Time Warner Telecom builds on extensive fibre base

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Time Warner Telecom is one of the best positioned competitive local exchange carriers (CLECs) in the US. Benefiting from a popular brand name and rights of way in a number of cities, it has been building extensive local networks based on SONET technology. Time Warner Telecom's president and CEO Larissa Herda talks about the company's plans.

Time Warner Telecom was spun off from Time Warner in July 1998. A national local competitive exchange carrier, it is building dense regional fibre-optic networks in the US, as it bids to become one of the leading providers of telecoms services to businesses. The operator currently offers services to 20 cities in the US. F. Drake Johnstone, a telecoms equity analyst at Davenport, talks about the operator's competitive advantages: "I would point out what I consider to be unique about them: if for example you look at the local North Carolina network, they have a very extensive local build for their fibre networks. They just don't slap a ring in the city. If you look at the North Carolina map, you see figure ends of fibre in all the surrounding communities. In my view that is positive, as it enables them to capture a high proportion of the business market within a certain area, and not just the big businesses that are right in the middle of the city."

The operator has over 300 route miles of fibre in each city, which is substantially more than double the CLEC average. Johnstone notes: "I think that this factor is extremely important, when you are talking about a company such as Time Warner Telecom, which has the potential to offer a superior service to other carriers. You can't be just another vanilla telco, enter this market and succeed. If you can offer services better than other carriers, I think you are in a better position. In addition, the CLEC market, a competitive exchange market, is about building out local fibre. It is interesting to look at the difference between what TWT and other CLECs are building. They are deploying a lot more local fibre than most of their peer group."

Time Warner Telecom recently went EBITDA positive. In May 1999 the company raised about $290 million in an IPO. These funds will be used to repay debt to its owners. The company has been able to leverage its relationship with Time Warner. Above all it can use a nationally respected brand name. In addition, the operator has benefit from Time Warner Cable's rights of way, gaining access to these cities.

Bill Garrahan, a telecoms equity analyst at Lehman Brothers, talks about the challenges that lie ahead for Time Warner Telecom: "I think that the main challenge will be to expand the business model from their traditional strengths. They derive most of their revenue and growth from selling dedicated private line capacity services on their fibre network. Secondly, they offer local voice services and are expanding into providing Internet services/packet-switched data services and long distance. So I think that the challenge is to continue to be able to grow the top and bottom line, while undertaking all that expansion activity."

He adds: "I think that over time it will become more important to build towards a more national network from the markets they are in today. Building towards a more national footprint will make their company better able to serve their customers and will make them more valuable strategically. This is important going forward. I think that they also need to grow their scale to help them compete with the larger players in the market. Again that adds strategic value. The bigger you get and the bigger your footprint, the better you are going forward."

As many businesses move out of big cites or expand into smaller towns and cities, demand for high-bandwidth services from this sector is growing. In an exclusive interview, the president and CEO of Time Warner Telecom Larissa Herda talks about the company's strategy going forward and explains how it plans to sustain its impressive growth.

How much is your SONET-based network costing to build? When will the network be complete? How many cities do you offer service to? How many customers do you have? What do you perceive to be the technological advantages of your network?

We have spent about $740 million on the construction of our fibre, facilities-based SONET networks in 21 metropolitan areas of the United States. That amount also includes building our back office support systems and network operations control centre.

We have just announced plans to enter our 22nd area - Los Angeles/Orange County, California. This network will be complete by the middle of next year. We are fortunate that 19 of our networks were built in conjunction with Time Warner Cable, so that our costs to build those networks are significantly lower than those of our competitors. Some of the new cities we are entering are Time Warner Cable cities. However, we are also expanding into other cities without Time Warner Cable presence. The costs are different. It really depends on the rights of way that we negotiate. The right of way is a big factor in building networks.

Under our current business plan we will add five new cities over the next year. We are not a company that will tell you that we are going into 40 cities. We are going to tell you that we will launch five cities, then another five, then another five. We would rather set the proper expectations and execute on those expectations. We sell only to medium and large business customers. Currently about 3,000 business customers buy services from us.

We offer significant technological advantages to our customers. All our networks are very large. On average, each one is between 300 to 400 route miles, so that we can bring our fibre directly into many buildings. We have over 2,000 buildings that are directly served with our fibre. The networks are entirely built on SONET technology. As they are ring networks, we have diversity and redundancy in those networks. As we co-locate in most Bell central offices in the cities that we enter, we can provide the same diversity to our customers. We have entrance facilities into all major carrier points-of-presence (POPS), as well as Internet Service Provider POPS. In general we provide very reliable networks to our customers. As we have the fibre, we can put any product or service that we want over that network.

What packages are you devising to attract small-to-medium sized businesses? Will most of your revenues come from value-added services? What do you believe to be your competitive advantages?

Most of our customers are medium and large enterprises. We began as a competitive access provider, which was by definition a company that built fibre facilities and sold private line services over those facilities. We typically sold to larger customers that qualified for private lines. We built our reputation on selling those services. Then we deployed Lucent's 5ESS switches on our networks and started selling switched voice services.

We developed a new product this year that we call the Integrated Business Line or IBL. This product combines both voice and data on a T1. Customers that would not normally have qualified for a T1 can buy the Integrated Business Line and combine their long-distance, local voice and Internet access services over a Time Warner Telecom T1. Now they have the diversity and redundancy that they could not obtain from anyone else. More of our smaller-sized customers will benefit from our services, as we have deployed Internet access and IBL. Value-added services will supplement current revenue streams in our various product lines. They are all very strong. We see value-added services as another good opportunity to build revenue.

Why did you decide to deploy Lucent Technologies ConnectReach Plus integrated access solution? Which other suppliers are you working with to build the network? Could you tell us about your relationship with Vina Technologies?

ConnectReach is part of our Integrated Business Line product. ConnectReach allows us to effectively provide integrated solutions to smaller customers. We work with many quality suppliers. As far as switching goes, we use Lucent switches. We use Lucent and Alcatel equipment for our SONET technology. We have routers from Cisco. We use Vina Technologies for our Integrated Business Line. In general we use a wide variety of vendors to build our networks.

Do you believe that your local networks are more extensive than those of your competitors?

Absolutely. Very few players out there have networks as extensive as ours. We have built them into the downtown business areas and the suburban tech centres and office parks. Our 400-mile network in a city such as Raleigh, North Carolina, is quite an extensive network that reaches into most offices of medium and large business customers.

As many US businesses have moved into suburbs, a considerable amount of business is located there. Many customers have told us that building networks to reach them constitutes a very significant advantage for us. As we have built these networks with Time Warner Cable, we have obtained rights of way to just about anywhere in the cities where we do business.

One of the other competitive advantages we have is that we sell the vast majority of our services 100% on our fibre networks. We sell 100% of our voice services on our switches. We don't offer any total services resale or LEC services. If you look at all our other services, 80% of them are provided 100% on our fibre networks. We think that this is very important. This allows us to control the quality of service to our customers. As a result our mean time to repair is much shorter than that of our competitors. We can install services on the same day if we need to. So our installation intervals are very short compared to those of our competitors.

What was the significance of Time Warner Telecom's acquisition of MetroComm? Will you make further strategic acquisitions to boost your competitive position? You also acquired Internet Connect recently. Are ISPs your main acquisition targets? Will you acquire other facilities-based CLECs to expand coverage?

MetroComm was a joint venture that we had with other business partners for a transport network. By acquiring the remaining interest in MetroComm, we consolidated our position in the city as both the transport provider and also the provider of switched voice and data services. This allowed us to be the single owner of that network. We are open-minded with respect to strategic acquisitions to boost our competitive position. We have grown organically, as we have been expanding our national footprint.

We will consider acquisitions or mergers, if they make strategic sense and complement our business plan. We decided to acquire Internet Connect, as we wanted to expand our Internet and data capabilities. Internet Connect was a regional Internet provider with substantial capabilities: it had a number of products that we wanted to roll out on a national basis. So that acquisition immediately threw us into the Internet world. As we had the local connections and they had the peering relationships required to provide a Tier One Internet service, it was a good strategic fit.

If we find a CLEC that has a similar strategy to ours - one that is asset rich, focused on high-margin services, and with complimentary cities to ours - then we would consider them as a potential acquisition. However, we don't need to acquire companies to meet our business objectives and plans.

The data/business markets are some of the most competitive markets in the US. How does a new player such as Time Warner Telecom compete against bigger more established players with greater financial leverage?

We have found that many players are building large national networks. They face the following disadvantage: they have a difficult time getting local capacity. Our ownership of the local loop allows us to sell data services more efficiently. The hardest part of data is getting the network operational and acquiring local connections.

We are selling transparent LAN services, which represent essentially an extension of our private line services. We sell private ATM networks both regionally and within the cities where we do business. We currently sell Internet access and will roll out web hosting, service level agreements (SLAs), E-mail and VPNs by mid-2000.

We have started to connect our regional networks with fibre. We have done this in Charlotte, Raleigh, Durham and Greensboro, North Carolina. We also connected Tampa and Orlando, Florida and plan to connect San Antonio, Dallas, Houston and Austin, Texas. Next year we will connect San Diego and Los Angeles with fibre. We will provide complete and total end-to-end solutions over our fibre network for customers, which have synergies between those cities. That offers us a considerable advantage.

Who do you perceive to be your main competitors? How do you view operators such as Qwest and Level 3? What are your target markets? Could you tell us about your recent agreement, which saw Level 3 provide Time Warner Telecom with access to their conduits in the greater Dallas area?

The local exchange carriers are our main competitors. There are many CLECs. Each one has a different strategy. Our long-term strategy is focused on medium-and-large customers, whereas many other CLECs seem to go after smaller customers. Only a few providers have the advantage of fibre networks in their cities. So we find ourselves competing predominantly against and taking business away from the LECs.

Qwest and Level 3 are very good customers. We are also a customer of Level 3. We chose to use their conduit in Dallas. We were driven to Dallas by our customers, as we were already in three other major Texas cities and many decision-makers were either in those cities or Dallas. When we looked at the market and at the right of way options, Level 3 was building a conduit system at a very attractive rate. This agreement allowed us to put our own fibre in the conduit system and launch our own network quickly. This was a good economic decision and Level 3 was a good vendor.

How do you view the potential for voice over IP? How important is it for Time Warner Telecom to be a one-stop shop for customers?

The potential for voice over IP is tremendous. Clearly the industry is going in that direction. The technology, however, is still not there to deploy on a mass scale. We are testing it in our labs and work with all the key vendors on this particular technology. As we have fibre networks, it is rather simple for us to deploy almost any technology over our networks. We believe that we have an inherent advantage when deploying voice over IP, as we own our local fibre networks.

One-stop shopping becomes important when you are selling to smaller customers and bundling your products. This is one reason why we launched our Integrated Business Line. Smaller customers can bundle their local voice, Internet access and long distance into one package that offers excellent reliability and value.

The vast majority of our customers - medium and large enterprises - like to buy the best value service from the best quality provider. If this means that they have to use multiple providers to do that, then that is what they will do. More often than not, those customers are looking for a diversity of carriers to enhance their network reliability. If there is a risk of failure, they may have several carriers, which provide similar services.

Do you believe that number portability is a key issue for business users? In your opinion which applications will prove the most attractive to business users?

Number portability is critical. Fortunately, we have number portability in all our markets. It was more difficult to sell services prior to full number portability. But that is no longer an issue.

Web hosting and E-commerce are two applications that our Internet division offers on a regional basis that we will roll out to all our cities. One of the advantages of acquiring Internet Connect was that they already had those capabilities in place and were very successful selling those services.

How much did you raise through your IPO, managed by Bear Stearns, Lehman Brothers and Morgan Stanley Dean Witter? How are the proceeds being used? Do you plan to return to the financial markets to raise additional funds after 2001?

We raised $289.8 million before underwriting fees and expenses. We used $180 million to pay back the debt to our owners. The balance is being used to run and continue expanding our business. We are currently EBITDA positive. Combined with our current funding position, our business plan is fully funded. However, if we plan to accelerate our business plan, we would expect to go to the financial markets at some point in the future.

How do you view the regulatory environment in the US? If as many suspect, RBOCs gain approval to offer long-distance services before the end of the year, how would this affect your operations?

The regulatory environment in the US is generally pro-competitive. If there is a problem with the 1996 Telecom Act, it is that it tries, perhaps too hard, to accommodate competitive entry through a variety of means, including the resale of finished services, resale of ILEC network elements and of course fibre facilities-based competition. In the long run, the true competitive choice for business and residential customers can only be achieved, if companies like ours continue to invest in facilities. Unfortunately, the policies and prices associated with resale are sometimes inconsistent with polices that would encourage investment in facilities. If regulators keep an eye on the policy requirements for achieving long-term fibre, facilities-based competition, as they deal with the ILECs/IXC efforts to remain revenue neutral and reduce access charges, then we can succeed in the current regulatory framework. Assuming this "if", such an observation would be correct, even if the RBOCs secure their Section 271 approvals.

What are your views on DSL technology? How do you view DSL providers such as Covad, Rhythm NetConnections and Northpoint? How big a technological advantage is the ability to offer remote provisioning to customers?

There is a substantial opportunity for DSL services. It is a very high-growth area. I believe that DSL is geared primarily towards small business and work-at-home environments. Typically, the customers we sell to are looking for fibre. So it is really a different competitive market. The biggest obstacle faced by DSL providers is no different than the largest obstacle faced by the CLEC industry: that is, they need to be able to scale the back office to support and deploy the volume of services that they are projecting to meet their business plans. This, combined with the price depression that the LECs are putting on DSL services, will be the primary challenge for DSL providers. I think that it is difficult, when the success of your business plan depends on a vendor that is also your biggest competitor.

We provide remote provisioning today. I don't know many of our competitors that actually do this as well. It is a significant advantage for us. It allows us to respond to customer troubles without rolling a truck. It allows us to turn up new services without putting a technician on site.

We had a situation about 18 months ago in one of our cities, where we had a customer on an emergency E911 centre trying out a digital PBX trunk from us. Several months after the service was active, the Bell central office in that city had a power failure and the rest of their DS-3 service went down. The customer contacted us and asked if we could help them. As we had the electronics at that location and had remote provisioning from Denver, we were able to turn up their entire DS-3 facilities within 45 minutes, which was simply incredible. We have many, many stories like that. You can only deliver this level of service if you have the fibre network in place with remote provisioning.

Will your future success be dependent on building a national footprint? Would you expand beyond your targeted amount of cities if revenues continue to grow above expectations?

I am not a big believer in the precept that bigger means better. Our success is based on providing quality local service. The addition of new cities that are individually successful adds to our growth as a company. We are a local company that provides the local communications backbone for local businesses. We build our business by being successful in each market that we enter. We build one city at a time.

Will we expand beyond our targeted number of cities if revenues continue to grow? Absolutely. We have a successful strategy and stringent disciplined business plans that maintain our focus on being EBITDA positive with strong revenue growth.

Which efficiency benchmarks do you use?

We measure our progress by our revenue growth and the margins that we can obtain from our various product lines. We have a very strict internal rate-of-return model. Most of our capital expenditures are success-based. This is a very aggressive growth model. We have achieved positive cash flow in some of our cities within as little as 11 months. On average we plan to achieve positive cash flow in about 20 months in each city. That is much more aggressive than most of our fibre-based competitors.

Is there not a possibility that if you try to accelerate growth, you could reduce operating cash flow growth? How do you think that the market would respond to such a strategy? Are your SG&A expenses likely to increase significantly over the next two-three years?

We continually assess different growth strategies for our business. We maintain a very stringent financial model. If we were to accelerate our growth, these strong financial models would allow us to maintain a good return on that growth. The market would respond very favourably to such returns. Our history has proved that we have met or exceeded all our financial objectives since becoming a public company in July 1998, following our public debt offering. Our plan is to continue in that direction.

I would expect our SG&A expenses to grow at a reasonable rate over the next several years. Obviously, as we continue to add new cities, we would increase our SG&A. You add more people; you add more expenses. We have a very disciplined approach towards expense and capital spending that has allowed us to become EBITDA positive.

Our back office provides a good example. As the systems have not developed as rapidly as the industry, many CLECs have struggled adding more and more people to accomplish their revenue objectives. The problem is that it negatively affects their EBITDA.

What we have done in our national operations centre (NOC) in Denver is to evolve our back office to increase our efficiencies, so that we add people in a very controlled manner. As our systems have become more efficient, we can process more orders than we could two years ago without using as many people.

Do you think that you will derive most of your revenues from data and Internet services in two-three years? Do you believe that revenue from local voice services will decline significantly? How do you view the long-distance voice market for Time Warner Telecom?

The total telecoms market is growing. The CLECs have a very small portion of voice services, which will expand considerably over the next few years. Both data and the Internet are growing by leaps and bounds and are competing for a significant piece of the pie. As we own our fibre networks, we can offer special access private line services and a wide array of services to meet an incredible bandwidth explosion in the local loop. It is difficult to predict which robust product lines will take over and account for most of our revenues. I predict that they will all do very well.

The company has traditionally served large corporate customers. In the future do you believe that the small-to-medium sized business market will be the place where you will make its biggest impact?

Our big customers are making a huge impact. We have decided to go after smaller customers, as many customers in the nearly 2,000 buildings are directly served by our fibre networks, that are not large or medium-sized customers. We want to leverage our networks and product offerings into those buildings.

Until this year we did not have a product line for smaller customers. With our Integrated Business Line, we have a bundled offering that will meet their needs. As we expand and reach smaller customers, it will have a very positive impact on our business. Will they represent a significant part of our business? They could, but medium-and-large customers are such a vital part of our business that we expect to see tremendous growth in all areas.

What is Time Warner Telecom's relationship with Time Warner? How important is it for you to have a recognized brand name? What role do Time Warner and MediaONE (AT&T) play in the development of Time Warner Telecom?

Time Warner Telecom has a very good relationship with Time Warner. Time Warner Cable is our right of way provider and we have the ability through our fibre lease agreement to expand into our current cities and other Time Warner Cable cities. It is an excellent strategic relationship, as we don't face the problem of "right of way", which is probably the biggest barrier to entry for a fibre facilities-based CLEC.

Time Warner is a recognized brand name and has been a very positive aspect of our business. It enables us to get our foot in the door with customers and explain our story. Once customers see what we have and perceive the value that we provide, they are very impressed. It has been a significant advantage to be Time Warner Telecom, as it is a very strong brand name with a very good reputation. Time Warner, Advanced Newhouse and AT&T/MediaONE are very supportive investors in our company, but we run our own business.

Do you believe that your revenue margins could be squeezed, as competitors offer widespread discounts to business accounts? Will you be able to grow volume significantly to offset decline in prices?

The pie is getting larger. Demand for telecoms services will only continue to grow over the next few years. Many companies end up missing the mark, when they solely depend on discounts and are the least expensive game in town. That has not been our strategy.

Our strategy is to provide value to our customers. We have built fibre networks and developed a very stable sales and technical organization to sell value and relationships. We provide solutions to our customers. We listen to them. The products we offer are products that have evolved, by sitting down with customers and asking them what they needed. If a company goes in and offers a 10% discount over another company, then somebody is going to come in right behind and offer another 10% off and take that business away.

But if you are providing a high-quality service: reliable, fibre facilities-based networks; customer care and responsiveness - which is really the name of the game in this business - then at the end of the day you will win and retain the customer. If customers get to know your sales organization and your technicians on a first name basis, it is a very powerful approach. Customers won't leave you, because somebody gives them a 10% discount.

We have customers who have told us that they would pay 25% more for our services, as we were that much better than our competition. That says a lot about customer requirements. I know this personally: I don't try to buy the cheapest product when I shop. I don't buy the cheapest car. I don't buy the cheapest clothes. I buy the things that will in my opinion provide me with the best value. I shop at the places where people are personable and responsive. I think that a lot of sales organizations lose sight of the fact that their customers are people too and that they want to be treated in the same way. We focus on that type of a sales approach. We find that it has been very effective for us.

When do you plan to offer services such as web-hosting, E-mail hosting and network security services? Are you planning to launch any other new services this year?

We are actually providing these services in our mid-west region right now through our Internet & Data Division. Our goal is to start the roll-out of these services towards the end of the year and through the course of 2000 in our new cities. We are always assessing new products. We will always have new products on the drawing board. This year we have released Dedicated Internet Services and Integrated Business Line.

Do you plan to build new fibre networks in Time Warner cable territories to lower costs?

Yes. We will continue assessing Time Warner Cable cities as great opportunities to build networks. We also assess other markets that would fit our business model.

Finally, what are your hopes and ambitions for the company over the next two-three years? Where do you hope to position Time Warner Telecom in that time frame? Which trends do you see emerging in the world of telecoms?

My goal is to position Time Warner Telecom as the premier, fibre, facilities-based provider of integrated telecoms services and solutions and offer the industry's best value to our shareholders and customers.

The market is expanding and technology is changing more rapidly than ever before. The bandwidth explosion is tremendous. We have seen companies build fibre between major cities. We have seen CLECs put switches in cities, but not fibre networks. We have seen DSL providers put their D-SLAM equipment in LSOs, but they need capacity to get from the LSOs to their points-of-presence. There is an insatiable demand and explosion of bandwidth in the local loop. I feel the following trend in the industry right now: there is a lack of supply to meet the incredible demand for local fibre capacity. But Time Warner Telecom is there now!

We are very well positioned to capitalize on that continued bandwidth explosion, as we have the fibre networks in place. As the technology changes, it is easy for us to put any technology over our fibre networks. As the world changes and industry trends evolve, we are very well positioned. Our goal is to stay very customer-focused, expand into new markets, provide solutions to meet customer needs and continue to provide rapid, reliable services at a good value for all our customers.