On its face, the franchise agreement reached last week between the Los Angeles City Council and fiber-optic company Western Integrated Communications sounds grand.
If Mayor James Hahn approves the deal, which he is expected to do, the city will allow Western Integrated to install fiber-optic and coaxial cable and, in eight years, all city residents will get a potentially cheaper provider of slick broadband services be it voice, data or video.
All of which will provide much-needed competition to the city’s current cable systems.
Trouble is, it takes a massive amount of capital to build the kind of system that Western Integrated known by its product brand name WINfirst has promised the city. And serious questions remain about the financial stability of WINfirst, a two-year-old Denver start-up with an unproven business model.
In fact, no start-up in the ailing telecommunications sector is in good shape right now. Early stage ventures of almost any kind are anathema in the risk-averse investment community, which has lost unprecedented billions of dollars in telecom. The picture doesn’t seem to be brightening. Earnings and revenues continue to fall sector wide. The window for initial public offerings is slammed shut for telecom start-ups, and valuations of private companies in the sector have dropped off the table.
WINfirst’s venture in L.A. is particularly risky. The company is betting that once it gets Hahn’s approval and invests hundreds of millions of dollars here, there will be enough demand for its high-speed Internet access, video and telephone services to justify its costs.
“We’re taking a major risk,” said Councilwoman Janice Hahn of District 15, who along with Councilman Nate Holden of District 10 voted against WINfirst. Hahn said she was discouraged by a City Administrator Office report that indicated WINfirst did not have the capital to build out the system.
WINfirst plans to begin construction as soon as this year and have its first Los Angeles customers 12 to 18 months after breaking ground. Under the city ordinance, WINfirst must complete construction by 2009 and half the project by 2007. It is required to wire all of the city, not just the franchise areas where demand might be the highest. As a safeguard, WINfirst put up a $29 million performance bond for repairing streets in case it runs out of money before completing the project.
The network in L.A. will cost $1.5 billion, according to WINfirst president Frank Cassaza. He said WINfirst will only need to spend between $200 million and $250 million in L.A. in order for the project to become cash flow positive. At that point, Casazza said revenues would fund the rest.
Rounds of financing
The company has completed two rounds of financing one in February 2000 and one last July and raised $850 million from investors J.P. Morgan, First Union Bank, Blackstone Group, GE Capital and others.
While raising $850 million in a year is a triumph for any start-up, it’s only a fraction of the funds the company will need to complete its ongoing projects in Dallas and Sacramento and its third, proposed project in L.A.
And WINfirst has other franchise agreements with San Diego, Austin, Texas, Houston and Seattle. While it has no revenue generating projects yet, the company said it is less than two months away from launching in Sacramento.
The company’s strong investor base and its ties to Bechtel Group, Accenture and Lucent Technologies Inc. all of which have taken equity stakes are a vote of confidence in the business model and the management team a group of telecom, cable and Wall Street veterans.
Company chairman and chief executive Jim Vaughn co-founded FrontierVision Partners in 1995, which he sold to Adelphia Communications for $2.1 billion in 1999. He took several former FrontierVision executives with him when he started WINfirst.
But steller management doesn’t resolve concerns about the business.
“The question is: if you’re going to spend this money, does it cost you what it says it’s going to cost and does it meet with the level of demand?'” said Sharon Armbrust, senior analyst with Carmel-based Paul Kagan Associates, a cable marketing consulting firm.
“They have to show cash flow in order to be able to continue to borrow,” said Rohit Shukla, one of the members of the city’s Information Technology Agency, which gave preliminary approval to WINfirst’s bid. “It’s going to be mighty, mighty challenging for them.”
WINfirst insists it will have access to the capital markets as soon as the company launches commercially. Besides, Casazza said, “if capital markets didn’t change and we couldn’t raise another dime, we could become self-sufficient in three to four markets with what we have today in terms of capital.”
Not if WINfirst’s competitors can help it. The current franchise holders are formidable rivals to a start-up with no cash flow. Besides Adelphia, WINfirst must first steal customers from deep-pocketed AT & T; Broadband, AOL Time Warner (which has expressed an interest in acquiring AT & T; Broadband), Charter Communications and Cox Communications, which currently serve a total of about 620,000 households in the city’s 14 franchise areas.
Incumbents like AT & T; already are offering voice, data and video to customers and, with further upgrades, could ultimately be indistinguishable from WINfirst’s services.
WINfirst’s agreement with the City Council follows on the heels of a failed attempt by Princeton, N.J.-based RCN Corp. to build a network in five of the city’s 14 franchise areas.