InfoHighway CEO: CLEC Industry Needs to Wake Up And Grow Up

Eureka Networks and InfoHighway Communications Corp. merged last year to create one of the largest CLECs in the Northeast with annual sales of more than $100 million. The combined company now serves approximately 14,000 SMBs in 14 Northeastern and Mid-Atlantic states with traditional and next-generation telecom services.

In August 2006, on the anniversary of the deals closing, Kelly Teal spoke with Raul Martynek, InfoHighways president and CEO, about the integration of the companies and CLEC Consolidation. What follows is an edited transcript of that interview.

Is InfoHighway looking at more M&A down the road?

Yes. Its been about a year since we did that transaction [with Eureka Networks] and it worked out very, very well for us. It pre-dated a lot of this M&A activity were seeing. The deal made a lot of sense for our shareholders and strategically for two companies. Eureka was a facilities-based carrier and InfoHighway was a nonfacilities-based carrier with a great customer base, and being able to merge those two companies makes lot of financial sense.

Were coming off record revenue and EBITDA in June and July. We continue to believe that consolidation is a very logical type of activity in this type of market and were looking at additional opportunities. Were hopeful to be able to able to do another transaction before the end of the year.

All this M&A is directly traceable to the TRRO, which eliminated UNE-P, but also set the rule that going forward, if you want to compete in the wireline sector, youre going to have to build your own network. Thats the unwritten message from the TRRO. With AT&T and MCI leaving the sector and joining the established sector — all the remaining players in the space were pretty shocked and quickly realized they also need to scale up to be able to compete.

People understand its a consolidation play. My personal view is we look at the competitive CLEC sector in 24 months and it will probably be at five-to-seven big companies, with a billion to three billion in revenue. I like to remind people — how many car companies are there in America? How many airlines? Not that many. [Telecommunications] is a very expensive business to be in. The growth dynamics are not that great anymore. You need to be big to have scale to be able to generate network, margins.

What are InfoHighways likely expansion plans?

Theyre completely consistent with our activities on the acquisition front. If our customer base is a northeast customer base — specifically D.C. to Boston and in the New York metro area — as we look at acquisition targets and expansion efforts, we look at it from that perspective. Theres a lot of room to get additional customers and revenue in those markets. Were not looking geographically. Some competitors have said to [expand] on a national basis, and we think thats not the most prudent strategy from a long-term point of view.

Its about being able to leverage your network assets — its all about the incremental margin. When you can add customers to that network, its so much more profitable the network is what makes the difference. You look at the transactions that have happened in the market, theyre all around geographic fault lines theyre mostly companies with overlapping network assets. You do these financial models and amazing how much value you can create. With PAETEC Communications and US LEC Corp., theres not a lot of overlap with those two companies — its one of the first significant deals that has not followed those rules and has been more of an expansion strategy. It makes sense for those companies. Almost every other deal thats been done, like One Communications — all of those are geographically aligned.

What changes have there been to the InfoHighway channel program since the merger with Eureka?

That was one of the huge assets that we saw at InfoHighway — this indirect channel [Eureka] had built. They had great relationships and productivity. The main change has been to introduce facilities-based products to the channel. Prior to the merger, InfoHighway was a UNE-P provider. Since the merger, the order flow changed from 60/30 UNE-P products to now 60 percent hosted PBX, integrated on-net T1s and 30 percent off net. Its been a product shift weve been able to do with the channel — they want to ensure their revenue stream.

Is the revenue different?

It depends on the customer situation. Most business customers have T1 services, so from a revenue point of view, its probably pretty similar for all these traditional products. For every customer you acquire, you acquire less revenue than the one you did last year. Thats one of the reasons we really like a couple of the initiatives we put in place — hosted PBX is the absolute killer product for the coming decade. Its great for the customer and it allows us a higher ARPU per customer.

Weve started to roll out some very high-bandwidth products based on fiber and new copper technologies. Were going to be rolling out a Zoom product, based on new copper Ethernet technology that will give us those price points over much wider technology. Were absolutely trying to find ways to bring solutions to our customers that make their communications experience better.

Did partners contracts change?

No. We grandfathered all of the legacy contracts and then created addendums for the new products and services. It was really simple to explain and assuaged everyones concerns — people always fear the unknown. But weve been able to solidify those relationships.

What is your general opinion of the CLEC market now that there are three billion-dollar companies?

My opinion is that consolidation is a healthy dynamic because it is making it so that the market is less competitive and, ultimately, I think the market had too many competitors that were too small and, hence, were desperate to get revenue at all costs. I think the CLEC market is going to consolidate more over the next 24 months [and] that well end up with half a dozen very large competitors, but those half a dozen competitors are going to be well run. And thats a very good place for the customers to be, for the agent channel to be and for the employees that end up being the best.

So I think thats where the markets going to go, and I dont think anythings going to arrest that. The regulatory landscape has changed forever, given the emergence of the cable companies and wireless as alternative players in the space — that was something that never existed in 1996. But now there are alternatives to the wireline network. BPL is a long stretch but just another example. I still meet people in the competitive CLEC sector that are still waiting for UNE-P to come back — they dont see whats going on from a very big-picture point of view. The CLEC market will find a natural state with half a dozen well-capitalized, well-run companies, and that will be more than adequate for a very vibrant market. Thats why I think this industry needs to wake up and grow up, and think about solutions that really help our customers. Its not just who can sell you that same service at a cheaper rate — how much lower can rates go? It really has gotten ridiculous. Unfortunately, I see a lot of people stuck in the old paradigm.

Do you expect to see any of the larger CLECs be acquired by cablecos or Bells or merge with each other?

I dont think the phone companies are interested in acquiring CLECs. The cable companies, on the other hand, I do think over the next couple years will start to view their lack of penetration in the business market as a competitive deficiency for them. I do think its possible that a cable company would be interested in the CLECs.

The CLECs could end up being a standalone player that serves business customers, and I think theres room for that for a long time.

Does InfoHighway plan to go public?

Its not in the immediate plans. Bankers have approached us on that and we evaluate all avenues for additional capital, but were a highly profitable business. Going public has its own set of dynamics that arent necessarily as fun as it used to be. You really have to think about why you want to do that. Really, the way weve been looking at it, theres no purpose in going public right now.