RCN: Can It Survive?
Mavis Scanlon
What Does Cable’s Nemesis Need to Do to Compete
This is a make-or-break year for RCN.
The once-cocky overbuilder’s recent history has been marked by disappointments.
Its revenue growth has been inconsistent. It scaled back its operations and halved its capital spending plans for 2001, moves that sent its stock tumbling 32%.
Despite its problems, the company has $2 billion in cash. But even with money in its pockets, RCN must execute and raise more capital in order to survive.
Even its supporters concede that RCN must meet its promises to Wall Street and improve its customer service.
While the company’s current cash reserves will fund growth through mid-2004, RCN will need to come up with another $1 billion to become free cash-flow positive, analysts estimate. That means it will need access to the capital markets.
And until it gets to that point, there will be those, particularly in the mainstream cable industry, who will argue that overbuilding just doesn’t have a sustainable business model. They’re watching RCN’s recent struggles and saying I told you so, until they’re proven wrong.
Execute, execute
First and foremost, agree analysts and investors, RCN needs to execute its business plan resoundingly well.
After its late-December retrenchment announcement, which caught many by surprise, investors will have little patience for missteps.
That means a fast and efficient integration of its back-office operations, including billing, training, provisioning of services, and customer service, is crucial.
Fully integrated systems will allow RCN to more quickly roll oat its ResiLink packages. RCN offers customers a choice of four bundled offerings, from its Bronze package that includes phone and Internet connections but no cable, to its Platinum package that includes full basic cable, several premium and pay-per-view channels, two phone lines, cable modem Internet access, and several bonus features.
Operational execution may be even more important than financing at this point, one shareholder says.
“I would rank [execution of the business plan] higher than financing,” says Peter Doyle, chief investment strategist at Kinetics Asset Management and co-portfolio manager of Kinetics’ Internet Fund and its New Paradigm Fund. “As far as I can tell they are doing everything they said they are doing.” Although Kinetics lowered its exposure to RCN by 30,000 shares in the fourth quarter, it held more than 2 million as of Dec. 31, according to LionShares.com, a Web site that tracks equity ownership.
Also paramount for RCN will be showing consistent quarter-over-quarter growth in both service connections and revenue.
Ultimately RCN’s goal is to increase the proportion of customers connected to its services via its own fiber optic network compared with those connected to the facilities it leases from third parties.
It has shown strong growth in this area. At the end of 1999, about 23% of RCN’s 947,305 connections were on its own network, what it calls “on-net.”
That percentage grew to 42% as of Dec. 31, but the company has not been specific as to when its on-net connections will be greater than its “off-net” connections. This is important as RCN derives more revenue and a greater margin from connections on its own network. Merrill Lynch estimates RCN will expand its onnet connections to 98% of total connections by 2009.
Some analysts also question whether RCN can meet its stated target of 30% revenue growth this year while adding to its work force and slashing expenses.
Manuel Recarey, VP-equity research who follows RCN at Fahnestock & Co., says that while he thinks the company has a “big opportunity” over the long term, he has kept his hold rating on the stock. He does not understand how RCN will grow revenue by 30% fourth quarter to fourth quarter, on the heels of the company’s higher-than-expected operating losses.
Revenue grew to $405.4 million in 2000, up 20.7% from 1999. For the year, RCN’s selling, general and administrative expenses ballooned to $552 million from $313 million in 1999.
Recarey, for one, sees a tough road to cutting expenses, especially in light of the marketing RCN must do in competitive markets such as New York and Boston. Its competitors in those markets, Cablevision Systems and Time Warner Cable, have much deeper pockets.
At Dec. 31, RCN had 7,050 employees, and is still in growth mode. A small number of employees will be added this year, says Valerie Haertel, SVP/investor relations, but the employees growth rate will be less torrid than 2000’s near-100% increase.
Saying nay
Naysayers used RCN’s higher-than-expected costs as fodder for charges that its business plan is overly optimisitic and unworkable. The main thrust of the arguments against RCN’s model — mainly from those aligned with cable operators — is that it cannot reach its projected penetration levels within its allotted budget.
Compounding the uncertainty of the allegations is RCN’s reluctance to give specifics on the capital expenditures needed even to reach its restated goal of passing 4 million homes this decade.
RCN estimates it will spend 8900 per-home-passed to build its network, and an additional $300 per connection. On average, customers are taking, or connecting, to 2.5 services, so the average cost of its network buildout, plus connections, is about $1,650. The payout? As much as $129 monthly per customer taking RCN’s ResiLink services, Haertel says. Customers not taking the ResiLink service ante up $70 per month on average. That’s higher than the average cable customer revenue per month.
In July, Ken Hoexter at Merrill Lynch estimated RCN would need a total of $15 billion to complete its buildout to 15 million homes. In a research note, he made perfectly clear that any failure to raise sufficient funds “may require the company to delay or abandon some of its planned future expansion,” which is exactly what happened.
But even with its reduced plans, RCN is still on track to become a top-ten cable provider.
What’s unusual is that the business strategy is unproven. As John Martin of ABN Amro points out in a recent report, “there is little to no historical evidence in the United States that an overbuilder can earn adequate returns on invested capital. In fact, virtually every effort thus far has ended in a high-profile market entry accompanied by a low-profile exit.”
To be sure, Martin was not specifically pointing out RCN. Indeed, several of the overbuilder’s biggest backers are in the smart money crowd.
Smart money
The most visible is Paul Allen, who has invested at least $1.65 billion in RCN through his Vulcan Ventures. Looking at the structure of that investment, it’s clear Allen has taken a long-term view.
Vulcan’s cash infusion, finalized in February, 2000, bought it 1.65 million shares of preferred stock, which are mandatorily convertible to RCN common stock within seven years at $62 a share. At Dec. 31, Vulcan owned 22.2% of RCN’s preferred shares, and 3.9% of its common stock.
Hicks Muse Tate & Furst owned 5.7% of RCN’s preferred shares, while strategic investor Level 3 Communications owned 30.8% of its common shares.
RCN supporters say its backers are in it for the long haul.
Vulcan “has proven over time they are long-term patient investors,” says a former executive at RCN. “It’s really hard to find fault with the role that RCN is stepping into in the market.”
Another RCN asset, says Doyle, the Kinetics strategist and RCN shareholder, “is what management did in a previous life.” David McCourt, chairman/CEO, ran telecom concern C-TEC since 1993, and guided C-TEC through a split into three publicly traded companies: RCN, Cable Michigan, and Commonwealth Telephone Enterprises.
Two other industry veterans, Jeffrey White and Robert Currey were brought on board to help bring RCN’s individual markets to profitability and to help read-just COSTS, says Valerie Haertel, RCN’s SVP of investor relations. In addition, RCN has shifted Mike Adams role from president/COO to president-wholesale and new product development.
Adams is overseeing efforts to leverage RCN’s network — the company uses just 15% of its total bandwidth capacity, and is looking into wholesaling the excess bandwidth to third parties as another source of revenue. For now there are no specific plans on the table, Haertel says.
Doyle concedes that, no question, RCN has had “issues.” But he applauds management’s openness in addressing those issues.
On the plus side, RCN is making inroads in the seven markets in which it offers service. From it inception, its strategy has been to target the densest areas in the U.S.
A highlight of the most recent quarter was the 30% increase in On-net additions, up slightly more than analysts predicted. That drove a 24% increase in revenue from RCN’s network connections. Of RCN’s On-net connections, 52% were related to RCN’s ResiLink product, down slightly from 54% in the prior quarter.
Positive target
RCN’s target is to bring two of its more mature markets to EBITDA positive by 2003.
RCN hasn’t given specific profitability projections beyond that, Haertel says, due to ongoing construction costs and regulatory uncertainties. “There are a lot of assumptions that go into making a bold statement like that,” she says.
Long view or no, RCN has a long way to go to climb back to $62, Vulcan’s conversion price. At $8.56 Tuesday, RCN has jumped 56% from the low of $3.87 it hit on Dec. 21 after disclosing it was pulling back its expansion plans, but is still down 87% from its March 2000 high of $70.
Even as many major shareholders were selling off portions of their stakes as RCN’s financing woes came to a head, some value investors snapped up shares at bargain-basement prices.
Tweedy Browne, for example, the 80-year-old firm known for investing in undervalued securities, purchased 1.4 million RCN shares in the December quarter, upping its total stake to 3.4 million shares, or about 4% of the company.
Then in January, several insiders snapped up shares near the lows, also boosting the stock. For now, as the company limits its expansion to existing markets, analysts will be crunching the numbers, quarter by quarter.
A big catalyst for the stock would be stellar execution of its plans this year, says Recarey at Fahnestock.
And, of course, he adds, “An overall stock market recovery wouldn’t hurt.”
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RCN
Headquarters: Princeton, N.J.
Web Site: www.rcn.com
Chairman/CEO: David McCourt
Vice Chairman: Robert Currey
President-wholesale and new product development: Michael Adams
EVP/CFO: Timothy Stoklosa
Employees: 7,050 as of 12/31/00
Fiscal Year: 2000
Fiscal Year Ending Date: 12/31/00
Sales (pro forma, in millions): $405.4
1-Yr. Sales Change: 20.7%
Ticker Symbol: RCNC
Exchange: Nasdaq
Price: (as of Feb. 21) $8.38
52-week Change: -86.5%
Market Cap: ($ millions) $724.4
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