The 1M/1M Deal Radar: Zayo Group

Zayo Group provides bandwidth infrastructure and neutral colocation solutions to wireless providers, carriers, enterprises, and other large consumers of bandwidth. Bandwidth is critical for these organisations to remain competitive and serve their customers, whose ever-increasing appetite for data-intensive devices and applications strains networks, prompting Time magazine to call bandwidth the new “black gold.”

The Discovery Institute’s Bret Swanson and George Gilder’s January 2008 report, “Estimating the Exaflood” estimates that U.S. Internet traffic will more than double between 2010 and 2013. With smartphones and mobile computing devices consuming more and more bandwidth each day, fibre networks no longer have the excess capacity they did in the early 2000s. Bandwidth-intensive devices and applications are compounding the capacity pinch already affecting carriers, large enterprises, and government entities. The form that this growing demand takes is not fully clear because numerous technologies appear and evolve each day. However, Zayo believes that it is clear that fibre is the most efficient medium of moving this traffic, and it is often quicker and more cost-effective for companies to lease fibre or bandwidth from companies like Zayo rather than to build new fibre routes.

Zayo CEO and co-founder Dan Caruso has witnessed firsthand the boom, bust, and resurgence of the fibre-based telecommunications sector. He began his career at Ameritech and MFS Communications, later became a founding executive of Level 3 Communications, and led the buyout with ICG Communications. Through his experience at Level 3 and ICG, Caruso observed three trends in the telecom industry: 1) the Internet was going to change everything; 2) bandwidth demand would increase dramatically; and 3) fibre would be the workhorse of the Internet. These observations and the pursuit of additional fibre-based assets and businesses were the genesis of Zayo.

At the time of the Colorado-based company’s founding in 2007, the broader telecom sector was perceived as hyper-competitive, but there was a general lack of understanding of the supply-and-demand dynamics of individual industry subsegments. Most investors and even industry professionals were still blinded by the overcapacity and meltdown of the early 2000s, missing a more nuanced reality. While larger players like Level 3, Qwest, and XO Communications continued to struggle, many smaller niche providers were finding success.

Zayo’s early strategy was to identify and acquire smaller providers that had unique fibre and other network assets, often in secondary and regional markets. The competitive dynamics in these markets were attractive because supply was more limited, yet the same demand forces (high-bandwidth applications, mobile broadband, cloud computing) were occurring as they were in tier 1 markets. Zayo then focused on developing these assets into simple, building-block bandwidth infrastructure products to market to a discrete, generally wholesale customer set.

Today, the public and private investment communities better understand and differentiate the various subsegments and players in the broader telecom market. The “bandwidth infrastructure” sector has received increased attention – and valuations – in the past 12–18 months, and the competitive environment for fibre-to-the-tower and similar services has only increased. Zayo now sees four other comparable bandwidth infrastructure pure play providers with a critical mass of business – AboveNet, Sidera, Lightower, and Fibertech. Given its base of unique assets and markets, Zayo is confident of maintaining a healthy supply/demand dynamic and profitable growth trajectory.

Zayo’s business model is based on leveraging its fibre network assets in the markets in which it operates. The company generally charges a recurring fee for these services under long-term customer contracts. It then uses its operating cash flow and access to capital to reinvest in these network assets to drive expansion and growth. Pricing is often transaction specific, and there is no standard price sheet for all solutions because the requested solutions are often customised and the supply/demand dynamic is very local, often varying even within a specific market.

The top target segments include wireless customers (29%), national carrier/ISP (24%), and public sector/enterprise (14%). Zayo’s wireless products include Antenna Infrastructure Solutions (AIS), Direct Connect, Hub Site Backhaul, Tower Backhaul, and Regional Transport Backbone. Running a close second to wireless solutions are those provided to the national wireline carriers. Zayo provides products designed to transport voice, video, storage, and data traffic for regional, national, and international communications service providers. Additional segments are PTT, regional carriers/ISPs, RLEC, CATV/satellite, media/content, resellers, and data centres/disaster recovery/tech. The product mix, as of FY1Q11, includes: 49% Sonet/Digital Signal, 12% Ethernet, 10% Dark fibre, 7% Wavelengths, 6% Colocation, 4% Access, 4% Interconnect, 3% Other, 2% Voice/Data Bundles, and 2% DIA.

As of FY1Q11, out of 2,074 customers, Zayo’s top 20 customers maintained 56% of the monthly recurring revenue (MRR). Its top 10 customers maintained 43% of the MRR, and specifically, its #1 customer maintained 11% of MRR, the #2 customer 9%, and the #3 customer 7%. Zayo’s top strategic customers include 12 Fortune 500 companies, and the company provides services to all of the nation’s major wireless carriers.

Zayo has raised more than $838 million in funding: angel funding from Dan Caruso and John Scarano in 2007; a $220 million Series A from Battery Ventures, Centennial Ventures, Columbia Capital, MC Venture Partners, and Oak Investment Partners in 2007; $180 million in bank debt in 2008; an $88 million Series B from Charlesbank Capital Partners, Morgan Stanley, and previous investors in 2009; about $350 million in secured senior note offerings in 2010; and a $100 million undrawn credit facility. The company has significant cash flow and does not need to raise more money at this time, but future capital programs, acquisition opportunities, investor liquidity, or exit needs may require additional access to the public or private financial markets.

Zayo’s revenue for the quarter ending September 30, 2010, was $68.8 million. This equates to $274.3 million and $107 million of annualized revenue and adjusted EBITDA, respectively. These results reflect the inclusion of AGL Networks, which the company acquired on July 1, 2010.

Zayo’s strategy to capture bandwidth demand is to remain focused on providing core bandwidth infrastructure services to its customer partners in those markets where it has the assets to leverage for that purpose. While there are no plans for an exit at present, the company maintains a proactive dialogue with all investor classes. The most likely medium-term scenario would be an exit or liquidity need by some or all of Zayo’s current investors, leading to either an IPO or recapitalization with another private equity investor. Zayo’s management is also open to discussions with strategic buyers but views that path as less likely given the current lack of any obvious buyers. The company does believe that further consolidation is both healthy and inevitable.

In the 1M/1M Deal Radar series, we celebrate entrepreneurs who have reached at least $1 million in annual revenue. It is part of the One Million by One Million (1M/1M) global initiative.

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