Corporate Profile - Colt Telecommunications: Live wires

Colt's stock market value has grown from pounds 300m to pounds 7.6bn in less than three years. It operates in one of Europe's fastest-growing sectors, business telecommunications. But can it ever live up to the City's expectations?
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LITTLE MORE than seven years ago, Colt Telecommunications was a business start-up. Today it is a constituent of the FTSE 100 share index, Britain's premier league of companies, with a market value of pounds 7.6bn and an investment following most chief executives would die for. Few companies can claim such a rapid ascent into the heavens. To make the phenomenon more puzzling still, Colt has yet to turn a penny's worth of profit. So what's so special about this company that the City rates it so highly.

Colt is in the business of communications networks, and if it were to do nothing else right at all, that in itself would be enough to guarantee star stock market status. In a low-growth world, the rapidly expanding communications industry seems to to offer unparalleled potential. Colt is therefore hitched to a very fashionable stock market bandwagon. But it is much more than just a follower of fashion. Colt is one of the pioneers in Europe's deregulating telecommunications markets, and the business model it works to is already producing impressive results.

But let's start at the beginning. Colt wasn't the only one to spot and act on the opportunity for creation business communications networks. In 1993, Colt was very much second fiddle to MFS Communications. Both were in the business of building alternative phone systems for big London companies. MFS had begun six months earlier than Colt, whose name stands for City of London Telecommunications. Both were aimed squarely at the bread and butter business of the second telecoms operator in Britain, Mercury Communications, which had been the first to launch an assault against British Telecom in its home market.

Although the UK telecommunications market had been liberalised for several years, BT still had a stranglehold on most of the market. Mercury had chipped a little off the BT mountain, but there was a big opportunity for other players targeting business communications.

"Colt was not the first to build a city network in Europe," says the Lehman Brothers analyst James Barford. "Mercury was the first. But Colt came along with US standards of quality and service and with an aggressive focus of getting high- capacity customers."

A little over five years on, and the three companies battling against BT in UK business telecommunications have taken different roads. MFS was taken over by WorldCom (now MCI WorldCom) three years ago, changing its focus from building local networks in Europe to routing local traffic to its long-distance network. Mercury has been subsumed into the cable TV company Cable & Wireless Communications, which has a very wide remit beyond the business market.

Alone, Colt stuck to the original strategy, single-mindedly ploughed ahead with serving top-level business customers at a local level. It now owns and operates city networks in 13 European centres across eight countries, including the key financial centres of London, Frankfurt, Paris and Zurich. Plans are under way to add a further 13 cities over the next 19 months. London is still its biggest market, generating 51 per cent of turnover in the most recent quarter, but as business in other cities accelerates, especially in Germany, the proportion from London has fallen significantly - from 78 per cent of turnover a year ago.

This is Colt's principal asset - the direct fibre connections it has built or is building to customers in Europe's business centres. These direct connections are expensive because they require digging trenches and burying ducts. But it gives advantages over others who are simply reselling capacity on others' networks.

Some operators in Germany, including Mobilcom and Mannesman, went this alternative route, and are now, in the wake of Deutsche Telekom's 60 per cent price cuts late last year, having to re-evaluate their business models to include buying or building their own networks.

In Colt's most recent results, the CEO Paul Chisholm said the German experience vindicates Colt's strategy. "In Germany, companies held back on construction whereas we kept building local loop (networks). I think we've been proved to be right."

With success has come an even more ambitious plan - linking the local networks together into a fully fledged international operation. Colt is building its first inter-city network in Germany. The 2,600km network will link businesses in Frankfurt, Hamburg, Stuttgart, Berlin, Munich and Dusseldorf. In the Benelux countries it has linked with its competitor, Level 3, to share construction costs on inter- city links. "We can create a seamless local network across Europe," says Mr Chisholm.

Colt joined the FTSE 100 last September, a month after a four-for-one share split. The achievement was all the more remarkable because the listing came only 21 months after the company floated in London at 275p a share, a price that valued it at just pounds 300m. Today Colt has a market capitalisation of pounds 7.6bn. Even taking account of its aggressive building plans, analysts expect Colt to be cash-positive by the end of this year.

The present level of growth seems to justify the City's high expectations. Colt counts only 2,500 customers, but they are all big spenders - giants including Andersen Consulting and Dresdner Bank. In its most recent quarter, private line growth was up 158 per cent from a year earlier. Colt posted more revenue in the first quarter of 1999 than in first half of 1998, or in the whole of 1997.

Colt's success has been made possible by the explosive wave of data and telecommunications growth, spurred by European liberalisation and the Internet.

The European market for telecommunications is worth somewhere between pounds 100bn and pounds 120bn. Approximately half of that is business telecoms. Analysts believe up to 50 per cent of the business market -or pounds 25bn to pounds 30bn - is within Colt's reach, and it is a market growing at 5 per cent a year. Lehman Brothers and Dresdner Kleinwort Benson believe Colt can "realistically" achieve a 5 per cent European market share by 2008, which Lehman says would mean Colt revenues would be pounds 4.4bn, up from pounds 215m at the end of 1998. Others have spotted the opportunity as well. MCI Worldcom expects to be offering services in the top 45 European cities by the end of 2000, but many operations are likely to be switched resellers, which depend on leased circuits, as opposed to the facilities-based services on offer from Colt.

Global Telesystems Group, owner of the Hermes pan-European network, spent $645m to acquire the UK-based Esprit Telecom in March and plans to complete construction on a competitive local exchange network in Paris by the third quarter of this year. Level 3 has announced plans to build local networks in six European cities by 2000, and has a service running in London and Frankfurt.

There are also local competitors, including CWC in the UK and Cegetel in France. Nor are the established PTOs sitting on their hands. All are highly active in each other's markets.

Yet Colt still has an advantage, the head start it got by building city networks from the beginning. "We don't see any dramatic changes in the competitive profile," Mr Chisholm says. "A fair amount of people said they'll build local nets but what you see in reality is quite different. There's no major activity coming from one company across Europe."

Colt admits that as network capacity increases, the prices for international bandwidth and services will be under pressure. "That's why we are putting in our own long distance network, so we can control our own destiny," says Mr Chisholm. "If you don't own the fibre then over time you become constrained, including your time-to-market."

As prices for telecommunications services fall, putting pressure on margins, demand for high bandwidth services is increasing. A corporate customer who may have used 64 kilobit to 2 megabit lines in the past, is today demanding up to 155 megabits and higher. Although unit prices are falling, volume is rising strongly. In the last three years the average spend per Colt customer has increased by 36 per cent per year. Much of this growth is data and Internet-driven.

Colt has been offering businesses Internet services for three years. As technology and demand from customers change, their broad band network is being upgraded using the latest IP technology more suitable for data traffic.

To position itself in France, Colt spent pounds 13m in cash and shares last July for French business Internet company Imaginet. From 50 corporate Internet customers a year ago in France, Germany and the UK, Colt now has 500.

Colt so religiously hits its projections and typically outperforms the market's expectations, that it is difficult to find an analyst with a negative view. James Friedland of Arnold and S. Bleichroder initiated coverage of the company in March with a "neutral" but was almost apologetic about it, stating: "Nevertheless, we believe that Colt should be a core long-term holding in a European telecommunications portfolio."

The man behind Colt's phenomenal success, Paul Chisholm, deliberately shuns personality driven publicity. When we asked his director of investor relations, John Doherty, for more insights into Mr Chisholm's character, explaining that otherwise the article might be a bit grey, he responded; "Oh, we don't mind grey. Grey is fine."

Mr Chisholm, 50, no doubt has many hidden interests and charms, but when it comes to business he is highly focused, matter-of-fact and to the point. When asked how he felt about being singled out by The Sunday Times last autumn as one the most "overpaid" executives in the UK, he finally said in the broad tones of someone born and bred in Boston, Massachusetts, that he thought the method of calculating was not completely accurate. "My compensation is very standard for an executive. My options depend on performance over time."

For the record, his salary plus benefits in 1998 totalled pounds 517,000, but he also has 6.8m share options, which given the rise in Colt's value are now worth a huge amount of money.

"He's not as flashy as some businessmen you see, but you don't necessarily need flashy," says Lehman's Mr Barford. "You need someone who can run a business and he's very good at running his business."

It was this operating expertise that originally attracted Jim Hynes, MD of Boston's Fidelity Capital. Fidelity Capital, the venture capital arm of the giant fund manager of the same name, had been an early investor in the US in Teleport Communications, which helped to pioneer the competitive local exchange carrier (CLEC) model to compete with former monopoly telcos. Mr Chisholm ran Teleport's Boston unit from 1988 to 1992, where he caught Mr Hynes' attention.

Mr Hynes though the UK was ripe for the CLEC model and in 1992, he dispatched Mr Chisholm to London with $100m of seed capital in his pocket. It has proved a spectacular investment. Today Mr Hynes is chairman of Colt and Fidelity remains a 55 percent shareholder.

And the future? "Europe is as big as the US," says Mr Chisholm. "We have a hell of a long way to go to control this market."

Galloping Ahead

Launched service: October 1993 Employees: 1,800

IPO Dec 96: 275p a share, value pounds 300m

Sept 98: 4 for 1 share split

Shares outstanding: 620m ( 30 March 99)

Market Cap: pounds 7.6bn

Largest single shareholder: Fidelity Capital with a 55 per cent

1998 Revenues: pounds 215m

1998 Profit/(Loss): (pounds 55.6m)

End 1998 stats: 13 networks in 8 countries:

Carried 3.4 billion switched minutes: Installed 1,200km of cable