After AFN Communications was formed a little more than a year ago by six East Coast energy concerns, the new management team took a long, hard look at how other communications companies have built their networks over the past decade.

Then they went in exactly the opposite direction.

“All the networks that were started in the late ’90s were all started in a very similar manner, and they all attacked the same opportunity,” says David Cordeiro, AFN's vice president of strategic planning and communications. “They all threw tens of billions of dollars in capital into building out the top-tier U.S. cities, and if anything was left over, the capital was deployed into Europe and Asia.”

What was missing was service in Tier 2 and 3 cities, he says. “That's our focus.”

That focus has led AFN to cities such as Kalamazoo, Mich., Harrisburg, Pa., and Charleston, W.Va. The company is attempting to leverage the dark fiber assets of its utility partners and cash in on what it believes is the enormous pent-up demand for bandwidth in locales that may be far from the country's megalopolises but that have the same needs and desires — perhaps more so.

As various utilities got bigger and more sophisticated through the ’80s and ’90s, predictably their infrastructures became more complex as well. Eventually, to adequately communicate between facilities and send necessary instructions to all sorts of pumps and controls, these utilities started pulling fiber through pipelines that they had placed in their rights of way.

According to Cordeiro, the problem was that they didn't know when to stop.

“The attitude of these companies was, ‘If two fibers are great, then why not 96?’” he says. “The result was that you had a large surplus of fiber going into these cities.”

The six entities that originally formed AFN — AEP Communications, Allegheny Communications Connect, CFW Communications, FirstEnergy Telecom, GPU Telecom and R&B Communications — were typical in this regard. Because their internal needs were only taking up a small percentage of available capacity offered by the fiber they already had in place, the utilities eventually came to an obvious conclusion: They needed to find a way to take better advantage of an asset that had cost a great deal of money to put in place.

But how?

Gordon Martin, AFN's president and CEO, claims Congress provided the answer when it passed the Telecommunications Act of 1996.

“Quite frankly, the Telecom Act opened their eyes to an ability to participate in the communications business,” says Martin, who before joining AFN was president of Williams Communications.

Having seen the light, Allegheny, First Energy, AEP and GPU, with the help of A.T. Kearney (which brokered the deal), formed AFN to create a long-haul fiber network — using existing assets owned by the four utilities — that would provide high-speed bandwidth to previously underserved markets.

Being able to rely on strong partners from the utility community has more advantages than disadvantages, says Mike Smith, co-founder and managing director of the telecom strategy practice for Stratecast Partners.

“If you look at the current market conditions, having access to capital and having stable investors is becoming more critical and, in fact, is becoming more and more rare,” he says. “So on the one hand, AFN has multiple investor partners to manage, and that presents more challenges for the company. But on the other hand, they have gained access to rights of way, and they have found partners to essentially fund their network buildout. Given current market conditions, that is very important to consider.”

Martin agrees. “The market cap of our utility partners is somewhere between $25 billion and $30 billion. So we're on good financial footing.”

AFN is fortunate in that it hasn't had to think about getting funded through more traditional methods, Smith says. “If they had pushed forward in the venture-capital community, who knows how long it would have taken and what they would have had to sacrifice in order to get what they were seeking.”

Given the stability of AFN's partners, Kevin Hart, a senior manager at Cap Gemini Ernst & Young, which is implementing AFN's operations support systems, believes AFN can temporarily avoid the need to tap into the venture capital or public equity markets for future funding requirements.

“Because these folks are coming from a stable industry, the funding is stable and the reliance on outside capital, at least to this point, hasn't been initiated,” Hart says. “So the external financial markets haven't affected them directly in terms of their growth and acquisition strategy and their ability to build out their internal infrastructure.”

While work continues to connect the various legs of its fiber network, AFN has already determined the markets it will target for its services. Like a latter-day Lewis and Clark, Martin and Cordeiro are setting their sights on a new frontier, specifically smaller cities that few if any service providers have thought about.

“The person in Harrisburg wants broadband Internet access just as much as the apartment dweller in Manhattan,” Martin says. “In fact, what a lot of people are continuing to find is that these people may want it more. It may be more relevant and important to them because it opens up the globe to them.”

Stratecast's Smith thinks AFN is heading in the right direction.

“We absolutely believe in the soundness of their strategy,” he says. “If you take several steps back to the original theories of business strategy developed by [Harvard Business School professor] Michael Porter, obviously one of his key theories is, ‘You want to be competing in markets where the barriers to entry are as high as they can be, and also where you have an opportunity to establish and then defend your position.’”

And AFN is targeting underserved markets, Smith says. “We think this will clearly give them an opportunity to establish a beachhead. They are targeting a market opportunity that has gone untapped by the current crop of service providers.”

Dahar Bouzayan, senior analyst of wholesale and broadband markets for Atlantic ACM, agrees.

“Competition is almost non-existent in Tier 2 and Tier 3 markets,” he says. “If you go to a Des Moines, Iowa, or some city like that, you'll barely find two companies offering services, if you're lucky.”

AFN Communications at a glance

Headquarters: Tulsa, Okla.

Key execs: Gordon C. Martin, president and CEO; Brian L. Cantrell, chief financial officer; F. Bunker Sessions, chief technology officer; Gary Watson, chief operations officer

Number of employees: 93 (as of May 2001)

Founded: March 2000

Focus: Creating value for customers and other stakeholders by delivering carrier-class broadband transport services to underserved markets, as well as primary markets, in a timely, predictable and efficient manner

Target markets: Interexchange carriers, utilities, local exchange carriers, international PTTs, Internet service providers, application service providers, cable service providers, DSL service providers, wireless service providers, niche providers and educational and research entities

URL: www.afncommunications.com

And that's lucky for AFN, says Martin. AFN seems more than happy to sacrifice what might appear — at first glance — to be more lucrative markets to gain the first-mover advantage.

“I wouldn't debate with you whether 25% of New York City represents a greater capacity than 90% of Harrisburg,” he says. “However, the fact is that there might be 200 people chasing New York vs. three to five chasing Harrisburg. Ninety percent of the capital has been deployed in the top 50 markets over the last decade,” he says. That means that a service provider can gain a first-mover advantage in those second- and third-tier markets, he says. And if the provider can design a low-cost position, it has staying power.

Not only that, such a provider can charge a premium for services, says Bouzayan.

“Bandwidth pricing works by routes, and routes work by popularity,” he says. “What AFN is basically doing is building exclusive routes — routes that have never been tapped before and on which they have almost no competition.”

Therefore, AFN can charge a premium for those routes, and the carrier can sustain that throughout the first couple of years of business, he says.

While these markets may have been underserved to date, their potential shouldn't be underestimated, says Rod Woodward, industry analyst of telecom services for Frost & Sullivan, who adds that this space — at least for the moment — is AFN's to lose.

“Take a look at Kalamazoo,” he says. “It's clearly not a New York; it's not even a Detroit. But Kellogg is there and so is Whirlpool. Not only is AFN tapping into an untapped market, but it's one that has a lot of community support.”

While it seems that AFN is already standing on its own two feet by making strategic decisions regarding the buildout of its network and its selection of target markets, Cordeiro acknowledges that many observers — including AFN's partners — will be looking for the company to start running, bypassing the walking stage almost entirely.

“In the next 12 months, we're going to concentrate on selling high-grade point-to-point services in those second- and third-tier markets,” he says. “We have to prove the reliability of our plant, our assets, and all of our operations capabilities.

“And our marketing team has to prove that there are customers willing to buy very large circuits into these markets,” he adds. “And we as a company have to prove that we can do all of this in a very cost-effective, capital-effective manner.”

This is good news, Smith says.

“Over the next 12 months, the focus has to be on deploying the network assets and getting the network in place so they have an infrastructure over which they can offer their services to their customer base,” he says. “So I will be looking for more network deployment milestones than revenue milestones.”

Smith adds that there should be sufficient demand for AFN's capacity from service providers over the long term, though he cautions that it may be 18 months or longer for the demand to come to fruition. Much will depend on the condition of the capital markets.

“The more open the markets are, the easier it will be for service providers to once again pursue geographic expansion,” he says. “But any [service provider] that hopes to survive on a long-term basis eventually has to look at the Tier 2 and Tier 3 market opportunities.”

But the current condition of the capital markets may work to his company's advantage, Martin says.

“The large carriers are having to be more capital-efficient. This has created a great opportunity for us because the large IXCs and ILECs — and potentially… the CLECs that are going to survive — have all pulled back on their capital investments,” he says. “So what they're ready, willing and able to do is lease capacity into these markets instead of executing on what could have been a build plan.”

While the economic downturn may be turning some carriers into customers, it could just as easily take some away, a possibility that Martin acknowledges frightens him a bit.

“If there is a question [about our plan], it is the timing of the recovery of our sector. Will there be only 200 customers to sell to at the end of 2002 vs. 2000 customers?” he asks. “Are we simply moving to such a rapid consolidation that it is going to be mission-critical that you are selling to the large ILECs, CLECs or IXCs because they're going to be the ones who can weather the financial storm?”

Even if enough carriers survive the shakeout to create a viable market to which AFN can pitch its services, Atlantic ACM's Bouzayan believes Martin, Cordeiro and crew have their work cut out for them.

“They have a huge marketing communications challenge,” he explains. “They're basically trying to convince IXCs and CLECs to come and serve second- and third-tier cities that their original business plans didn't include.”

In the end, Bouzayan believes that AFN will succeed in attracting service providers to the Tier 2 and Tier 3 cities, thanks to one indisputable fact: “Whether the economy is going to enter into a recession or not, there is one thing that will flourish for sure, and that's the need for bandwidth,” he says. “Video streaming is getting bigger and bigger, and there is simply the need for bigger pipes for data transmission.”

He adds that they won't even mind paying AFN's premiums.

“Think about it as if you were buying an airline ticket,” he says. “Airline A has a direct flight from Boston to Des Moines, but they're going to charge you a premium. Let's say their fare is $150. Airline B can fly you from Boston to New York for only $80, and from New York to Des Moines for only $100. Which is the better deal?

“Even though AFN may be charging a premium, it will still be less expensive for carriers to buy services from them than buying from a patchwork network.”

Even as AFN strives to connect and light its network that currently covers 13 eastern states, senior management is already thinking about the future.

One of the things they're thinking about is an expansion of its footprint. AFN plans to take its concept to other sections of the country, hoping to find other utilities with expansive rights of ways and under-used infrastructures that may be cobbled into regional networks. The first places they will look to expand are New England and the Southeast. After that, AFN will turn its attention to the West.

Another item to consider is how to better leverage the assets of its utility partners, says Cordeiro.

“In the future, two clear opportunities will present themselves,” he says. “One is bandwidth trading. If you look at our utility members, they have huge trading floors… and we can leverage those capabilities into bandwidth trading as it evolves.

“They also have huge retail customer bases and very strong local brands in [their regions]. So do we develop a retail product offering that our utilities then can brand and offer? Or do we simply provide bandwidth to strong retail telecom companies, identify very good retail products offered by other carriers and bring those to our utilities to, again, offer to their customers,” he says.

‘The person in Harrisburg wants broadband Internet access just as much as the apartment dweller in Manhattan.’
— Gordon Martin, AFN

The easiest thing for AFN would be to identify strong vendors that customers champion their product offerings into the utilities, Cordeiro says. “But at some point or another we may decide that we're the best at providing those services and take that additional step,” he adds.

While these plans appear to be logical next steps, Bouzayan wonders where AFN — despite its strong utility partners — will get the money to fund them.

“[An expansion] is based on a lot of assumptions,” he says. “They have to be able to raise money to fund these expansions. And to raise money, they have to prove that their model is successful.”

One of the ways to raise money, of course, is through an IPO, something that is at least a year away, Cordeiro says.

“To be entirely up front, you can't point to much in our first year,” he says. “Today we are promise. We've had great interactions with other carriers, and we're building a great infrastructure,” he says. “But until our infrastructure is filling up [and] we're taking circuit orders… we can't point to historic performance. Which is why, even if the markets were kinder today, you wouldn't see us [going after an IPO]. We need to have this conversation again in another 12 months.”

That's just as well, suggests Smith. “I'm not suggesting that they shouldn't pursue an IPO, but what I am suggesting is that if you go IPO and you don't have a very clear business strategy and you don't adhere your business plan, you clearly can create problems for yourself,” he explained. “There are a whole host of examples you can reference on this in the service provider space.”