Telco buys fiber-optic networks

Louisville firm finds market ripe for acquisitions

By Jeff Smith, Rocky Mountain News (Contact)

Thursday, January 24, 2008

Jacob N. Ware / Special to the Rocky

Zayo co-founders John Scarano, left, and Dan Caruso pose in their Louisville office. Caruso said the current economic conditions will help Zayo's acquisition strategy. The company is eyeing 20 to 25 small fiber-optic networks.

Dan Caruso's prolific BearonBusiness.com blog opines about the telecommunications industry, pays homage to Warren Buffett, relishes riddles and chronicles the careers of the "MFS mafia."

That's the three dozen or so people from old MFS Communications who have gone on to become executives at their own telcos. James Crowe and Kevin O'Hara of Broomfield-based Level 3 Communications are prime examples.

So are Caruso and John Scarano, co-founders of Louisville- based Zayo Group.

These aren't exactly heady days for the telecommunications industry, given the housing crisis and jitters over a likely recession.

But Caruso and Scarano are finding market conditions ripe to buy up small fiber-optic networks across the country and sell chunks of bandwidth to communications carriers, Internet providers and other Web-centric companies.

Zayo, founded in late 2006, has acquired five such fiber networks in the East and Midwest in the past year, with another deal soon to be completed.

The company then will have 325 employees in 12 states, with projected annual revenue of about $160 million. Zayo plans to acquire a few more companies this year.

"You never want to see a recessionary environment," Caruso, 44, said last week at the company's downtown Louisville headquarters.

The office was abuzz with activity the entire morning, until employees took a break for a pizza lunch.

Caruso said the current economic conditions will help Zayo's acquisition strategy. He said there are still 20 to 25 small fiber networks that could fit Zayo's bill, and he reasons that some owners will be more inclined to sell in a slowing economy.

"A higher sense of urgency plus less options means more opportunity for the buyer," he said.

Caruso and Scarano, Zayo's 42-year-old chief operating officer, worked together at Level 3 and ICG Communications. They headed ICG in the final phase of its turnaround, selling off the assets, the final block to Level 3.

While Zayo's primary business is selling wholesale bandwidth services, it also targets financial, hospital and university customers.

And it provides voice and Internet services to medium-sized businesses in certain markets.

It has about 2,000 customers overall and high-speed Internet connections to more than 1,000 buildings.

Venture capital support

The company's rapid emergence surprised analysts.

Zayo secured $225 million in venture capital last year, the most of any company in Colorado, and since has added $85 million of debt financing. Lead investors are Oak Investment Partners, Columbia Capital and M/C Venture Partners.

The two executives say they learned a lot from their ICG experience.

"Industrywide, I think we learned that the recovery had begun," Scarano said. "Bandwidth pricing, which has been in a free fall for so many years, had largely stabilized."

Demand continues to grow with the proliferation of online video and music applications. Zayo also sells transport services to wireless carriers, which are also enjoying that boom.

Why didn't Caruso pursue a Zayolike plan at ICG?

"I wish I would have," Caruso said.

But he added there was a desire by the investor group and management team to clean up the company, then "find a more sustainable home" for the assets. Caruso says in his blog that ICG investors reaped $225 million from an $8.7 million investment.

Caruso's "BearOnBusiness" blog comes from his nickname during his Level 3 days. Caruso joked he likes to think "The Bear" was an affectionate term for being warm, friendly and approachable.

But he acknowledged there was a second version: "mean, grizzly," someone who shouted at others.

As Level 3 raced to build a nationwide network, people like him were overwhelmed, he said.

"I was so frantic, I didn't communicate well. My soft side, let's say, was not well- developed."

He believes his soft side is more developed today, but he also believes in communicating frankly.

"People want to be treated respectfully and be told how it is," he said. That way, he said, they can make decisions to protect their career and family.

Caruso said Zayo's goal is to help investors make two to three times their money back within two years.

The company is projecting cash flow of $37 million to $39 million this year.

But Caruso and Scarano say they see Zayo as a long-term venture, even if it means finding a different set of investors.

Long-term player?

Donna Jaegers, a telecommunications analyst at Janco Partners in Greenwood Village, agreed there are still a number of potential networks to buy, including fiber strung by electric utilities over the years. And she notes Zayo doesn't have to worry right now that Level 3, struggling to integrate its acquisitions, will be an aggressive bidder.

But Jaegers isn't convinced of Zayo's intent to be a long-term player.

"I'm always skeptical when I hear that," Jaegers said. "It seems the end plan is to flip it to someone else."

Potential buyers, she said, could range from a Qwest or Level 3 to a Verizon or a cable company.

Caruso maintained that's not the plan.

"We've been very explicit with our investors from day one that we're looking for this to be a long-term way to spend a good part of the rest of our careers," he said.

smithje@RockyMountainNews.com or 303-954-5155

Zayo Group at a glance

* Business: Telecommunications

* Founded: Late 2006 by Dan Caruso and John Scarano

* Operations: 17,000 fiber miles in 12 states, high-speed connections to more than 1,000 buildings. Primarily sells bandwidth services to communications carriers and Internet-centric companies.

* Headquarters: Louisville

* Colorado work force: 35

* National work force: 325

* Projected revenue this year: $160 million

* Acquisitions: PPL Telcom, Memphis Networx, Indiana Fiber Works, Onvoy, Voicepipe. Will soon complete acquisition of Citynet Wholesale.

* What Zayo means: Forthright and responsive, derived from the South African language Xhosa