Zorro...This is interesting reading:
businessweek.com
BUSINESS WEEK ONLINE
January 27, 1998
RCN: THE LITTLE PHONE COMPANY THAT CAN?
By Patrick Lambert in New York
Telecommunications upstart RCN Corp. has of late been working overtime to draw attention to itself. It has been tweaking titans such as Bell Atlantic, Cablevision, and Time Warner as it seeks to gain a foothold in the rich residential phone, cable, and Internet access markets of the Boston-to-Washington corridor. "No empire lasts forever," reads an RCN billboard, against a background of raised fists and cold-war symbolism. "Especially one that keeps you waiting five hours for a repairman" -- a wait RCN promises to shorten.
RCN Chairman and CEO David McCourt, an industry veteran with a seat on the board of WorldCom, the company that gobbled up MCI Communications Corp., estimates that the Northeast region accounts for 28% of the nation's telecom traffic, jammed into just 4% of its land area. Such density allows a small player such as RCN to target a large market with an infrastructure of manageable size -- meaning one that it can at least aspire to afford.
RCN certainly has high hopes: Its 10-year plan calls for it to squeak by what McCourt calls the "entrenched monopolies" to gather a sizable share of residential phone, video (cable-TV), and Internet connections in the Northeast. Of the 25 million households there, SBC Warburg Dillon Read estimates that perhaps 7 million homes--representing a current market of around $10 billion in local phone and video alone--will be within the reach of RCN's network.
RCN emerged as an independent, publicly traded entity last Oct. 1, when parent C-TEC Corp., of which McCourt was also Chairman and CEO, spun its three business units off into separate companies. So far, RCN's secret weapon has been the Telecommunications Reform Act of 1996. It cleared the way for the Baby Bells to enter the long-distance market -- if they opened their local phone markets to competition. And Northeast heavyweight Bell Atlantic Corp. is doing just that.
Another provision of the 1996 law, the Open Video System (OVS), lets phone providers offer video service as well, while bypassing local cable-system franchisees. RCN differs from other competitive local exchange carriers (CLECs) spawned by telecom reform in the scale and diversity of its offerings. For the time being, it has little competition from other small providers in the Northeast region -- leaving only the big companies in its sights (and vice versa).
Indeed, RCN's plan reeks of immodesty. Bell Atlantic currently boasts some 25.1 million local residential phone connections, compared with RCN's estimated 250,000 phone and cable -- mostly cable -- connections. To grow sufficiently large to compete, RCN, which expects to record revenues of approximately $130 million for 1997, will have to absorb losses until around 2002, according to analysts.
Where will all the money go? RCN is investing heavily in an advanced fiber-optic network, which is central to its plans. While it presently maintains a mishmash of traditional cable operations, wireless video, and resold voice lines, it expects eventually to place all of its services on the fiber backbone it began rolling out in the second quarter of 1997. (As of the end of the third quarter of 1997, about 7,000 of RCN's connections utilized the nascent fiber network).
Once the company is able to offer all of its customers local, long-distance, and Internet access, as well as video, from a single pipe -- sometime within the next couple of years, it hopes -- its "infrastructure costs will be lower than using traditional methods, if it can cross-sell multiple services" to single customers, says Bruce Roberts, an analyst for SBC Warburg Dillon Read. SBC Warburg began following RCN on Jan. 9 with an outperform rating and 12-month target of $45 for the stock. Since last October, when the stock hit its 52-week high of $43.25, it has been trading in the 32-to-40 range,
closing on Jan. 26 at $40.25. Salomon Smith Barney also initiated coverage of the stock on Jan. 9, with a buy rating.
RCN's plan for drumming up customers is to go at it "the old-fashioned way: kick down some doors," says McCourt. The pitch? Better service, lower prices, and more channels. To get the word out, RCN launched a $10 million advertising campaign last June in the Boston and New York markets. Its telemarketing and door-to-door sales back up the ads but are admittedly a drop in the bucket compared with the spending of the mighty marketing machines RCN is going up against. So the company also hopes to get a boost from fiber-building partnerships it has made with Boston Edison in Boston and Potomac Electric in Washington. The deals call for these companies to flex some muscle cross-marketing RCN's services as well.
Roberts says RCN needs to achieve at least a 10% market share in its targeted regional phone and video markets to become a major player. Still, he sees a "pretty positive" outlook for the company, noting that "they have very good penetration rates in areas they are in." RCN cites numbers as high as 25% to 30% in areas of Somerville, Mass., where it began pre-marketing its services in November and is now doing the first installations, with customers signing up for 2.7 services apiece, on average.
RCN took another step toward bulking up its customer list on Jan. 21, when it entered the Internet service provider (ISP) market by acquiring Erol's Internet Inc. in Washington and Boston's UltraNet Communications. While still dwarfed by the likes of national providers such as America Online and AT&T WorldNet, Erol's and UltraNet make RCN the largest regional ISP in the Northeast, with 325,000 subscribers -- several times more than Bell Atlantic has.
Acquisitions aren't new to RCN -- it picked up New York City's Liberty Cable in March of 1997 -- and McCourt figures he'll probably do more takeovers in the future. The Erol's/UltraNet deal fits with RCN's regional strategy and buys it a healthy bunch of customers to push its other services on. Reading the tea leaves, Roberts figures RCN can hit 30% to 35% penetration in its targeted phone and video markets at the 10-year mark, if it can roll out its infrastructure on time and
cross-market its services effectively.
Trends in the telecom industry jibe nicely with RCN's plan, Roberts adds. He thinks that soon the lines between local, long-distance, and Internet providers will blur, with customers becoming willing to purchase all their services from a single source. The industry divide will be between telecom aggregators with a business focus and those with their sights on consumers, says Roberts. "The fact that [RCN is] choosing a group, a real boundary" -- the residential market -- "and
focusing on it is an advantage," he adds. And if its business plan pays off, infrastructure savings should allow it to package its offers at attractive prices.
With that in mind, RCN is hard at work building its local fiber loops around Boston, New York, and Washington. It put $100 million worth of cable in the ground last year and plans to spend up to $1 billion more over the next two years. All in all, RCN estimates that it will drop some $7 billion over 10 years, a number that Roberts agrees sounds realistic. To begin financing these operations, RCN raised $575 million in an October, 1997, debt offering, pumping its war chest up to $700 million -- though the company spent some of that acquiring Erol's and UltraNet, which will cost a combined $110.5 million in cash and stock.
It will surely help, then, that RCN has a deep-pocketed ally in the big construction and communications holding company Peter Kiewit Sons' Inc., of which C-TEC was a subsidiary. Kiewit is RCN's largest shareholder, through its 90%-owned Kiewit Telecom subsidiary, which has a 48% stake in RCN. The other 10% of Kiewit Telecom belongs to McCourt himself, who holds shares of RCN amounting to less than 1%. McCourt's involvement with Kiewit dates to 1988, when his communications engineering and design firm was bought out by then-Kiewit subsidiary Metropolitan Fiber Systems, which was eventually sold to WorldCom.
By starting with '90's technology and building from the ground up, RCN hopes to avoid many of the costly anachronisms that hinder established telecom companies. Cable operators must ponder spending $200 to $1,000 per subscriber, depending on the rate of adoption, to accommodate cable modems, while the phone companies face costs in the range of
$500 to $700 per subscriber to add digital subscriber lines (DSL) to their aging infrastructure, says Randy Carlson, an analyst at Yankee Group Inc. And these are just stepping stones to their goal: reaching the day when they both invest in fiber, adds Roberts.
Meanwhile, RCN can offer a range of services on its single-fiber network at a cost of roughly $1,250 to $1,500 per household, assuming a 15% penetration rate, according to estimates from SBC Warburg Dillon Read. "Being there first [with fiber], RCN has the ability to take the best neighborhoods," Roberts adds. "They have a time-to-market advantage that can't be measured in dollars today."
Indeed, McCourt pooh-poohs the Jan. 20 agreement by Compaq, Intel, Microsoft, and several Baby Bells to promote DSL technology for Internet access as trying to squeeze more blood from a stone. "[DSL] is only a 10th as fast as what I am doing," McCourt says. RCN hopes to start rolling out 'cable' modems that hook into its fiber network in mid-first quarter of 1998. As for the Bells' copper wires? "Their network is the wrong network, and they're stuck with it."
Of course, the "wrong network" has a lot of capital behind it. And if RCN manages to pull off its grand plan, one of its competitors might not be stuck for long. Analysts agree that a successful RCN would be attractive takeover bait. Likely suitors? The "entrenched monoplies" themselves: Perhaps AT&T or one of the Baby Bells.
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