Cbeyond Confident New Cloud Strategy Will Boost Customer Spending

By Josh Long

Customers of Cbeyond Inc. in the second quarter on average spent less money with the telecommunications provider.

Average monthly revenue per (Core Managed Services) customer location was $641. That is down from $642 in the first quarter and $660 in the year-ago quarter.

Cbeyond isnt overly concerned because it believes its strategy focusing on technology dependent” or 2.0″ subscribers will result in significant higher revenues per customer. The company thinks these customers provide 30 percent higher ARPU than its traditional telecom subscribers otherwise known as its 1.0 customers.

Of course, Atlanta-based Cbeyond is doing some guesswork. The 2.0 strategy focusing largely on selling cloud services is still in its infancy. The company brought home a mere $8 million in revenues from these 2.0 customers during the first six months of the year. Cbeyond defines 2.0 customers as those who buy network access at speeds exceeding 10 Mbps, subscribers who purchase such cloud-based services as dedicated server and cloud PBX services and customers using its MPLS service.

What will likely make or break Cbeyonds strategy is its ability to persuade its current base of roughly 62,000 small- and mid-sized business customers to trust a competitive telecom provider with their IT needs. Cbeyond estimates nearly half of its Core Managed Services customers are tech-dependent.

Our strategic shift is expected to result in little to no net growth in overall customers in the near term,” the company admitted in a regulatory filing. [H]owever we expect that in the longer-term our overall ARPU and customer additions will increase as our customer mix becomes more oriented to those who are technology dependent and are using our services to satisfy their technology needs.”

Deutsche Bank Securities analysts are optimistic that Cbeyond can execute on its strategy.

We believe that CBEY has put in place all of the key elements necessary in order to implement its 2.0″ strategy and the company is emerging as one of the more interesting turnaround stories in telecom,” Deutsche Bank research analyst Brett Feldman wrote last week.

Still, Feldman cautioned that a return to growth” at Cbeyond seems unlikely until next year.” The company last week reiterated its 2012 guidance of $485-$490 million in revenues. That would result in flat revenues for the year compared to 2011 ($485.4 million).

To support its new strategy, Cbeyond is planning to connect 1,000 buildings with fiber by the end of next year, analysts said. Cbeyond has 700 buildings under contract for construction of fiber, according to financial analysts with Raymond James & Associates.

“We believe a large number of Cbeyond 1.0 customers and almost all Cbeyond 2.0 customers will ultimately require speeds greater than what Cbeyond has historically been able to offer,” Raymond James analysts Frank Louthan and Alexander Sklar wrote in a research report.

But D.A. Davidson & Co. analysts are worried that Cbeyonds margins could endure pressure next year unless the company is able to accelerate sales of cloud services. Cbeyond posted a second-quarter gross margin of 67.5 percent.

In a phone interview, analyst Donna Jaegers of D.A. Davidson explained that other fiber-based providers have gross margins of roughly 60 percent. I dont necessarily believe the company can hold margins where theyre at,” she said.

Cbeyond is projecting that 10 percent of its revenues will derive from tech-dependent customers by the end of the year, according to Feldman. Its target number increases to 25 percent by the end of 2013, the analyst wrote. As of the second quarter, Cbeyond generated 6.5 percent of its revenues from such customers, he said.

The new sales force at Cbeyond will prove crucial in its strategy. The company has been hiring sales professionals who are more IT savvy while scaling back its traditional sales team. Cbeyond cut its traditional entry-level sales team by roughly one half, according to FBR Capital Markets & Co. analyst David Dixon.

It wont be an easy or quick sell, analysts maintain.

“I hear smaller business are looking at the cloud but given Cbeyond’s reputation as having a lot of pretty green sales people cold calling and pitching people on telecom services they sort of have to change their reputation and that always takes longer than just hiring salespeople,” Jaegers told us.

Raymond James analysts don’t believe the financial picture will improve until next year other than “some modest cloud wins over the next few quarters.”

In a research note, Jaegers also noted two other challenges facing Cbeyonds sales team: Unfortunately, the decision times for cloud services are longer than more vanilla telecom services. Also, CBEY is attempting this transition in a very slow economy with very little new business formation.”

Cbeyond acknowledged the soft economy in its 10-K filing. Explaining the decline in its ARPU, the company cited the effects of the ongoing current economic conditions on customers and the continued increased competitive pressures from alternate providers who compete primarily with our Cbeyond 1.0 services, such as cable companies.”

Long-term, we expect that our focus on technology-dependent customers, or Cbeyond 2.0 customers, will increasingly benefit ARPU,” Cbeyond stated in the filing.

Cbeyonds fate is far from certain.

The stock is very cheap,” wrote Jaegers, but until there are better signs of improving cloud sales momentum, or an improving economy, we expect it to stay that way.”