360Networks on the Hunt for a Profit

In the summer of 2001, before the bankruptcies and scandals crushed the shares of Global Crossing Ltd., WorldCom Inc. and other telecommunications titans, there was the downfall of 360Networks Corp.

Led by a former Microsoft Corp. finance chief, Greg Maffei, Vancouver-based 360Networks ran out of cash during the broadband marathon to lay fiber cables under the earth and seas. Vancouver-based 360Networks filed for protection from its creditors in the United States and Canada, listing approximately $2.7 billion in debt.

Its revenue shriveled and things didn’t look promising.

Those days are history, though 360 has yet to turn a profit.

After emerging from bankruptcy with a fraction of its original debt, the carrier’s carrier has acquired a large Canadian phone company and announced an agreement to buy a U.S. network, picking up 50 customers. 360 emerged from bankruptcy last November with $215 million in long-term debt.

360 Networks’ bank group, led by J.P. Morgan Chase, is the primary owner. The group anticipates generating positive earnings before interest, taxes, depreciation and amortization for 2003. The milestone would be more significant now that 360’s interest expenses have been pared down thanks to its restructuring.

The company does not appear to be finished with its buying binge.

360Networks is pursuing other mergers and acquisitions, says Chris Mueller, vice president of finance.

In February 360 closed the acquisition of previously bankrupt Group Telecom, a competitive phone and data provider serving 13,000 customers in Canada. Many customers are small and medium-sized businesses. Prior to the Group Telecom acquisition, 360Networks did not compete directly with communications providers targeting consumers and businesses. It sold private lines and wavelengths — lit capacity – on its network to phone and data providers needing a point-to-point connection from one city to another.

Under 360’s ownership, Group Telecom is cash flow positive going forward each month, says Mueller. How is that possible? Had it not been for the phone company’s expenses incurred outside its own network, it would have been profitable, he says.

Last week 360 announced an agreement to buy the U.S. network of energy company Dynegy Inc. for an undisclosed sum. The network spans 16,000-plus route miles and reaches 44 cities. It also snakes through Atlanta, Boston, Chicago, Dallas, Denver, Houston, Miami, New York, San Francisco and Washington D.C. 360 also is picking up about 50 wholesale customers, who are primarily small to regional telecom providers, says Mueller.

Mueller says 360’s most recent acquisition will be operating on a near break-even basis the day the agreement closes. He says 360 will save money on payroll expenses and associated costs as Dynegy employees leave the day the acquisition closes.

“It will be a nominal loss,” he says.

360 will acquire the Dynegy network for a fraction of its cost, he says. Dynegy executives said the company initially invested about $700 million in the network.

Dynegy Global Communications — which included the U.S. network and its former European network — posted a $548 million net loss in 2002. Operating losses for the year totaled $745 million.

Seth Libby, an analyst covering the wholesale carrier market at The Yankee Group, says there are problems with the Dynegy acquisition.

Even if 360 got a great bargain, there are expenses associated with running that network, he says, adding that in all his briefings with wholesale customers, he has never encountered a service provider who used Dynegy as its primary carrier. 360 has not disclosed the names of the Dynegy customers.

“I view that as one operationally challenged firm buying another operationally challenged firm, not resulting in a significantly stronger new company,” the analyst says.

But Libby adds Dynegy’s optically switched mesh network can be more efficient than a network based on a ring infrastructure. Data can be transmitted directly from one point to another over a mesh network, rather than having to travel around a ring.

The Dynegy acquisition is logical if 360 is picking up customers for an inexpensive price, says Rod Woodward, an analyst at Frost & Sullivan.

“I think any customers right now are probably good customers if you can get them,” he says. “To me what would probably make most sense . [is] is they took them, put them on their network and I wouldn’t even worry too much what network Dynegy had,” the analyst adds, explaining 360 probably has a national presence where Dynegy’s network extends.

However, 360 also will pick up 10 city networks.

“The metro access would be of benefit as well,” says Woodward.