MFN is currently reorganising its operations under Chapter 11 bankruptcy protection in the U.S., and expects to emerge from this process by late 2003.

MFN filed for Chapter 11 bankruptcy protection on May 20 2002, at which time the company held 'reasonable' cash reserves. Mr. Gerdelman noted that cash reserves have, since this time, increased three-fold. During the past year MFN has succeeded in halving expenditure and has rationalised revenue streams to optimise profitability, primarily through stripping out under-performing product lines.

The prime objective for MFN presently is emergence from the Chapter 11 process. The company's Disclosure statement was approved by the bankruptcy court on July 2, marking a path to the vote for emergence, which is expected in August 2003.

When MFN does emerge it will officially be renamed AboveNet Inc. Since the company is currently branded with the new name, AboveNet will be used from now on in this article.

Transformation

Commenting on the transformation of the company since entering Chapter 11, Mr. Gerdelman stated that operations have been radically altered to both optimise efficiency and fit activities to prevailing market conditions. Illustrating this point, he noted that data centre facilities have been reduced from twenty-five in 2002, of which twelve were operational, to six today - these remaining facilities are now approaching capacity.

The market focus for this business has also changed, for example in California, from that of small dot-com companies to established 'brand name' customers. Mr. Gerdelman commented that these customers tend to also utilise AboveNet's network infrastructure, managed services and IP backbone services.

A key focus for AboveNet going forward is stated to be the leveraging of existing assets to expand its addressable market, one example of this being the introduction of Gigabit Ethernet services enabling the provision of IP connectivity 'by-the-megabit' to buildings currently served by AboveNet network links.

Investment

AboveNet currently holds cash reserves totalling $92 million. As noted previously, the bulk of this amount has been amassed with the help of measures implemented since entering Chapter 11. John Gerdelman added that the company is investing between $1 million and $2 million per month in capital expenditure. He emphasised, however, that this represents ongoing expenditure rather than major projects, such as the extension or completion of network infrastructure.

"Where we can invest, for example in wave-channel equipment that will pay for itself in perhaps one year, to boost revenues quickly, we are doing so. Large infrastructure projects, where the return on investment may take ten or twenty years to break-even, are not of interest currently."

Mr. Gerdelman stated that AboveNet is 'comfortable' with its footprint covering twelve cities in the U.S. market, emphasising that this infrastructure is sufficient to enable fulfilment of the revised business model. It was noted that, when it becomes necessary, extending the AboveNet network to a total of fifteen or eighteen U.S. cities would be feasible employing minimal capital - completing Los Angeles was stated to have entailed expenditure of approximately $2 million.

Assets

With regard to the ownership of assets, Mr. Gerdelman said that data centre facilities and IP backbone networks are owned outright by AboveNet, although with dark fibre networks the picture is less clear, due to the preponderance of joint-build projects with external companies. Mr. Gerdelman noted that compliance with Chapter 11 rules necessitated delineation of all company assets, which has proved a useful exercise.

"AboveNet now knows precisely what assets it owns, including dark fibre infrastructure. Assets associated with the dark fibre networks are not one hundred percent owned by the company, beyond the actual fibres - cables may be in shared ducts, or running in ducts that sit next to those of another service provider that we worked with when originally installing the link."

Commenting on the disposal of the PAIX.net business, John Gerdelman stated that the division was already earmarked for sale when he joined the company. While he would have been happy to keep this business, in particular the skilled team attached to it, at the time it was sold the overriding priority for AboveNet was debt reduction - this business was relatively easy to divest, due to its largely autonomous nature within AboveNet.

He added that a good deal was agreed with Switch and Data Facilities, which acquired the business in March 2003, also that AboveNet hopes that a relationship will be maintained with the group for future activities. It was noted that for customers of PAIX.net there has been little or no discernable change or interruption to services. Mr. Gerdelman said that the loss of the PAIX.net division represented one of the many difficult decisions that had to be taken during the early stages of the Chapter 11 process.

Life under Chapter 11

AboveNet does not feel constrained operationally as a result of operating under Chapter 11. Mr. Gerdelman commented that the prime issue relates to relationships with customers, and to a lesser degree the industry at large:

"When going through Chapter 11 the company is effectively branded a failure, there is a sword hanging over your head, this obviously makes customers in particular nervous about dealing with you".

John Gerdelman noted that many companies refuse to do business with a company undergoing Chapter 11 restructuring, while at the same time declaring a willingness to do so as soon as that company emerges from the process. One positive aspect of this situation is that business can be expected to grow significantly once AboveNet is clear of the bankruptcy process, purely because it is no longer 'branded'.

Industry bankruptcies

Discussing the Chapter 11 process generally, Mr Gerdelman noted that within the telecommunications industry, more than half of companies entering the process do not re-emerge. In these circumstances the company is wound-up and its assets sold off, a notable example being Winstar Communications.

A further proportion of companies will emerge from Chapter 11, but quickly falter and re-enter the process (often dubbed 'Chapter 22' companies), typically not to be seen again. Mr. Gerdelman stated that these would be companies attempting to operate under inherently weak business plans.

Mr. Gerdelman was keen to emphasise that AboveNet is determined to ensure that it has developed a realistic business model, to this end regularly re-evaluating plans against market conditions. The company is confident that it has a viable business plan in place covering the period to the end of 2004.

Financial commitments

Mr. Gerdelman reiterated that AboveNet is now focused exclusively on meeting balance sheet commitments for 2003, adding that, to date, objectives are being surpassed.

The company is comfortable with present cash reserves, although John Gerdelman noted that exiting Chapter 11 entails expenditures, particularly legal fees and 'cure' costs - the latter relating to settling debts with long-term customers outstanding prior to Chapter 11 filing. It was stated that work is in progress towards reconciling these amounts, also that the total sum involved is lower than was originally estimated. Included in AboveNet's published reorganisation document is notification of a rights offering for $50 million:

"It is not essential that this sum is raised, but it would certainly be nice to have, mainly as it would allow more flexibility and scope in our responses to customer requests - there could otherwise be instances where AboveNet would be unable to meet a customer's requirements due to insufficient funds. I would like to be in a position to take on a project with a major customer, such as Chase or Microsoft, where it offered good returns even though demanding significant initial outlay on AboveNet's part. A secondary consideration would be the acquisition of strategically valuable assets if such became available."

On this last point, Mr. Gerdelman believes that no opportunities have been missed during the past year - only metro networks would be of real interest to AboveNet and none have become available.

AboveNet has a presence in twelve U.S. cities, including New York, Washington, McLean (North Virginia/ Maryland market), Dallas, Houston, Chicago, Los Angeles (where the small existing network will shortly be augmented by a large metro ring that is nearing completion), San Francisco and Seattle (primarily serving Microsoft).

Mr. Gerdelman commented that in Los Angeles, both partners and customers are requesting that AboveNet completes network rings in areas where no other service provider has a presence - this issue will be addressed upon clearing Chapter 11.

AboveNet retains operations in Europe, where it has facilities in the UK plus a minor presence in Austria. Mr. Gerdelman confirmed that operations in Amsterdam plus all interests in the Asia-Pacific region have been sold off. He stated that business in European markets is stable - currently an important factor.

AboveNet's presence in the UK was described as effectively behaving as an extension of the network in New York, as the company has submarine backhaul connections between the two locations. Future requirements for a presence in Asia will be accomplished, if necessary, through partnering agreements.

Transport links

Transport links - the IP backbone, between metro rings in the U.S. - are provided by WilTel Communications, the former Williams Communications, recently emerged from Chapter 11. Mr. Gerdelman commented that previously, numerous service providers were tapped for these services.

The sole long haul network that AboveNet owns runs between Boston, via New York, to Washington D.C. Where a customer requires long haul in addition to metro services, AboveNet will partner with any suitable carrier.

AboveNet states that it has 430 peering arrangements, and claims a network capacity of 212 Gbit/s, a theoretical maximum that in practical terms means little. According to Mr. Gerdelman, this was a number cited mainly for marketing purposes prior to the market downturn.

"A more relevant figure would be the 60 Gbit/s capacity of the metro network rings, the 212 Gbit/s capacity relates to long haul links between the metropolitan areas."

With regard to the peering arrangements, Mr. Gerdelman noted that the number fluctuates on a daily basis, adding that, of these, the top twelve represent the bulk of AboveNet's business in this sector, with major companies; the remainder are with smaller companies.

AboveNet's IP network has recently been rationalised and largely re-engineered through a partnership with WilTel Communications. Mr. Gerdelman believes this network, extending across the U.S., is now extremely efficient and is probably the best in the U.S. today.

It was noted that at the time of the original deployment, the IP network was not implemented optimally - long haul routes that were available to the company were not used in place of leased circuits. These unused routes have subsequently been lit and are being used in place of the leased circuits.

The bulk of the network equipment owned by AboveNet is sited on its IP backbone, including router systems from vendors such as Cisco Systems and Juniper Networks. Equipment located in the six data centres constitutes much of the remaining assets - Mr. Gerdelman noted in passing that electrical power in the data centres, in terms of watts per square foot, is unparalleled, a legacy of company founder and electrician Stephen Garofalo.

Pinpointing a flaw in AboveNet's strategy, Mr. Gerdelman offered the view that the rate of growth of the market was over estimated - AboveNet perhaps installed too many networks too fast. This misjudging of the market opportunity is seen to arise from an early reticence by potential customers to adopt new technologies, resulting in a lag between a product offering and market demand. When market sentiment catches up to the technological possibilities, demand often grows very rapidly.

Highlighting the difficulty of judging the market accurately, John Gerdelman noted that while in New York AboveNet has found it necessary to over-build networks to boost bandwidth capacity, in other cities, such as Kansas, there is excess capacity in the network.

"In the euphoria of the boom years, companies simply got carried away, installing massive network capacity in cities everywhere without stopping to consider actual demand for capacity. If the same companies had installed that same network infrastructure over a ten year period - corresponding with a normal technology curve - there would likely have been no problem."

Customer focus

Commenting on changes to AboveNet's plans, Mr. Gerdelman said there was, at one time, an intention to construct sixty-seven metro networks. While this figure has been revised down to the present twelve metro areas, the fact that New York, for example, could be counted as fifteen individual networks means that these two figures are not directly comparable. It was noted that AboveNet did have a presence in fifty cities at the height of the market; of this total, the minor assets have now been divested. Mr. Gerdelman stated that, in the future, expansion in network coverage would be strictly in response to customer demand.

AboveNet believes that it is able to respond to customer requirements very quickly, a capability that it feels is not displayed by many rival service providers - thus representing a gap in the market. Mr. Gerdelman offered the example of Sprint, which approached AboveNet with a large number of orders, all of which were completed within two weeks.

This facility is a strategic aim for AboveNet - basically the creation of an agile, customer-focused company. In the current market, the ILECs in particular, Mr. Gerdelman noted, are unable to provide a high degree of flexibility when responding to customer requirements.

Mr. Gerdelman emphasised that the current focus for AboveNet is with 'the present' and achieving a steady EBITDA, rather than future activities A central facet of this outlook is seen to be talking with customers, to both define their needs and also assess what requirements are not currently being met, with the aim of finding solutions.

Key to these activities is the leveraging of existing assets and developing partnerships with other companies where value can be delivered. The overriding factor, Mr. Gerdelman reiterated, is optimal use of existing assets, as in the present circumstances there is very little capital available for building new facilities.

Market conditions

In the present environment, Mr. Gerdelman believes AboveNet possesses a valuable and distinctive asset in its metro networks and connections to data centres. From this perspective the best option for the company is to remain independent.

The view is that in the current market most service providers will be concerned above all with getting their existing operations right, and simply staying in business; the activities of other companies, and whether they represent a good acquisition target, would not be expected to rank as a priority.

Despite conditions, there have been a number of offers for AboveNet, even if the sums mooted were not realistic. Mr. Gerdelman commented that he has been involved in the merger and acquisition process six times during the past fifteen years: "I know that I would not necessarily have any control over when and how such an event transpired".

"A new player wanting to move into New York would find it a tough job to set up a rival network, due both to the scale of the network that AboveNet has, also the regulatory conditions in force today - it would probably take ten years to install comparable infrastructure. AboveNet has built up its network over a long period, since 1992."

IP services

Under the IP services product line falls Gigabit Ethernet, representing a new offering for AboveNet. John Gerdelman said this service represents an effective way of leveraging existing assets to generate new business. AboveNet has lateral fibre connections into many buildings, plus equipment in the building basement, connecting to dark fibre under the street. Utilising this infrastructure, AboveNet is able to approach companies that use IP services and offer more or less infinite burstability - bandwidth-on-demand at a low price, which is ideally suited to small companies. With these services AboveNet will be competing with 'traditional' DS-1 and DS-3 offerings from carriers such as Verizon.

AboveNet also provides IP connectivity to large companies, including other service providers. One example is Cogent Communications, for which AboveNet carries a large volume of traffic. Cogent links to AboveNet's network either at one of its data centre facilities or at a Point of Presence (PoP). It was explained that a customer may connect to AboveNet's network via a third-party service provider where the customer is not passed by AboveNet's own network - for example through a T1 link into a data centre, from which the customer will have access to IP services.

Data services

Storage (SAN) services are regarded as a healthy market and Mr. Gerdelman noted this is anticipated as being one of the first sectors to emerge as the market recovers. It is believed that SAN offerings will gradually blend to form a subset of IT services. John Gerdelman sits on the board of McDATA, a SAN solutions provider.

AboveNet maintains a subsidiary catering exclusively to the government sector in the U.S. - AboveNet Government Services - which Mr. Gerdelman explained was spun-off from AboveNet prior to the Chapter 11 filing in order to protect business that would otherwise have been suspended or lost.

Mr. Gerdelman sees AboveNet's prime advantage as deriving from the locations of its metro networks, in particular those in New York, Chicago, Los Angeles, Dallas, Houston and McLean, North Virginia. In contrast, AboveNet's presence in Boston is felt to be on a par with all other service providers in the city, with no one company able to claim a significant advantage.

Assessing AboveNet capabilities at a more granular level, John Gerdelman stated that key features include access to almost 700 buildings, and the company's policy of placing exit points on metro rings every 1,000 feet instead of the more usual half-mile (approximately 2,600 feet).

The dot-com companies have largely been dropped from the customer list, due, apart from other factors, to the failure of many. AboveNet has adopted a policy of focusing on the largest users of network services within different industry sectors. This has been enforced to an extent by the types of service that the company offers.

Mr. Gerdelman said that, in addition to high-capacity, high-end, dark fibre offerings, AboveNet now offers lower scale wave-channel services - an offering anticipated to move down the corporate hierarchy to the medium-sized company segment.

Catering to the small business sector, AboveNet provides IP services. For example, through its data centre facilities in San Jose, California, the company serves a wide range of customers, generally within the electronics and IP space, although not, it was noted, true dot-com companies.

The data centre business is seen as primarily a real estate activity, experiencing minimal growth. It was noted that, typically, as one customer is gained another will be lost. Mr. Gerdelman believes that the best profit margins are to be found through bundling products - basically, doing more for the customer. AboveNet is currently assessing options in this respect, with a view to delivering solutions rather than individual services.

The company believes that the future for its dark fibre business is secure, the main challenge being maintaining profit margins - a factor aided by recent pricing stability. Likely consolidation within this market sector is expected to improve the situation.

The merits of addressing the dark fibre market from the service provider perspective, are foremost the simplicity of the business - there is no dependency on technology and switches. Once a customer is signed up the only danger that the provider has to contend with is the fibre being cut.

When required by the customer, AboveNet will install equipment to light the fibre, however commenting on AboveNet's approach to this business, Mr. Gerdelman said:

"AboveNet did not follow the path of installing Class 5 switches into dark fibre networks, as some service providers have, and has no plans to do so - this strategy requires substantial capital expenditure and ongoing maintenance costs. Additionally, I believe that Class 5 switches will be superseded by softswitches."

Describing from a customer perspective the developing wave-channel business, a lower capacity alternative to dark fibre, Mr. Gerdelman explained that AboveNet supplies and installs all necessary equipment to light the fibre for the customer. It was noted that the market for this service is beginning to grow significantly as companies become comfortable with the concept, and in particular as concerns relating to security are dispelled.

In terms of the breakdown in revenues deriving from U.S. and European operations, Mr. Gerdelman stated that as a requirement of the Chapter 11 process, UK revenues must be kept separate from those of the U.S. business - there must be no flow of cash between the two units. Although the two businesses still comprise a single company, the UK operation is currently operating independently. Mr. Gerdelman remarked that the UK business is healthy, offering a similar range of services to many of the same customers as are found in New York - many of the large financial institutions have offices in both New York and London.

Future prospects

Demand arising from the metro market as a whole is seen to be growing, driven by a number of factors. Illustrating the point, it was stated that customers for dark fibre are consistently "coming back for more". Demand for storage services is also increasing, powered mainly by the large financial institutions that are now required to conduct double and triple data back-up procedures; and by the accelerating transition from text to multimedia e-mail messages.

Each of these developments results in further demand for transport capacity, often over greater distances than in the past. Summing up, Mr. Gerdelman commented that when the market finally settles there will probably be room for many service providers in the data communications space:

"Stepping back and taking a dispassionate view of the market now, it is generally flat. Companies are still reluctant to invest in IT and telecom, but, although there is always the possibility that some random event could extend this downturn, the probability is that they will begin to do so once more very soon."

Commenting on recent world events, Mr. Gerdelman said that while those such as 9-11 and the war in Iraq may not have an overt impact on company activities, there is nonetheless a psychological effect. However, a greater impact is felt to be the traditional reticence by large companies to commit expenditure during the first quarter of the financial year, followed by a more relaxed stance in the second quarter - it was noted that AboveNet is witnessing this pattern in 2003.

Future strategy

Looking ahead, Mr. Gerdelman considers gaining access to more buildings in the metro areas a key factor, noting that the act of passing a building with dark fibre generates no value until there is a lateral connection from the fibre into the building and to potential customers. It was stated that currently, only approximately five percent of buildings are connected to a metro network, representing a huge growth potential for network operators.

Describing underlying reasons for this low penetration level, Mr. Gerdelman said foremost is the fact that a service provider would in the past only go into a building if invited to do so by an occupant - generally, of necessity, a large company. However, with the launch of services such as Gigabit Ethernet it is a viable proposition to serve a far greater range of customers - potentially all the occupants in a building.

Commenting on the economics for a service provider of installing a lateral connection to a building, Mr. Gerdelman said that at the height of the boom the cost could reach $500,000, while in today's climate this has fallen to nearer $100,000. Similarly, real estate costs have declined, thus reducing expenditure associated with locating equipment in building basements and also running cabling within the building.

New technology

With a view to technology, Mr. Gerdelman said there are a number of developments that could aid AboveNet's cause, and some of these are currently being evaluated. Relating to wave-channel services, in particular, reducing costs to the subscriber via CWDM - as opposed to the present expensive, high capacity DWDM - is considered potentially important. AboveNet has been working with ADVA (see also Interview with ADVA) in pursuit of CWDM solutions.

The provisioning of lateral connections into buildings is another area of interest, with the possibility of utilising technology such as Free-Space Optics (FSO) to dramatically reduce costs, currently being assessed - although none has yet been purchased. Mr. Gerdelman said these solutions are "no longer regarded as flaky".

Concerning technology generally, he believes there have been numerous developments over the past five years that are now reaching the stage of commercial viability and warrant attention:

"However, AboveNet is not sitting waiting for any specific technological solution or capability, and is certainly not counting on any such development to ensure its survival."

Mr. Gerdelman was asked about the feasibility, or necessity, of adopting different strategies in metropolitan areas, such as utilising technology from the likes of CableRunner, which is rolling out fibre infrastructure through city sewerage systems. He responded that a key issue relates to the characteristics of the specific metropolitan area under discussion. New York and London tend to lead this market and so strategies applied in these cities have often been duplicated elsewhere, and as noted earlier, there is currently excess network capacity in many cities beyond these two.

Consolidation

Generally, on the market landscape, Mr. Gerdelman stated that consolidation is expected, though the question is when will it occur? The market is believed to have reached the bottom, and, if so, should be conducive to merger and acquisition activity. Level 3 Communications, for example, is one service provider currently acquiring assets, and with a stated intent to continue doing so.

John Gerdelman stated that AboveNet is comfortable operating as an independent entity, although, if a suitor puts a realistic sum of money on the table, the creditors - making up a majority of the board - would be likely to accept. Countering this eventuality is the fact that today represents very much a buyers market, therefore it is likely to be a poor time to sell.