Deal Summary Memorandum | |
| |Maria-Fe Arribas, Derek Bly, Carolina Ratto |
|Deal Team Members: | |
|Date: |4/09/12 |
|Company Name: |Horizon Communications |
|Description of Idea: |Provide local switched telecommunications services to targeted sectors of the market. These sectors include high margin |
| |corporate applications, custom internet access offerings and strategic alliances with value added resellers of its services.|
|Stage/Opportunity: |Start-Up Stage. Horizon has developed its network architecture and strategy but has yet to implement. |
|Business Description: |Invest in state-of-the-art-switching platform capable of providing services offered by the incumbent carriers. Horizon would|
| |design its switches to meet the needs of its specific target markets and engineer them to handle high volumes of traffic. |
| |Minimize capital expenditures by foregoing the construction of costly fiber optic transmission facilities; lease instead. |
| |The factors would ensure a capital investment structure per access line less than half of the incumbent local exchange |
| |carriers, while minimizing the risk of stranded investment. Functionally Equivalent, Technically Superior, Low Cost local |
| |telecommunications services. |
|Macro Industry Structure: | On February 8, 1996, the Telecommunications Act of 1996 (the Act) was signed into law, |
| |opening the door to competition in the local telecommunications market -- a market with close to |
| |$100 billion in annual revenues. The Act required existing carriers -- known as local exchange |
| |carriers (LECs) -- to: (1) sell interconnection to each part of their network at reasonable prices; |
| |(2) provide existing rights-of-way at reasonable prices; and (3) pay reciprocal compensation for |
| |calls to new competitors -- referred to as Competitive Local Exchange Carriers (CLECs). The |
| |Act, therefore, opened the local loop to competition, ending the last non-competitive remnant of |
| |the once vast monopolistic empire of AT&T. Previous changes to telecommunications law had |
| |spawned or expanded multi-billion dollar industries such as equipment manufacturing, long |
| |distance and wireless telecommunications services. |
| | |
| |The local loop is dominated by the networks of LECs. In a metropolitan area, the LECs |
| |would have a large number of wire centers (e.g. 130 in the Chicago area alone). The locations of |
| |these sites were dictated by the electrical properties of copper wire (which is still the |
| |predominant medium used in the local loop for switched services). Within any wire center, there |
| |might be several switches or "central offices" directly serving customers. Thus, the switch that |
| |served any given customer was predetermined by geography, rather than marketing potential. For |
| |a customer to be served by another switch (to change or avoid changing phone numbers, to |
| |reduce toll charges or for protection in case the customer's primary switch were to fail), a huge |
| |premium known as a foreign exchange charge is typically applied. |
| | |
| |There are over 150 million switched access lines in operation nationwide. Local |
| |exchange carriers generate over $80 billion per year in revenue from these lines. (They |
| |generated additional revenue of about $20 billion from private line services, yellow pages, and |
| |miscellaneous sources.) On average these carriers had EBITDA margins in excess of 43% and |
| |operating margins in excess of 23%. Switched access lines had grown at a compound annual |
| |growth rate of nearly 4% over the past three years, and usage (as measured by interstate minutes |
| |of use) had grown at over 8% per year over the same period. Exhibit 1 provides some |
| |information on the historical growth of LEC access lines. |
| |Another indicator of the growth of the industry was the |
|OUTSIDE |
|(O) Opportunity? |Large market potential and signing of Telecommunications Act opens the door for new venture and reduces barriers to entry. |
|A- | |
|(U) Uncertainty? |Leasing of access lines. Expecting 50% higher revenue per line from an imbedded capital investment less than half that of |
|B- |the incumbents. |
|(T) Team? |Strong proficiency in Telecommunications operations, but lack of entrepreneurship side, eg. Making money for investor, |
|B- |business start-up etc. |
| | |
| |Robert C. Taylor, Jr. - President and Chief Executive Officer |
| |Mr. Taylor most recent position was Vice President, Strategic Business Operations and the Chief Operating Office of the |
| |Mexican operations for MFS Telecom Companies. At the time, MFS was the largest CLEC in the U.S. In the first of these |
| |positions, he operated and managed the Global Services Group which included MFS' 50 largest customers. Responsibilities |
| |included developing marketing strategies, business analysis, budgeting, compensation plans, financial reporting, sales and |
| |revenue forecasting and contract management.. As head of the Mexican operations, Mr. Taylor managed the day-to-day |
| |operations, negotiated construction and vendor contracts, right-of-ways and building access agreements within Mexico City. |
| |Previously, he served as a regional director of development for MFS, as a vice president of marketing for McLeod |
| |Telecommunications Group (a successful Iowa-based CLEC), as a corporate development staff member for MCI, and as a director |
| |of new product development for Ameritech. Mr. Taylor has a BS in Mechanical Engineering from the University of Denver (1985)|
| |and an MBA in Management and Finance from the University of Chicago (1990) |
| |John R. Barnicle, Executive Vice President/Chief Operating Officer |
| |Mr. Barnicle was Vice President of Marketing for MFS. In that job, he was responsible for product management, product |
| |development, sales support and business analysis for the subsidiary of MFS Communications which provided services to large |
| |end users, long distance carriers and Internet service providers. Prior to this, from 1994 to 1995, he worked for Duff and |
| |Phelps as the analyst responsible for providing credit ratings on public bond issues of telecommunications firms. From 1992 |
| |to 1994, he was a director of product development for MFS Telecom. In that role, he developed MFS' |
| |collocation/interconnection business. His duties included development of company strategy, regulatory filings, and |
| |negotiations with ten major local exchange carriers. He also developed MFS Telephone, the subsidiary which sold switched |
| |services to large end users and wholesale customers. Before joining MFS, Mr. Barnicle held a variety of positions with |
| |Centel. Mr. Barnicle earned a BS in Electrical Engineering from the University of Illinois (1987) and an MBA in Finance from|
| |DePaul University (1995). |
| |Joseph Beatty - Executive Vice President/Chief Financial Officer |
| |Most recently, from 1994 to 1996, Mr. Beatty was an investment analyst at Nations Bank, responsible for investment research |
| |coverage of the telecommunications industry with a concentration in the CLEC segment. The duties of this position included |
| |providing support to trading and investment banking professionals, advising investors, and maintaining contact with |
| |management teams of companies in the telecommunications sector. From 1992 to 1994, he worked for Duff & Phelps as an analyst|
| |responsible for providing credit ratings on public bond issues of telecommunications firms. From 1989 to 1992, Mr. Beatty |
| |worked as a manager of sales engineering for Centel where he was responsible for providing engineering and sales support of |
| |business telephone services. From 1985 to 1989, he worked in technical planning for Centel. Mr. Beatty has BS Electrical |
| |Engineering from the University of Illinois (1985) and MBA from the University of Chicago (1989). |
| |Brian F. Addy - Executive Vice President |
| |From 1993 to 1996, Mr. Addy worked for Security Capital Group, a start-up Real Estate Investment Trust that focused on the |
| |acquisition, development and operation of bulk distribution facilities. As acquisitions officer, Mr. Addy analyzed and |
| |executed property acquisitions in Phoenix, Salt Lake City, Reno, Las Vegas, Albuquerque and Denver. From 1991 to 1993, he |
| |was the general manager of Centel Cellular Company of New Mexico, a start-up cellular telephone venture of Centel. In that |
| |position, he had complete profit/loss responsibility including engineering, customer service, sales, strategic alliances and|
| |capital program. From 1986 to 1991, Mr. Addy held various sales and operating positions with Centel. Mr. Addy has a BS in |
| |Electrical Engineering from Duke University (1986). |
|(S) Strategy and required IRR? |Highly focused, low cost strategy positioned Horizon to maximize cash flow opportunities presented by the Act. Although |
|A- |leasing fiber rather than building a network would lead to a higher operating cost per access line, Horizon’s customers were|
| |expected to generate 50% higher revenue per line from an imbedded capital investment less than half that of the incumbents |
| |leading to a superior return on capital. |
| | |
| |Horizon has identified nine primary target markets for its services: Chicago, New York, San Francisco, Washington DC, Los |
| |Angeles, Seattle, Detroit, Boston and Miami. These markets have been chosen based on market potential, regulatory climate |
| |(co-carrier agreements with reciprocal compensation terms already in place), presence of one or more alternate transport |
| |providers such as MFS and Teleport, and location (proximity to potential secondary expansion markets). The Chicago area had |
| |been chosen as the initial market for investment. After a successful launch in Chicago, Horizon would expand to the eight |
| |additional primary markets, Horizon Communications Corporation (A) 8 expansions which would require additional external |
| |financing. |
|(I) Investment? |Based on their financial projections in Exhibits 5A, 5B, and 6, the founders anticipate Horizon will need external equity |
|C |contributions of roughly $25 million over the first three years. |
| |The remaining external capital is expected to come in the form of secured financing from the vendors of its switches or |
| |other third parties. |
|(D) Deal? |Based on the ABC Term Proposal |
|B |$5mil |
| |Series A Preferred, Common Stock and Common Stock Options. |
| |Investors will purchase the number of shares which reflects a 75% ownership position. The founders will retain 25% ownership|
| |on a fully diluted basis represented by options vesting over five years. Additional options for up to 10% of the company |
| |will be set aside by the investors to help recruit a CEO and CFO for the company. All vesting will accelerate upon the sale |
| |of the company. |
|(E) Exit? |Take company public |
|A | |
| |
|(I) Idea / Industry? |Large customers often ask if MFS could provide additional local dialtone, i.e., alternative switched services. The customers|
|A |want an additional provider both to provide redundancy in case of a service disruption and to use as leverage in negotiating|
| |with their RBOC or other LEC. MFS, however, does not satisfy the demands of these customers. Before the passage of the Act |
| |and the requirement of reciprocal compensation, the economics of local switched services were substantially less attractive.|
| |With the passage of the Act, it is possible to imagine starting a company that could satisfy this customer demand. The |
| |previous juncture of telecommunications deregulation and new competitors had grown to become worth billions of dollars. |
|(M) Market/Valuation |Large market potential - close to $100 billion in annual revenues. |
|A |There are over 150 million switched access lines in operation nationwide. Local exchange carriers generated over $80 billion|
| |per year in revenue from these lines. (They generated additional revenue of about $20 billion from private line services, |
| |yellow pages, and miscellaneous sources.) On average these carriers had EBITDA margins in excess of 43% and operating |
| |margins in excess of 23%. Switched access lines had grown at a compound annual growth rate of nearly 4% over the past three |
| |years, and usage (as measured by interstate minutes of use) had grown at over 8% per year over the same period. Exhibit 1 |
| |provides some information on the historical growth of LEC access lines. |
| | |
| |Another indicator of the growth of the industry is the number of new area codes that have been introduced recently to |
| |accommodate the need for telecommunications-related services, including cellular, paging, fax services and Internet access. |
| |Area code splits were once relatively rare. During 1995 and 1996, however, forty-two new area codes were introduced or |
| |planned. These new area codes often result in customer confusion and animosity. In the Chicago area alone, the market had |
| |gone from one area code in 1989 to five area codes by 1997. |
| | |
| |About 30% of the above-mentioned switched access lines are multi-line business access lines. These lines generated revenue |
| |at nearly twice the rate per line as residential or single business lines. Thus, nearly 50% of the total switched local |
| |services revenue was concentrated in 30% of the market. In Chicago, there are over 1.2 million business lines provided by |
| |Ameritech and Sprint/Centel-IL. Based upon ARMIS data filed with the Federal Communications Commission, the annual revenue |
| |generated from these lines was over one billion dollars. |
|(P) Present Value? | |
|(A) Acceptance? |Strong customer desire for selection and non-monopolistic costing makes acceptance a high probability. |
|B+ | |
|(C) Competition? |While the Horizon team is confident of its analysis, they also realize that the Act will accelerate competition in the local|
|C- |loop, attracting many other new entrants. Several companies have already announced plans to enter the local market in major |
| |metropolitan areas targeted by Horizon. Exhibit 4 presents a detailed competitive analysis. |
| | |
| |This is an optimistic assumption by Horizon. Competition will be fast and fierce. |
| |Competition includes: CAPs, Cable TV Companies, Local Service Resellers, Wireless Local Service Providers, Electric |
| |Utilities, Local Telephone Companies and Private Networks. |
|(T) Timing? |Timing is positive. Moving quickly after the passing of the Telecommunications Act will help Horizon capture the market |
|A- |before others. |
|(S) Speed? |6 month turnaround time to be up and running in Chicago is beneficial as long as financing and estimates are accurate. |
|B+ | |
|Investment | |
|(Dollars invested) | |
|Unit Model: |The Chicago market. No proof of success yet. Fear of growing too quickly rather than focusing strongly on a few markets. |
|(Smallest unit of investment to test | |
|business theses) | |
|B | |
|Financing (Description): | |
|(Securities Purchased) | |
|Financials: | |
|(Company Case): | |
|(Partnership Case): | |
|Key Areas of Concern: |Ability of revenues to ramp up in year 4 from $99mil to $204mil in year 5. |
|Income Statement | |
|Revenue | |
|Cost Components (Specify) | |
|Key Areas of Concern: |Significant negative Cash and Marketable Securities through year 5. Significant ramp up of PPE to $128mil by year 5. |
|Balance Sheet |Negative cash and C/A through year 5 is biggest concern |
|Cash Burn | |
|A/P | |
|A/R-DSO | |
|Inventory (etc.) | |
|Returns: | |
|APV Table | |
|Discount Rate | |
|VC (Partnership) Table | |
|IRR / Cash-on-cash | |
|Positives: |Strong industry knowledge by key players. Leasing of PPE in early stages. Multiple markets for potential success. Corporate |
| |Customers. |
|Risks / Issues: |Developing market, post-monopoly. Lack of start-up experience by founders. Buy in by customers for new service. |
|Other Issues: | |
|Term Sheet Highlights: | |
|Recommendation(s): | |