'Convergence' Remains a Pipe Dream as Convergent's
IPO Approaches
By Kevin Petrie
Staff Reporter
6/14/99 11:02 AM ET
thestreet.com
SAN FRANCISCO -- Phil Kalin, chairman of Strategic Healthcare Solutions in
Denver, was thrilled last September to hire Convergent Communications as a
Johnny-on-the-spot to manage the telephone and computer wires at his 30-worker
software company.
"We get one bill, with one price on it," says Kalin.
But when Convergent suggested taking the relationship a step further by handling
Strategic's phone calls on its computer network, Kalin declined. "It just seemed far
out," says Kalin. "I'm not sure the technology is there or is the most cost-effective
yet."
Kalin's reluctance to "converge" his firm's voice and data networks, expressing an
unease echoed by corporations nationwide, explains why Convergent isn't yet the
story Wall Street expects. The Englewood, Colo.-based carrier is preparing to raise
$115 million during the last week of June in an initial public offering underwritten by
Goldman Sachs. Backed by Cisco (CSCO:Nasdaq), Convergent is growing robustly
by lavishing attention and services on its small corporate clients. Experts laud its
efforts to benefit from the growth of both telephone and data communications.
But Convergent continues to find convergence largely elusive. Even as its sales force
touts the company's ability to mingle speech and digits on a single line, many
customers are holding off. "You've got to be careful not to confuse the hype with the
revenue picture," says one executive who works for an equipment supplier that
competes with Cisco and who asked not to be named. Even in three years, he says,
Convergent will be "a plain old phone company and a plain old" Internet service
provider, rather than the convergence play Wall Street might be anticipating.
Officials with Convergent declined to comment for this story, citing an offering-related
quiet period enforced by the Securities and Exchange Commission.
Cisco has big plans for Convergent, which a Cisco marketing vice president, Larry
Lang, says will "pioneer a unique path to the new world." Cisco in April extended a
six-year, $103.5 million line of credit to Convergent. In return, Convergent plans to
install 50 Cisco switching systems on its nationwide network to handle data and
eventually voice calls. Cisco also has a warrant to buy 1.1 million shares over three
years, potentially giving it a 4% stake in the company.
Despite an aggressive sales campaign for converged voice, data and video services,
the business hasn't exactly taken off. To date, less than 10% of Convergent's traffic
actually is carried as converged voice-and-data signals. Pairing with Cisco,
Convergent intends to change that this year.
The problem is, potential customers are still hesitant to sign up. One Convergent
customer says he might test Internet calling in a year or more. But right now, he
won't trust his phone calls to a data network. "If it's not working 100% all the time, I'm
dead," says Michael Brown, technology director for Yellow Transportation, which
runs taxis and shuttles through metro Denver.
Indeed, the key is reliability. While Internet users will forgive some outages of email
service, they have come to expect 99.999% reliability on voice calls. Currently data
networks, which send messages in individual packets and reassemble them at their
destination, fall short of that standard in many cases.
Until customers believe Net telephony is reliable, they will continue to balk at
combining voice and data lines. Given such reluctance, Convergent seems likely to
keep hawking Cisco gear right alongside phone systems from Lucent (LU:NYSE)
and Nortel (NT:NYSE). While this strategy can fuel heady growth, it's not the
convergence investors might be expecting.
Convergence issues notwithstanding, Convergent is off to a good start. In the first
quarter, revenue nearly quintupled from year-ago levels to $30.5 million, and gross
margins rose to 34% from 26%. Convergent's net loss for the quarter expanded to
$20.7 million from $5.1 million a year earlier, but Internet investors know that isn't
unusual as a young company spends heavily to lay the groundwork for growth.
Convergent Quarterly Operating Data
(in millions of dollars)
Q1 98
Q1 99
Revenue
6.5
30.5
Operating loss
5.1
15.8
Net loss
5.1
20.7
EBITDA
4.3
12.9
Employees
Over 1,000
Customers
Acme Markets
Federal Bureau of
Land Management
Franklin Covey
Employees Credit
Union West
Lucky Stores
Motorola
Osco Drug
State of Georgia Board
of Regents
Source: SEC filings
The company has so far declined to predict growth from converged services. Right
now, its revenue is evenly split between services -- consulting and maintenance -- and
communications-equipment reselling, areas that should themselves continue growing.
"I think the beauty of the story is that they've deployed intelligence ... in strategic
areas," says Bruce Boland, president of First Continental Group, which owns 1.8
million shares, or 6%, of Convergent.
Already Convergent, founded in 1995 by its CEO John Evans and other veterans of
the phone carrier ICG Communications (ICGX:Nasdaq), has raised $204.5 million in
private placements and offerings. After acquiring 14 companies, Convergent has seen
its ranks swell to more than 1,000 employees.
First Continental's Boland, who first viewed the company as an Internet play, believes
Convergent will come to earn its name. Internet telephone service is "becoming more
important than I realized two years ago," Boland says. Still, he makes no prediction
about the immediate prospects for revenue growth in that business.
Others agree that walking both sides of the line is wise. "If you have [just] one or the
other, you ignore important market opportunities," says J.B. Haller, director with the
research firm Current Analysis in Stirling, Va. (Cisco is a client of Current Analysis.)
Haller points out that Qwest (QWST:Nasdaq), widely viewed as a
telecommunications play with enormous potential in years to come, operates both
voice and data networks.
But for now the name Convergent sounds, if not ironic, then premature |
