CLECs Strive to Morph Into IT Providers as Legacy Products Hurt Sales

EarthLink Inc., whose 2011 acquisitions have radically transformed the company, has been growing and shrinking. It just depends on the criteria being applied.

During the first six months of the year, business services revenues grew 26 percent to $517.7 million, from $410 million, at the company once best known as a low-priced dialup Internet provider.

Dig deeper, though, and it’s evident EarthLink’s revenues from businesses have been falling, albeit at an increasingly slower rate. On a pro forma basis, adjusting for the 2011 acquisition of One Communications Corp., business services revenues decreased $25.9 million from $543.6 million during the six months ending June 30, 2011, to $517.7 million in the same period this year.

In a regulatory filing, EarthLink blames the shrinkage on “certain legacy products, including traditional voice, Web hosting and lower-end, single-site broadband services.”

EarthLink, nonetheless, has figured how to narrow its declining business sales. In the second quarter, business services revenues only fell 5 percent on a pro forma basis. That figure is down from 9.5 percent in the year-ago period.

Equity analyst Scott Kessler of S&P Capital IQ anticipates that EarthLink will boost revenues 2-5 percent annually from 2012 to 2014, thanks to growth in business services, which now comprise more than three-quarters of total revenues.

“We see notable investments in 2012 helping to build on considerable offerings and capabilities in business services,” wrote Kessler in a stock report Sept. 1.

Banking on IT Customers

EarthLink is among a group of competitive local exchange carriers that is aiming to court higher-end businesses in need of information technology and communications solutions.

EarthLink, Cbeyond Inc. and Windstream Corp. are “all trying to morph their business so they can sell more IT services,” said Donna Jaegers, a senior research analyst with D.A. Davidson & Co., in a phone interview. Among their challenges, Jaegers said, are persuading customers they are viable suppliers for IT services and equipping their sales organizations with personnel capable of discussing information technology.

Many prospective customers have shown interest in EarthLink’s IT services, Jaegers said, although she noted they want to examine EarthLink’s data centers to confirm they are state-of-the-art and close enough to their locations so to avoid unacceptable latency.

Developing a fast-growing IT business is not a trouble-free endeavor for carriers accustomed to offering voice, data and Internet services. Consider Cbeyond’s ambitions. The company is zeroing in on customers it classifies as tech-dependent, but analysts aren’t convinced its new business model will thrive. In its 2011 annual report, Cbeyond forecast that nearly half (46 percent) of its 62,000 customers are prospects for its “2.0” strategy focused on cloud and other technology revenues.

It’s a slow transformation. In the second quarter, 2.0 sales only comprised a modest 6.5 percent of total revenues ($123.8 million).

Challenges Remain in CLEC Transformations

While Cbeyond Chief Executive Jim Geiger “has significant expertise in the early days of Web hosting, few others in the organization do to the best of our knowledge,” analyst Greg Miller of Canaccord Genuity, the global investment bank, wrote in a letter to investors Aug. 2. “Further, with so many well-funded competitors flocking to the CBEY-2.0 market, it remains anything but a foregone conclusion that the company will be successful.”

In an annual letter to shareholders, Geiger noted 2.0 customers could spend $2,000 a month, more than triple what its traditional communications subscribers shell out ($640). Investors likely won’t observe growth immediately. In its second-quarter earnings, the company reiterated guidance of $485-$490 million in annual revenues. If Cbeyond meets the low end of the guidance, revenues will be flat for the year compared to 2011 ($485.4 million).

The traditional communications business, analysts say, has faced challenges. In a severe recession like the one Americans still aren’t convinced is behind us, fewer small businesses are created than in a healthy economy  limiting the number of potential new SMB accounts for CLECs. Meanwhile, Comcast, Time Warner Cable and other cable companies have been steadily increasing their phone and Internet sales partially at the expense of business-focused CLECs. In a special report earlier this year, Moody’s Investors Service warned that the competitive telecom sector could face more growing pains. Moody’s also projected that telecom business revenues will be flat or decrease in 2012 and next year.

Hope on Horizon

In spite of these challenges, some CLECs have managed to sustain growth. In the second quarter, business-focused tw telecom inc. reported its 31st consecutive period of revenue expansion. Enterprise revenues increased 2.1 percent sequentially and 10.9 percent year over year.

Still, its business customer base has barely budged in a year. As of June 30, 2012, the company served 27,569 customers; that figure is only slightly up from 27,322 customers in the prior year. So what explains the revenue growth? tw telecom is acquiring bigger accounts, said Jaegers of D.A. Davidson.

Integra Telecom Inc. has not been as fortunate as tw telecom. In the second quarter, revenues fell to $148.6 from $151.3 million in the year-earlier period. For the six-month period ending June 30, 2012, revenues declined to $296.5 million from $302.7 million.

Integra, though, is reversing a course of contraction. It achieved a second consecutive quarter of sequential organic revenue growth in 2Q. The company expects such gains to continue throughout the year.

In a second-quarter investor presentation, Integra cited a “continued shift in sales towards more strategic, higher growth products that are in greater demand from enterprise and wholesale customers.”

Strategic products like MPLS and Ethernet represented 77 percent of average new sold revenue in the second quarter. That number is up significantly from 56 percent in the first half of 2011.

Ken Smith, Integra’s executive vice president of sales, also said the company is “seeing the average deal size increase significantly.”

Over the course of a year, the percentage of customers spending $1,000 or more in monthly recurring revenues has increased from 57.5 percent in June 2011 to 61 percent in June 2012. And more than half of those same customers are actually shelling out more than $5,000 in monthly recurring revenues, according to Integra. Meanwhile, the percentage of customers spending less than $200 in monthly recurring revenue decreased to 8.3 percent in June 2012 from 9.7 percent in the same month last year.

The numbers reflect the increasing focus in the CLEC space on business customers with bigger telecom and IT budgets.

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