for RCN during its initial funding phase and now CFO for ICG Commerce.

RCN has 1 million homes in the best markets, and nearly all of the capital goes into the ground for networks. Its extremely valuable, Godfrey says.

And well-heeled. The companys venture capital came from its initial cash and its CLEC, and the rest from public equity, debt and Paul Allens (Vulcan Ventures) $1.5 billion convertible preferred. The companys need to raise more money now is based purely on its growth. It really is a unique business plan, Godfrey says.

All of RCNs 500,000 customers reside in the Boston to Washington corridor, and the company is expanding its market to include the San Francisco to San Diego corridor.

Most overbuilders arent in RCNs or Knologys enviable position of actually having customers, however, which adds an element of risk to a lenders decision to invest in them.

When overbuilders are evaluated, they are looked at in terms of subscribers, and only RCN and Knology and a few others have them, so investors look at what the management team is and the market dynamics. The success of one company will dictate what other companies will do in regard to raising money, Rosenberg says.

For smaller overbuilders such as Co-Serv Broadband and Everest Connec-tions, two companies in the midst of building their networks (Co-Serv in the Dallas-Ft. Worth area, and Everest in Kansas City, Minneapolis-St. Paul and Tulsa, respectively), funding comes from a composite of different sources.

Co-Servs financing comes entirely from the Co-op Finance Corp., a co-op of 1,400 utility companies and a $21 billion lending facility. Co-Serv has raised about $800 million, $200 million of which is targeted for its communications build. Its strategy is to take its seven different services to new developments in the Dallas-Ft. Worth area.

Were looking at 33,000 single family housing starts and 70 percent of them are in the areas we serve. Those are compelling numbers for lenders, says Bill McGinnis, president and CEO of Co-Serv Broadband.

Co-Serv will test the private placement market with an offering in 2001 and has no illusions about its future financing needs.

We recognize going forward we have to restructure how we finance because well outgrow our current facilities and will have to raise additional equity. So, we plan to admit other partners and expand our equity position, says Ed Frazier, a partner in the Strategic Advisory Group, a partner with Co-Serv Broadband.

For Everest Connections, its funding comes from a combination of vendor financing, venture capital, individual investors and a substantial investment by the management team. Everest is planning another round of financing as well.

This business is so capital intensive, were talking hundreds of millions of dollars. We need to weather the difficulties in the equity markets and will look for someone with the ability to reach into their pockets for a second round of financing, says Mike Roddy, president and COO of Everest Connections Corp.

Just where that financing will come from for the majority of overbuilders is likely to depend on how compelling their business plans are, how their management team is put together, and what the market looks like.

Says one venture capitalist circling the overbuilder market: The appeal is that most believe therell be lots of broadband services into the home, and if you get a third of the homes, youve got a cash flow positive business. But, are these cable systems on steroids? And is this the right time? This is probably the first real meaningful activity for broadband services to get into the home.

Meaningful or not, overbuilders are sprouting up, and theres little the cable or telephone industries can do about it. Says Rosenberg: Overbuilders are looking at the weak cable markets to steal their market share, so market selection is a key for them. But how long will their cash last? Their second round of funding will require creative new sources, and how much they get will depend on their business plans. Its hard to find an individual investor wholl put up half a billion dollars.

They may not have to. With the growing appeal of fiber-rich advanced networks built from scratch and the capacity to provide several bundled services, overbuilders are looking to the first-round of lenders and equity partners to take them into phase two.