IRUs: back to reality - American Line

Telecom Asia, Oct, 2002 by Elizabeth Starr Miller

The winds of change are blowing strong for the one-time standard indefeasible right of use contract, a.k.a, the IRU. As the investigations into Global Crossing and Qwest Communications intensify, IRU deals are being put under the microscope.

IRUs began as a way for service providers to bridge the Atlantic and Pacific using the network of undersea fiber optic networks each of which was controlled, not by one company as it is today, but by a consortium of cable companies. Contracts were generally a one-time upfront purchase and set at 20 years because that was the average lifespan of the active equipment located on the bottom of the sea.

When carriers such as 360networks, Global Crossing, Qwest Communications International and Williams Communications began building out terrestrial fiber networks, they continued to use the IRU method to do business because it was familiar.

In the "go-go" years of 1995 to 2000, many service providers struck out by building networks based on IRUs, says Ron Vidal, senior vice president of investor relations at Level 3 Communications. "Wall Street analysts were searching for ways to measure companies that didn't have cash flow, revenue or EBITA," he says. Analysts began giving value to a company's fixed assets, such as IRUs, instead.

"Service providers thought, `I could buy IRUs instead of leasing capacity and get higher stock market value'," said Vidal. "If they bought month-to-month they didn't get a bump in the stock price."

As a result, business models built around IRUs were flawed and the businesses using them failed, says Jay Taparia, principal of Sanskar Investments. "The cash up front went to debt repayment," he says. "But the revenue had to be amortized over the life of the contract," he says. "There was a lot of aggressive accounting with IRUs."

Invaluable

But it's not that the IRU wasn't a valid way to build out networks, says Seth Libby, senior analyst at Yankee Group. "If a carrier has reasonable expectations that it will be doing business in a market for five- to- ten years, they want to be able to treat fiber as a piece of capital equipment and be able to depreciate it," he says. "They are an invaluable tool for carriers."

But many of the IRU buyers among US competitive carriers couldn't earn enough cash to shoulder the millions of dollars they paid up front for long-term contracts. Meanwhile, the IRU sellers began to realize that a one-time upfront payment didn't lead to additional monthly revenue. Hence the downfall of many carriers, both IRU buyers and sellers, including 360networks, Global Crossing and MFN.

Although the long-haul wholesale customer base still reaches into every segment of the service provider market, sales are down across the board. In 2001, wholesale long haul transport accounted for 48% of all North American transactions, according to Libby. From 1996 to 2000, that percentage was as high as 78%, he said.

OnFiber, a metro transport company that bought the assets of bankrupt Sphera Networks for a mere $2.3 million back in May, has already changed its IRU strategy, according to CEO Danny Bottoms. Instead of spending $3 million--$5 million up front for a long-term deal, capital constraints have forced the provider to buy term leases to match demand. "Instead of wanting a 20-year IRU for fiber to Fort Worth, Texas, for a three-year, Sonet services deal, we try to match what our business plan is," says Bottoms.

Also, OnFiber now prefers to pay for its capacity on a monthly basis, instead of an up-front lump sum, in order to protect itself against supplier carriers filing for Chapter 11, says Bottoms. "The fact of the matter is that the capacity isn't going to go anywhere if a company files for Chapter 11," he says. "And a bankrupt carrier needs our monthly payment to continue to operate and do business."

As little as one year ago carriers would not have sold OnFiber short-term leases, but with fewer service providers buying standard IRUs, carriers are willing to deal, Bottoms adds.

IRUs aren't a bad business if the customers buying are buying for the right reasons, Vidal confirms. Today, Level 3's main IRU customers are stalwarts like Verizon, BellSouth, AOL, France Telecom, British Telecom and Deutsch Telecom. "They have demonstrated demand for capacity and know what they need to own vs. what they need to lease," he says. "Plus they know the demand is going to be there for a long time."

A brief history of IRUs

                    Then                     Now

  360networks, Comdisco,     The players     AOL, BT, BellSouth, DT,
 Enron, Global Crossing,                     FT, Level 3, Qwest,
    Level 3, MFN, Qwest,                     Williams, MFN, Verizon
                Williams

       upfront, lump sum       Payment       upfront, lump sum or
                                             monthly payments

    demand for capacity,    Reasons to buy   defined demand for
slide through on another                     capacity, subscriber
 company's right of way,                     growth
  positive reaction from
             Wall Street