Metro Special: The key questions facing metro CEOs
11 May 2012 | Richard Irving
Metro providers are to face more than their fair share of challenges over the coming months, from a new wave of consolidation that promises to reshape the competitive landscape, to a shortage of fibre coming out of Japan. Capacity invited four of the industry’s most influential thinkers to share their thoughts on the key themes facing them.
President and CEO
President and CEO
CEO and founder
Judy Reed Smith
Are we heading for version 2.0 of the tech bubble?
Shanahan: The metro fibre providers of today operate in a completely different environment to that which was prevalent in 2000, when an enormous amount of money went into speculatively building out intercity fibre networks. Today, both gross margins and EBITDA margins are high and the majority of capital expenditure is pegged to success-based projects. The business fundamentals and the economics of the metro fibre markets are extremely attractive and will continue to be going forward with IP traffic and metro and WAN Ethernet expected to grow at compound annual growth rates of 26% and 35% respectively.
Caruso: Our industry is in a much healthier state than it was around the time of the Tech and Telecoms bubbles. Firstly, bandwidth demand is real, large and growing - nearly every person and business in the United States will consume more bandwidth in 2012 than they did in 2011. Secondly, there has been a tremendous amount of consolidation, which has resulted in fewer, but healthier, providers who are demonstrating good financial results. There is no reason to believe that things will change for the worse.
Miller: Today companies are running their businesses by focussing on their core competencies and the return on invested capital. The basis for continued growth is centered around the explosion in demand for bandwidth, which was not really prevalent ahead of the last telecoms crash. I see no evidence of a slump from where I sit today.
Reed Smith: Most metro fibre players consider expansion moves far more carefully before committing to a new capital-intensive project, unlike the build-it-and-they-will-come era. Many of today’s mergers target geographic and customer diversification in ways that drive genuine synergies in scale and scope, as opposed to scale-at-any-cost.
Q: Where is the metro market heading in terms of the build-versus-buy debate and where are the hotspots for greenfield fibre construction?
Caruso: I don’t believe there are compelling economics or available capital to overbuild the core networks that were built in the US in the late 1990s. However, expanding these networks to new sources of bandwidth demand can be very attractive and I envision ongoing investment to help precipitate this. Zayo is committed to offering dark fibre solutions as well as lit solutions, providing customers with a compelling economic argument to “buy” rather than build their own solution. Having said that, we have seen a few situations where the fibre infrastructure was not available to meet growing bandwidth demand and Zayo has committed to building new networks in those markets.
Reed Smith: Hotspots for build-outs include areas requiring wireless backhaul capacity and routes that can support ultra-low latency capacity, especially longer-haul routes between financial centres such as New Jersey and Chicago. However, the number of customers engaged in high-speed trading is limited and metro operators would be wise to consider the long-term sustainability of higher-margin, low-latency services if the playing field becomes too crowded.
Shanahan: Large-scale metro fibre construction can be prohibitively expensive and time consuming making the barriers to entry very high for greenfield builds. Competitors looking to buy scale must therefore resort to buying assets but the challenge is to find a provider who will sell dark fibre to a rival. It is unlikely that we will see any meaningful greenfield expansion in the more established metro markets in the future.
Miller: The metro markets are clearly heading towards the buy-versus-build end of the spectrum but there are some anomalies that can blend the rationale. Build projects are typically limited to extensions of the network backbone and aimed at bringing more locations and more buildings on to the network. Greenfield hotspots, such as they exist, typically relate to expansion projects where providers might be looking to push out from the central business district to more rural locations.
Q: Is the metro market keeping pace with demand for capacity in general and the roll-out of LTE in particular?
Miller: Absolutely. The build-out for LTE is largely complete in my opinion. The next big push to keep up with the delivery of wireless bandwidth is in semi-rural and rural areas.
Caruso: Recent studies project that wireless demand will grow by 82% annually over the next five years, fuelling considerable demand for bandwidth capacity. The wireless market is extremely important to Zayo and we continue to see new opportunities to serve that space. I believe we are keeping pace with the level of investment our customers are willing to support although they are facing a huge demand challenge.
Shanahan: Scalable network electronics should enable fibre providers to meet the growing demands of the market particularly among fibre providers who can offer a dense and high fibre-count network. Meeting the bandwidth demand for LTE should not be an issue provided that the provider has fibre connectivity to the tower, aggregation PoPs and MTSOs.
Q: How should metro players embrace the cloud?
Caruso: Metro providers need to pay attention to how customers are using the cloud. Our opportunity as an industry is to create an Ethernet platform that advances cloud computing and cloud storage, creating the right experience for customers that gives them scalable and secure access to virtual computing facilities. As the “Ethernet cloud” evolves, the infrastructure companies with the best fibre footprints and with the most strategic current and future cloud sites/data centres/server farms on-net will be in the best position to support this demand.
Shanahan: Fibre providers will have a tremendous opportunity to provide service to cloud service providers to connect directly to customers or through a shared web-based connection. The demand for bandwidth will require significant capacity at data centres, end users and cloud provider hubs as the adoption rate for cloud services grows. Cloud services will have broad sector appeal and potentially open up new customer opportunities for fibre providers.
Reed Smith: Customers are definitely coming. The timing is like any real estate deal and a game of balance: one must ride the tightrope between being ready when customers want to move in but not to overbuild and sit vacant with capital at risk.
Q: How do you see the M&A “end-game” playing out?
Miller: There will be another round of serious M&A in 2012. Several companies have reached critical mass and will need to either increase debt or seek more equity investment from new investors. Many of the companies in this space are reaching maturity and some investors are looking to capitalise on their investments. 2012 should be a banner year, certainly if investors are paying attention to the Presidential race and the tax implications that can effect wealth creation for the buyer and the seller.
Caruso: While there will continue to be consolidation, I think we are wrapping up that phase of our industry’s life cycle. I believe the industry will stabilise with a handful of larger bandwidth infrastructure providers as well as a handful of national companies focussed on providing a full range of telecommunications services.
Shanahan: I would expect to see further consolidation among larger fibre providers creating a small number of super regional or national players that may also consolidate with national and global long-haul providers. There is significant value in metro fibre assets that, if combined with larger national networks, could create a powerful end-to-end solutions provider.
Reed Smith: I don’t expect to see reckless expansion, but for companies to recognise the mistakes of the past and learn from them. Larger carriers are clearly looking to enhance networks, expand product lines and move up-market and this might prompt some to look more closely at the metro arena.
Q: What other technological advances will shape the sector in the coming year?
Caruso: There will continue to be a movement toward Ethernet and wavelengths. They each offer compelling economics for high bandwidth services. Having said that, the rumours of SONET’s demise are much exaggerated and SONET remains an important workhorse in most carrier networks. Enabling cloud computing will accelerate as a driver to new technology adoptions. Applying some of the same principles of dynamic consumption and configuration will find its way into carrier networks making it possible for customers to have the same level of network flexibility as they are getting with their computer facilities.
Reed Smith: Metro Ethernet is the chief technology shaping local access, and available in several forms. Ethernet-over-fibre will remain the ‘go-to’ technology for connections greater than 100Mb. For connectivity below 100Mb, select Stateside CLECs are rapidly scaling metro Ethernet-over-Copper (EoC) products, offering wholesale customers capacity to end-user access points. Wholesale customers targeting business customers will continue to drive demand.
Shanahan: As businesses move faster and faster to adopt the cloud, demand for metro, regional and long-haul fibre networks as well as data centre space will increase significantly. The shift from satellite to fibre for HD video transport will drive demand for fibre and data centre space and the rapid increase in all things mobile data will continue to drive demand for wireless backhaul and IP network capacity. Demand across all sectors will continue to grow and drive further expansion of the metro fibre infrastructure and data centre infrastructure.
Q: What do you feel are some of the main challenges for 2012?
Caruso: There are a lot of positive tail winds for our industry – growing demand, improving industry structure, capital availability and, hopefully, an improving economy. But none of these are as important as excellent execution. Success is a function of knowing your business, meeting your customers’ needs and executing with discipline. We have focussed on building out our management systems and tools to enable us to execute as we grow. We can never take that for granted and will remain focussed on the fundamentals.
Reed Smith: Making the right investments in: a) fibre placement and timing; b) in new technologies and product lines; and c) in scale expansion decisions. Managing customer expectations for faster provisioning times and lower pricing are key in the near-term.
Shanahan: The challenge will be to continue to deploy capital in the most efficient way and stick to the economic model that has created a healthy metro fibre business. There will be no shortage of demand from all sectors and the resurgence of fibre-based last mile providers has enabled the data centre business to flourish, broadband data to accelerate and has facilitated the growth of distributed data transport applications and solutions. As always there will be challenges building fibre in an environment of inconsistent or non-existent municipal regulation and standards for access to rights of way. As an industry we should be working together to develop clear and standardised regulations and processes.
Miller: One of our biggest challenges this year is finding fibre. The lack of fibre being manufactured in Japan has put a real strain on companies getting the fibre they really need. We are building over 3,500 miles of fibre network in 2012 and 2013, and our challenge will be centered around overcoming regulatory road blocks to meet this demand.
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