Cashing In

By Khali Henderson

Posted: 08/1999

Cashing In
Agents Calculate Risk of Equity Play
By Khali Henderson

Amidst the stock market’s longest winning streak, the telecom industry has been engaged
in consolidation at all levels as service providers jockey for position. Mid-sized players
are gathering steam–and their smaller brethren–while mega-players are merging and
next-gen service providers are building sky-high market caps.To share in the wealth,
telecom agents have been staking out the "hot" carriers and pumping minutes into
them like so many quarters in hopes of accumulating equity for the big jackpot. Some are
hedging their bets and playing two or more at once. Others are shoulder-surfing, looking
for the first signs that equity participation is a worthwhile pursuit. So far? No equity
events. No big payouts. Nothing to refuel the frenzy of last fall when agents were
scrambling to ally themselves with a sure thing.

"Eight months ago at the AgENt Conference in Tampa there was a real panic in the
air in the agent community," says Ted Schuman, president of master agency U S
Telebrokers Inc., Scottsdale, Ariz. "They saw voice over Internet coming into play,
[and] they saw rates [for long distance services] going lower and lower, and thought, ‘Oh
my God! I’ve got to hitch my ride to somebody. I’ve got to get an equity plan.’ And in Las
Vegas [at the AgENt Conference in April], you didn’t see the same panic."

It’s not that they are disinterested; far from it, agents say. It’s just that they are
taking a step back and evaluating or re-evaluating their options. And those options have
broadened considerably in the last six to nine months, with dozens of new equity plans
introduced by dozens of providers, making the equity value proposition a much more complex
decision. What remains is a mix of confusion, skepticism and, among some, tempered
optimism that payday soon will come.

The Deal

"When we first started advertising [our agent equity program] in 1997, we received
an overwhelming response from agents that were interested in ‘getting their piece of the
pie,’" says Bernadette Richardson, president of long distance reseller TMC
Communications Inc., Santa Barbara, Calif., one of the first companies to offer agents
equity. "There weren’t any other options out there at the time that did not require
any buy-in fees to participate in equity. Some of these agents understood the concept and
have become valuable partners with TMC; others never really did much. Although we did our
best to educate them, I don’t think they really understood why equity is so important to
their future."

Today, Richardson says agents are more savvy about the financial opportunity
represented by the equity play. On this point agents and carriers agree.

"Agents come in all different shapes, sizes and stripes. The more mature the
agents, the more important equity is to them," says Greg Praske, CEO of master agency
Association Resource Group (ARG), McLean, Va. "Over the years they have seen their
vendors profit significantly [from the sale of businesses they helped to build]."

In January, Coastal Telephone, Old Orchard Beach, Maine, sold to IXC Communications
Inc., Austin, Texas, for $100 million–some 13 times monthly revenue.

Agents are not only keenly aware of the upside of an equity play, but also what they
are willing to do to get it.

"Agents are wiser about contracts generally and how they affect the residual
commission or the equity they might receive," says Brian Twomey, senior vice
president of sales and marketing, TransNational Communications International Inc., a
Boston-based reseller. Twomey and other agent program developers have found that agents
aren’t willing to trade their ongoing commissions for an equity stake. Instead, they want
and are getting both.

"In the beginning TMC thought they could lower the commission schedule in exchange
for equity," says master agent Rick Sheldon, co-founder, Intelisys Inc., Petaluma,
Calif., the largest participant in the TMC equity program. "But they soon found that
agents need to have equal commissions and the bonus on the sale, so along with the market,
they lowered rates but kept the commissions the same."

Wheel of Fortune
Agent Equity, Cash Options Run Gamut

As the early entrants, TMC and UniDial Corp., Louisville, Ky., often are criticized for
the structure of their groundbreaking programs. UniDial, which offered the first agent
equity program in 1994, is chided for its $25,000 "franchise fee" and unrealized
promises for an initial public offering (IPO). TMC is attacked for its monthly revenue
commitments ($50,000 per equity earnings level) and its multiple goals (10 times monthly
revenue), both of which are considered by some to be unrealistic in today’s market. While
UniDial’s program was closed to new applicants in April 1997, it and TMC’s continue to be
held up as benchmarks for those that have followed. And there are many. So many, in fact,
that the equity option is becoming an expectation.

"I don’t think you can compete as a small reseller without it unless you have some
other unique advantage," says agent Sheldon.

On a Roll

One of the first copycats was a program offered by Telecorp Ltd., Hewlett, N.Y., which
was uniquely developed by master agents Gene Foster, president, Communication Management
Services (CMS), San Diego, and Daryl Heller, president and CEO, Premier Telemanagement
Corp. (PTC), Lititz, Pa. Introduced in spring 1998 to a standing room- only crowd
attending the AgENt Conference & Expo in San Diego, the program is built around the
idea of selling the distribution channel rather than simply the customer base. Foster
claims that more than 20 agents representing some $28 million per month in billing have
committed a portion of their business to the program as of summer 1999.

Positioning the channel as part of the value equation has become a significant part of
other equity programs as well. TransNational, for example, rolled out a program in April
that includes what now is known as an "evergreen clause." An evergreen clause is
a provision in the agent contract that ensures agents will continue to receive their
residual commissions following the sale of the company. TransNational’s Twomey explains
that the provision assures the buyer that the channel is not going to abandon the
customers it just acquired, minimizing churn that can result following an acquisition.

For some agents, the clause confirms their contention that even though the customers
belong to the carrier on paper, at the end of the day their loyalties lie with the agents
who service their account.

Nevertheless, some carriers question the logic of including such a provision. If you
are bought out, you are bought out, they say. Furthermore, they add, as a form of equity,
it amounts to being paid twice. "The person who invented the evergreen clause never
dreamed of equity," says Brian Sledz, president of reseller Connect America,
Naperville, Ill. "Getting paid forever was equity."

Others are wary that it may make them less attractive to a buyer, which may not want to
continue to pay commissions that can be 10 percent to 15 percent right off the top.
"I would look closely at any entity that offers an evergreen clause," says TMC’s
Richardson. "It is undermining their ability to gain a high multiple. That said, if a
buyer just paid $30 million, they are going to do whatever it takes to keep that
investment, even if it means continuing to pay commissions."

Lower Ante

Other programs lowered entry thresholds and incremental earnings requirements to meet
the needs of smaller agents, or to answer objections from agents unwilling to put all
their eggs in one basket. According to Randy Berlin, president of discountcall.com,
Atlanta, and an agent for ATCALL, Vienna, Va., early programs were forcing medium-sized
and small agents to ally with one carrier more than another. "You would normally
divide your business equally among two or three carriers, but splitting 80/20 to qualify
for equity makes me nervous," he says.

TransNational’s Twomey says his company’s program was designed with this in mind.
"Our program focuses on new business brought in," Twomey says. "They can
grow it with relatively small levels of incremental business. A number of plans have
$50,000 increments. I don’t believe it’s realistic for most agents. We focus on what’s
truly attainable."

TransNational’s program requires a minimum $60,000 monthly revenue commitment in
exchange for up to 15 percent equity. However, each quarter, additional points are added
based on incremental revenue, starting at 1 percent for $15,000 earned per quarter and a
half percent for each additional $5,000 per quarter.

Another program, introduced by Connect America in conjunction with master agency
Visioncom Inc., Minnetonka, Minn., allows for agents to combine small revenue levels to
achieve a higher multiple percentage. If the group volume is $150,000 per month, an agent
who turns up only the minimum required $20,000 per month still would receive the 50
percent multiple percentage earned by the group. Likewise, if the group volume was more
than $250,000 per month, the agent would receive 60 percent of the multiple on its $20,000
sales volume. In addition, agents that can’t meet the $20,000-per-month minimum can become
a subagent for Visioncom to qualify for 70 percent of the achieved multiple percentage of
the group.

High Stakes

Yet another group of programs has emerged that offers not a multiple percentage, but
stock options themselves. The board of directors of multinational carrier PRIMUS
Telecommunications Group Inc., McLean, Va., approved Dec. 16, 1998, an equity program for
the company’s agents in the United States, making it the first publicly held carrier to
make such an offer. The company has reserved 500,000 shares for the program, which rolled
out in January.

A spokesman for the company says PRIMUS offers agents a billed-revenue contract with a
fluctuating commission schedule plus the ability to earn stock equivalent to 10 percent of
the quarterly revenue share growth. Agents must cross a $75,000 quarterly revenue
threshold to participate, and revenue growth must be $15,000 or greater than the previous
quarter. For example, the spokesman says, an agent earning $75,000 in the first quarter
and $95,000 in the second quarter would qualify for 10 percent of the revenue growth
($20,000), or $2,000 in stock. The stock vests after two years. The vesting period is
accelerated if PRIMUS is purchased, so agents will not lose their unvested stock.

After its first full quarter in operation, the PRIMUS agent equity program already has
several participants who have earned stock certificates, according to the spokesman.
"It’s not a multiple of the base. Agents get stock based on the value that it was at
the time it was earned," he says.

A similar program debuted in April from PaeTec Communications Inc., a competitive local
exchange carrier (CLEC) and interexchange carrier (IXC) based in Fairport, N.Y. PaeTec
plans to issue approximately 800,000 warrants to agents before its IPO, which is set for
the next eight to 12 months. Stock options are granted at the current stock price on the
date agents achieve set performance thresholds. At $50,000 per month, agents receive 2,500
warrants; at $100,000 an additional 5,000 warrants and so on. Agents become vested over
four years.

Calling the Bluff

Like a double-edged sword, the demand for equity has given agents dozens of different
programs to choose from, but it also has made the decision more complex (see Bettering the
Odds, below) and has piqued suspicions about the motives for me-too offers.

"Now that so many resellers have tacked on an ‘equity’ option to their agent
program, there is a lot of confusion about which plans are really legitimate," TMC’s
Richardson says, adding that agents have a right to be skeptical since some are just
"paper-based offers" not backed by the experience or the plan to make it happen.

A spring poll of agents conducted by the Independent Agent Network (IAN), Baltimore,
and published in the June issue of PHONE+ found that most agents were confused by the
equity proposition. One agent agrees. "Agents are confused by equity offers from
carriers," says discountcall.com’s Berlin. "Are they in line to be bought, or
are they just begging for business?"

The IAN agent poll, which included responses from 604 agents, showed that more than
half (54 percent) believe that equity participation would not pay off. More than
one-fourth (27.3 percent) weren’t sure, and only about one-fifth (22.3 percent) felt
certain that the payoff would be there.

"Agents will remain somewhat cynical until a provider actually pulls off a
sale," Richardson says.

So far there have been no sales, or IPOs for that matter. The closest thing to an
equity event was a special distribution made by UniDial to its agents in October 1998.
Following a $27 million cash-for-equity injection from the Williams Network, Tulsa, Okla.,
UniDial offered the distribution to agents participating in its original "Bonus
Program," which offered agents 25 percent ownership of their base for a $25,000
agency fee. The program was discontinued in April 1997. Agents were offered the choice to
remain under the original program or opt for an accelerated payout schedule and a reduced
bonus upon the sale of its accounts to 21.875 percent. A third option eliminated an
agent’s rights to a bonus commission on the sale of its accounts in exchange for a refund
of the agency fee paid. More than 200 agents were eligible for the special distribution,
which UniDial estimated to be $8 million to $10 million.

UniDial’s Director of Business Development Clay Masters claims that the company is
attracting agents of a higher caliber as a direct result of the distribution. While the
company itself no longer offers equity, UniDial has managed to convert the leads anyway by
referring them to master agents who agree to bring subagents under their agreements with
UniDial.

If the UniDial experience is any indication, a positive disbursement may buoy agents’
confidence in the equity proposition. On the other hand, a negative outcome could send
them running.

Not everyone thinks that a poor showing by an early-exiting reseller will have
widespread impact. As in the stock market, says UniDial’s Senior Vice President Henry
Hunt, "When companies of like nature have trouble, there will be some degree of
fear." But, "We don’t have that fear in the telecom industry," he says,
noting that the value of technological companies has been strong.

Still, says one master agent, "The first couple that go through will tell the
story for the rest."

Winning Hand

The real trick for agents is allying with the company most likely to succeed. And that
is no small undertaking, requiring an evaluation of the company’s business plan,
management team and financial status.

"The road is littered with many a reseller and facilities-based carriers that
didn’t make it," Richardson says, adding that this history may make agents wary.
"If they do their due diligence and partner with someone that has a track record …
they are hedging their bets."

A track record, Richardson and others say, means prior experience building telecom
companies for sale.

"If you are going to have equity in a company, it boils down to trusting that the
company has the wherewithal, the contacts and the synergies to move forward and create
value," Hunt says.

Are they a sinking ship or a rising star? That’s the question agent Praske and partner
Bill Power, ARG’s president, ask themselves before hitching the future of their growing
master agency with a particular company. In addition to evaluating the company’s ability
to deliver products, support, services and competitive commissions, Praske says he
considers whether the company has a realistic chance of realizing its goal.

The goal itself can be a sticking point. Some resellers have been accused of peddling
pie-in-the sky sales multiples. "There is rampant misinformation that resellers are
going to sell for 10 to 15 times monthly revenue," says Connect America’s Sledz,
adding that he spends a lot of his time trying to dispel the rumors.

While it’s true that values have declined in the past, the news isn’t all bad. Value
ranges for long distance companies are holding and are even better if the company has
deployed other services, says valuation consultant Casey Freymuth, president of Group IV
Inc., Phoenix, and publisher of "The Telecom Service Provider: How Much is It
Worth?" "A year ago the question was, ‘Where were values going to bottom out?’
when, in fact, they already had," Freymuth says. "Bundling at the very least
keeps companies off the floor [of the value range]. At the most, it represents an
opportunity to recapture the value that was lost in this segment." (See The Bottom Line.)

In broad terms, Freymuth says the range of monthly revenue multiples is holding at
between four times and 12 times, with the bulk of transactions falling in the
five-times-to-nine-times range.

As Freymuth suggests, many resellers are adding additional services in an attempt to
bump up their multiple. TMC, for example, has added data services such as private line,
frame relay, dedicated Internet access and integrated access products to its portfolio in
an effort to reach its target. "We are about halfway (or approximately 18 months) to
the goal of being able to achieve the maximum possible multiple," Richardson says.

Agents remain concerned about what is going to attract a buyer, questioning the
salability of resellers and carriers that continue to pay high (e.g. 20 percent-plus)
commissions on low rates (7.9 cents per minute). "If a reseller has a book of
business that’s not profitable, why would you want it? I understand that question,"
Praske says, noting, however, that Telco Communications Group Inc., Washington, was in a
similar situation when it sold in June 1997 for $1.2 billion. Today, a CLEC might be
interested in acquiring the customers of a long distance reseller purely as a ready base
for its local services, he notes.

In fact, the needs of the buyer do weigh heavily on the final multiple that is paid.
But, says Chris Edgecomb, chairman and CEO, STAR Telecommunications Inc., Santa Barbara,
Calif., those needs are changing. "The market has changed," he says. " It
used to be with companies that were more regional, i.e. West Coast Telecommunications
(Inc.) or even LDDS (WorldCom, now MCI WorldCom Inc.) and others, that we were acquiring
bases around the nation to extend our reach. But they’ve already done that. Now when
someone buys a base, they’re looking for a new type of product … they’re looking to pick
up a different distribution channel."

In addition, he says that fewer and fewer small customer bases are being purchased.
"You don’t see the giants buying $10 [million], $20 [million] or even $30 million
companies; it just doesn’t do them any good," he says. "Once you do $1 billion a
year in revenues, acquiring a small company does not change your earnings one bit."

Perhaps because of such uncertainty, agents have gone in search of a sure thing. And
many carriers and resellers seem willing to oblige. The fare ranges from bonus programs to
guaranteed buyouts and, in one case, an arrangement called a "pre-buy."

Bonus programs are not new, but they’ve taken on new potency as an alternative to
equity programs by offering agents a lump payment after a certain revenue threshold is
reached. One such program was launched in April by One Star Long Distance, Evansville,
Ind. Created by the company’s new Agent Sales Manager Rick Ribas, a former master agent,
the program offers agents a bonus after one year. For achieving monthly billings of
$25,000 to $50,000, they are paid 25 percent of their billings–half at one year and half
six months later. For billings of $50,000 to $100,000, agents receive 50 percent, and for
billings more than $100,000 per month, they receive a dollar-for-dollar match.

Ribas says that because of its bonus program, One Star has signed more business in the
past two months than in the previous six, and it has added back-office staff to handle the
increase. "We had (and still have) an equity program, but no one jumped on it,"
he says, "because it only mattered if One Star sold."

That lack of control was cited by agents as a disincentive to equity participation in a
survey commissioned by ATCALL in April. An independent research firm polled 40 agents and
found that many had not yet allied themselves with an equity program because they are
based not so much on the agent’s performance, but on that of the reseller or carrier.

"We wanted to give agents as much control as possible," says ATCALL’s Vice
President-Subscriber Services Jason Schnur. "[With an equity program], they don’t
know what the multiple will be or what our profitability will be."

This summer ATCALL is rolling out its bonus program. Unlike One Star, ATCALL awards
bonuses at $20,000 per month billing increments. So, at $20,000 per month, an agent gets a
check for $5,000, at $40,000 per month, $10,000, and at $60,000 per month, $15,000 and so
on.

Agent Berlin says he has opted for the ATCALL model. "No other company has been
able to commit, [to give me] something concrete to build my business around."

In fact, some agents are doing quite well off bonuses. Praske, for one, says 20 percent
of ARG’s income last year was attributable to bonuses. He understands why a majority of
agents would be attracted to the immediacy and control offered by bonuses, but says they
"can’t compete with what we could get on the equity play."

Agent Sheldon agrees, noting that at the equivalent of perhaps one-time-monthly
revenues, a bonus does not come close to what he and his partner Rick Dellar expect to
gain from their equity stakes. "We would not trade one for the other. We’d rather
take the risk," he says. "We are building our business on the residual. The big
win is a side-bet."

Minimizing Risk

Like performance-based bonuses, buyouts are offering agents a guaranteed payout that
equity programs don’t. Under its plan, for example, Connect America will purchase the
revenue stream from an agent no later than October 2000 if Connect America is not acquired
by another carrier. "I’m a built-in buyer," CEO Sledz says.

The purchase price is calculated at present value. "If an agent earns $10,000 per
month in residuals, I determine how much he will have earned in the next three
years," he says. "So, I look at the present value of the stream of cash, which
is $10,000 times 36 months, and that ($360,000) is the payout."

STAR, through its retail arm ALLSTAR, also is poised to offer a buyout, or what it
calls a "put" contract. "A put contract works in a similar manner to a put
option in the stock market. The agent has the right to PUT the base to us at any
time," CEO Edgecomb says. Therefore, with ALLSTAR’s put option, the agent does not
have to wait for the company to sell, go public or effect a material change of control to
cash out.

In another twist, the designers of the Telcorp equity program are circulating the
notion of a pre-buy. In this scenario, a buyer would be lined up, not for the agents’ base
but for Telcorp itself. The concept developed organically after Telcorp was approached by
larger carriers interested in the distribution channel the reseller was developing through
its equity program. (Telcorp’s stated sales goal is $5-million-per-month billing, for
which it expects to sell at a multiple of eight to 10 times monthly revenues.)

Foster says four of the seven largest carriers now have met with Telcorp to discuss the
unique arrangement. By September, Foster expects Telcorp to have made public an agreement
with a carrier or pair of carriers.

On the surface, the pre-buy model has a chicken-and-egg quality–the distribution
channel is required to attract the buyer, but the buyer is required to attract the
distribution channel–that seems to try to cheat the system, to circumvent the natural
order of a consolidating marketplace.

Foster is not concerned about not having the traffic in hand and says neither are
Telcorp’s suitors. He says the pre-buy has performance-based triggers by which
distributions will be made to the agents at one year, two years and three years after the
acquisition at certain multiples, based on preset billing targets. "If we only reach
$3 million a month in billings at one year, we get nothing," he says.

Besides CMS and PTC, ARG is one of the agencies signed on to the Telcorp program. ARG’s
Praske says it’s one of three such alliances the agency has made. The others are with
TransNational and a CLEC. "We fully expect to earn significantly more in equity than
in commissions over the next five years," he says.

Agent Sheldon says he’s also working for that million-dollar check, but doesn’t expect
to become a multimillionaire from its equity holdings. "Anyone who is expecting to
get rich is nuts."

That reality pill is a little hard for many agents to swallow, however. Says reseller
Sledz, "It’s difficult to explain it to them, ‘Look Joe Agent, customers you don’t
own aren’t worth much.’"

Khali Henderson is editor-in-chief of PHONE+ magazine. Copy Editor Jill Collins
contributed to this article.