Industry Spotlight: Zayo’s Dan Caruso

January 27th, 2011 by · 6 Comments

Zayo Group and its founder, President, and CEO Dan Caruso have been a rising force in the fiber sector since the company’s founding in 2006.  Dan used to blog over at Bear on Business and was a regular commenter here, but that level of access to his thoughts and opinions became a casualty of his success (and of Zayo’s issuing of publicly traded debt).  Today Dan Caruso returns to Telecom Ramblings, this time on the other side of the microphone, to discuss recent events and future directions at Zayo:

TR: Zayo makes incredibly detailed operational and financial metrics publicly available while many of its peers are rather opaque.  Why do you do that?

DC: First, we feel it is important to be transparent with investors on the drivers of our business. Second, we’re trying to lead the industry past the mindset of the meltdown.  With bandwidth growing the way its growing, companies that supply it are doing quite well and should articulate how the sector is performing.

TR: With all the acquisitions, how do we judge the value of a company like Zayo and measure its progress?

DC: The most important metric by which we measure ourselves is what we call our Invested Capital Ratio.  It’s the amount of capital invested in the business divided by our annualized adjusted EBITDA.  It states our investors’ cost basis in the same kind of language that we quote the value of companies like ours.  Since our inception, we’ve made sixteen acquisitions, most in the 7-10x EBITDA range – healthy valuations. Through growth and synergies, we’ve grown our adjusted EBITDA to achieve an Invested Capital Ratio of 4.3x as of our last reported quarter.  So if you think we’re worth say 10x adjusted EBITDA, then the spread between those two indicates the value we’ve created for our investors over the life of their investment.

TR: Following Zayo’s purchase of AGL networks, you created a new division called Zayo Fiber Solutions that focuses solely on dark fiber sales.  Why did you do that?  Is that business so different from the rest of the metro bandwidth business?

DC: This is still a somewhat contrarian view, but we believe the dark fiber business is very similar to a tower company in its financial profile.  Tower companies are valued at 15x EBITDA or higher, why is that?  Once you lease space on your tower, there’s not much more involved.  If something breaks then you fix it, but there is no difficult provisioning, maintenance or monitoring involved. It remains for years and rarely churns.   Dark fiber works similarly.  It is generally leased under long-term contracts. It requires minimal ongoing operating costs – from either an operating or capital expense perspective. And it is deeply embedded in a customer’s network. Churn is very low, and there are a lot of upsale opportunities over time.  While we are very bullish on the lit bandwidth business, we believe dark fiber has some especially compelling attributes.

TR: Some have never liked the dark fiber business, preferring lit sales.  Will ZFS be focusing mainly on the former AGL footprint or will you expand the effort across all your other markets alongside your other bandwidth offerings?

DC: We are providing dark fiber services across all of our network footprint with sufficient fiber depth to support it. And this will only grow over time as we expand the network and augment segments that are not currently as fiber rich.  We started in earnest on dark fiber with the acquisition of AGL. Then about one third of AFS’s revenue was also dark fiber related.  We expect continued dark fiber sales traction through both our direct dark fiber sales force and the new Zayo Networks shared sales channel.

TR: Some providers dislike the Fiber-to-the-Tower business, but Zayo has been aggressively pursuing FTT deals in its deepest markets.  With the AFS deal you now have several new markets that seem similarly favorable; will you be active in the FTT space there as well?

DC: Yes, we will pursue FTT opportunities wherever we can achieve an attractive, contractually guaranteed return.  That’s often correlated with where we have strong fiber assets, but sometimes branches off from there.  AFS was not particularly active in fiber to the tower, largely due to internal capital constraints.  As to whether we will be successful with FTT in the markets we acquired from AFS, it’s very customer driven.  Sometimes, if you’re not there at the right point in time, you lose out on an opportunity.  In some of the AFS markets there may have been opportunities a year ago, but not now. That said, I’m confident we will be active in at least some of those markets given the strength of the assets.

TR: One of the big knocks against the FTT business is that the payback period is quite long, and in Zayo’s earnings supplement the figure seems to be in the neighborhood of 40 months.  Is that representative of the opportunity?

DC: Yes that is accurate, if you take into account only the initial contractually guaranteed revenue, i.e. only the day one contract in hand and associated minimum amount of revenue the customer has guaranteed to give you.  If there is any upside from incremental bandwidth beyond the day one commitment or second tenants or you put the fiber to commercial use in other ways, the payback period shortens – often significantly.  Net-net, we view FTT and other large success-based capital deployments as great opportunities to significantly expand our network while generating a positive return and setting ourselves up to achieve even higher returns over time.

TR: You won several stimulus awards, what stage are those projects at?

DC: They’re all being designed and built out in earnest.  The Indiana project is well along, Minnesota too.  That money is being put to work in real time.  There are also some stimulus projects where a company like us participates, but the lead recipient is a public sector entity.  Some of those have been delayed a bit, caught up in administrative, decision making processes.  But in cases where we are in a lead position, we are driving the projects forward just like everything else we do.

TR: 2010 saw a wave of consolidation in the metro fiber sector, do you think that will continue into 2011 or might there be a pause?

DC: Yes, consolidation will definitely continue.  A lot of consolidation has already happened, but fast forward three years from now and half of those remaining will likely be combined.  What you saw in 2010 was a number of smaller acquisitions.  There is certainly more consolidation amongst the remaining smaller players. But in the next year or two, some of the medium sized players will likely merge with each other or with the larger players.

TR: Zayo is made up of so many disparate pieces that have been assembled in just a few years.  How have you integrated them all so smoothly?

DC: First, what we’re integrating is more straightforward because we focus on providing infrastructure services to a targeted customer set. There is a somewhat finite amount of customers, products and network to be integrated, so our job is easier.  In contrast, if you had to integrate a CLEC or a large managed services business, the undertaking is orders of magnitude larger and more complex.  That said, we have built a competency in acquiring and integrating businesses and assets, so we do believe we have some secret sauce in this area.

TR: Is Zayo done or will you still be actively seeking acquisitions?

DC: We’ve demonstrated strong competency in effectively acquiring and integrating companies, and then further growing into the asset base.  Two years from now, if I look backwards, I would expect to see another 2, 3, 4 acquisitions that we’ve done in that timeframe.  The landscape has certainly gotten more competitive in the past year, , but we have capital on hand – and access to significantly more – to fund additional value accretive acquisitions in the future.

TR: Thank you for talking with Telecom Ramblings!

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Categories: Industry Spotlight · Mergers and Acquisitions · Metro fiber

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6 Comments So Far

  • carlk says:

    So, If I understand Dan correctly, he “believes” his company is worth, depending upon the percentage of Dark Fiber in his whole diet, somewhere above 10X EBITDA, but less than 12.5X knowing DF is less than half.

    I continue to like his ICR formula for creating or destroying value.

    What’s this “secret’s in the sauce” talk copyrighted from Sunit Patel he chooses to use?

    The last time I heard that, I needed to extrapolate it to mean, “Indian software engineers” brought to the US on Visa in order to straighten out “integration messes!”

    Dan told us that wasn’t so, though, I think! 😉

  • Anonymous says:

    Seems Dan is now using the term merger more often. I wonder who Zayo is likely to merge with ? if this is a hinting an upcoming move who woudl be a likely medium size company for Zayo to joing forces with.

    • Rob Powell says:

      Rumor had them bidding for XO a year and a half ago, and if given the chance I’d bet they’d do it again. The thought of that much more historically underperforming fiber falling into Caruso’s hands is … formidable.

  • Anon says:

    does this roll up create, maintain or destroy value? one can hope-assert that the terminal multiple is 10x, but is there comp support for this multiple? (i.e., which buyers other than zayo pay this for clec/fiber/similar companies?).

    the public values twtc, abvt, paet, gblc, et al at somewhere between 5x-8x EV/EBITDA.

    at those metrics (plus cost of capital considerations), etc, hard to see any value creation.

    • carlk says:

      With enough time and the right mix of assets, one can see how Dan’s formula could be the gift that keeps on giving, especially when 4.3X goes to par or negative, at which time the”cost of capital” goes the opposite direction as well, i.e., a perpetual credit upgrade story. You will know how good Dan and his boys are at allocating capital by watching the metric he is allowing you to consume. Right now, it tastes yummy in my mind, at least until some road block that Dan isn’t aware of catches them off guard.

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