XO Admits Over-Ambition

Industry high-flier XO Communications has been forced to scale back its ambitious network buildout plans to avoid the crash landing other competitive carriers have experienced.

The company said today it will conserve its existing cash by halting plans to build a fiber-optic network in Europe and scaling back its network expansion in North America. XO will also exit the application service provider business and will no longer market lower-end digital subscriber line services to consumers and small businesses. It also announced an additional $250 million investment by Forstmann Little, one of its current investors.

XO had announced the European expansion in November, buying capacity on Level 3 Communications' fiber-optic network there as it had in the U.S. Under a renegotiated deal with Level 3, XO will apply the $128 million it has paid for the European capacity toward its North American purchase. XO will retain ownership of fiber-optic cable and conduit it has bought in North American from Level 3, but will not be buying equipment to light up that network and instead will lease long-distance services on a wavelength basis from Level 3 for the next five years. XO has also surrendered "tag-along" rights—the ability to buy future capacity on Level 3's North American network—as part of the overall deal.

These actions will "extend our cash reserves while we continue to strive for long-term profitability and shareholder value," said XO Chairman Dan Akerson in an investor-relations conference call. Akerson and Nate Davis, the company's COO, said XO remains strong and is fully funded through 2003, by which time it expects the telecom market to have bounced back.

"We have developed a five-year plan that leaves us with $1 billion capital gap," said Akerson. "Investment by Forstmann Little further reduces that funding gap. We have a variety of alternatives to meet our remaining funding needs and we have over two years time for market conditions to improve. We expect to have enough capital to fund the company well into the first half of 2003, at which point we expect to have reached positive cash flow including EBITDA and capital."

"We believe XO is one of the strongest companies in the telecom industry and we intend to come out stronger and more successful than ever before," said Davis.

XO reported total revenue of $277.3 million in the first quarter of 2001, a 10 percent increase over revenue reported in the fourth quarter of 2000, and a 162 percent increase over revenue reported in the first quarter of 2000. Data services, the company's new focus as of a year ago, accounted for $142.2 million of that total, more than the $131.1 million XO earned from voice services, which includes local, long-distance voice and other enhanced-voice services.

The company reported an EBITDA Loss of $77.1 million for the quarter, down from $88.7 million for the fourth quarter of 2000. XO's net loss per share for the first quarter of 2001 was $1.31 per share.

On the positive side, XO did well on two internally developed metrics: sales of voice-grade equivalents or VGEs, and revenue per customer. According to Davis, the company installed 3.9 million VGEs, or circuits generating revenue equivalent to a 64 kilobit per second line, and 65% of those were "on-net," meaning they traversed XO's local and long-distance network. Revenue per customer per month was $941, an increase from $916 in the fourth quarter of 2000.

The company will continue to support a full range of DSL services but has raised its DSL prices, will no longer waive installation charges and will no longer market Asymmetric DSL and IDSL, two lower cost options that appeal more to consumers and small businesses, Davis added.

It is also backing away from being an ASP, ceasing operations related to XO Interactive including its e-commerce operation.

The company will expand to only two cities this year—Cincinnati and Minneapolis—and will be conservative in adding buildings within its existing cities served.

"Our capital expenditures will be based on success," said Akerson.

Like other competitive carriers, XO has been hurt by bankruptcies of large customers in the high-tech and service provider arena, he admitted. XO is carefully watching those large customers that may face financial trouble in the future, in some cases requiring weekly checks to cover estimated bills, he said.

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in The Net Economy.