Zayo demos the modern way to create a service provider

by Stephen Hardy

The first announcement appeared last May, when PPL revealed it would sell its optical-network based PPL Telecom subsidiary to a company called Communications Infrastructure Investments (CII). Then CII started making announcements of its own: in June that it would acquire bandwidth and services provider Memphis Networx; in August that its newly created subsidiary, Zayo Bandwidth, would acquire Minnesota service provider Onvoy Inc.; and in October that Zayo Bandwidth, touted as a �regional provider of fiber-based services,� would add Indiana Fiber Works to its portfolio. In between, CII raised $225 million in venture capital and added in November an $85 million round of debt financing. Who are these people, and what are they doing? They�re a group led by a pair of telco veterans who have demonstrated the post-bubble way to get into the networking business. You don�t lay new fiber networks�you buy them.

CII�s most recent announcement is the formation of the Zayo Group (www.zayo.com), under which it will operate three business units. Zayo Bandwidth, as its name implies, offers optically enabled bandwidth services for carriers, companies, municipalities, and educational institutions in Minnesota, Indiana, Memphis, and the northeastern United States. Onvoy Voice Services provides the traditional roster of voice offerings to LECs and other service providers, principally in Minnesota. Zayo Managed Services provides managed voice, video, and data products to customers in Minnesota, Colorado, and Ohio.

The company�s cofounders, chief executive officer and president Dan Caruso and chief operating officer John Scarano (who is also president of Zayo Bandwidth), have crossed paths several times, including coincident stops at MFS and Level 3. Immediately prior to their work together at Zayo, the two led the purchase of ICG Communications in 2004. Scarano recalls that ICG, a publicly traded bandwidth services provider, was �hurting� and available for sale. He and Caruso rounded up some investors (including Columbia Capital and MC Venture Partners, who now back Zayo) and took ICG private. After jettisoning some underperforming assets, Scarano and Caruso found themselves with a full-service competitive telecommunications provider in Colorado and another in Ohio. The units performed well�a turn of events the company�s shareholders celebrated by deciding to sell ICG to Level 3 last year.

The sale left Caruso and Scarano both richer and somewhat at loose ends. �Dan and I are operators, first and foremost,� says Scarano.

They were also feeling somewhat nostalgic for the niche ICG occupied, which had begun to turn around. �Beginning in �04, when we concluded the acquisition [of ICG], is when we noticed that pricing for bandwidth-oriented products had stabilized in general. Pricing is still decreasing, but far more gently so in the last two-and-a-half or three years than certainly in the early 2000 timeframe, when pricing was in free-fall status,� Scarano notes.

Thus, when the ICG alumni began to look for a way back into the telecommunications field, they used the healthier aspects of ICG as a model. They sought to create, in Scarano�s words, �a fiber-rich, metro/regional-oriented telecom providing simple, bandwidth-oriented services to customers�really, large wholesale customers and medium-to-large enterprise-type customers, customers that found bandwidth needs [to be] mission critical to their underlying businesses. Those were ICG�s best customers. And pricing was far less the issue than being able to provide sufficient bandwidth for high quality.�

Using their own money as well as backing from investors such as Battery Ventures, Centennial Ventures, and Oak Investment Partners in addition to the venture capitalists mentioned previously, Caruso and Scarano founded CII. Since building a new network would be expensive and time consuming, the company�s strategy involved acquiring existing plant. Scarano concedes that Zayo�s resultant footprint mostly covers Tier 2 and 3 markets. This had more to do with where the Zayo team could obtain assets than an original strategic decision, he explains.

However, the management at Zayo finds the smaller markets appealing. �We actually like them a lot because there is generally less competition,� Scarano says. �There is generally recent, meaning in the last five to eight years, build-out, so the assets are new.�

But even if the assets are new, sometimes the systems attached to them won�t support Zayo�s growth projections. Scarano says that Zayo generally attempts to leverage existing equipment for as long as possible. Sometimes that involves moving systems with limited expansion potential from high-growth routes to quieter locales.

However, this strategy will only take Zayo so far, Scarano admits. �We believe that demand is going to continue to grow at geometric rates, and as a result, equipment will need a pretty complete refresh in most platforms,� he explains.

Currently Zayo tends to avoid issuing requests for proposals when it needs new equipment; the company�s engineers are �pretty familiar� with current system capabilities, Scarano says. �We�re likely to use more equipment from vendors that are in place, although newer versions, than we are likely to go to new vendors altogether,� he adds.

Scarano says that the recent debt facility puts them in a position to shop for more assets, a process he anticipates will focus more on deepening Zayo�s current footprint than expanding into completely new areas.

The company has several acquisition discussions underway but isn�t focusing on them to the exclusion of other expansion avenues. �We have multiple tens of millions of expected incremental investment, capital expenditures, planned for our �08 horizon to extend the reach of in-place network and increase capacity of in-place network. So that is our first and foremost emphasis, and incremental acquisitions are secondary in terms of priority,� Scarano says.

Whatever they decide to do, Scarano says that he and Caruso established Zayo with an eye toward a longer-term commitment than they experienced at ICG�the sale of which �we regret, by the way,� Scarano says. �We�d like to have that business back.�

Stephen Hardy is the editorial director and associate publisher of Lightwave.

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