Tag: failed investment

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The Loop

It’s difficult to tell who exactly emerged victorious from last week’s MLGW board meeting that finalized approval of the sale of its interest in Memphis Networx to Denver-based Communications Infrastructure Investments (CII). The big losers, however, were easier to spot: MLGW ratepayers, who saw the public utility’s $29 million investment in the city’s fiber-optic future go up in a cloud of virtual smoke.

MLGW ratepayers once owned 80 percent of Networx but watched that share slip below 50 percent in 2006, when private investors operating under the umbrella of Memphis Broadband, LLC guaranteed a $7 million loan to prop up the sagging business after the Memphis City Council refused to do so. Shortly thereafter, the new majority owners instructed Networx management to search for a buyer, a search that culminated last week with the approval of the sale to CII.

Given the disastrous course this public/private partnership has taken since Memphis Networx’ creation in 1999, the fact that a cloud of confusion and suspicion hangs over the final dissolution of that partnership should come as no surprise. Whether such suspicion is justified or not, it isn’t reassuring that representatives of Networx and MLGW have been less than forthcoming about how the final deal evolved and, further, have failed to voluntarily disclose several eyebrow-raising facts connected to the sale.

How close, for example, are the private investors and current and former officers of Memphis Networx to the presumed buyer? Close enough that buyer and seller share at least one mutual strand of DNA.

Robert Blow, a Virginia/Memphis-based telecommunications entrepreneur and one of the original investors in Memphis Broadband, was only 52 when he died of a heart attack in July 2002. Based on documents and comments from sources close to Networx, the Blow estate is still involved in Memphis Broadband, a group that includes local investors such as FedEx founder Fred Smith, Dunavant Enterprises, former NBC chief executive Thomas Garrott, and AutoZone founder Pitt Hyde, among others. Blow was also a founding partner of Columbia Capital Partners, one of the venture-capital firms backing CII, the Colorado-based holding company in the process of buying Networx.

Blow was, additionally, a founder of Paradigm Partners, a venture-capital firm that worked with Memphis Broadband to develop a $30 million institutional fund to help finance Memphis Networx. After the telecom crash of 2001, however, the funding environment for telecoms stagnated, and Paradigm bailed on the project shortly before Blow’s death.

Current Networx board member Andrew Seamons was also a partner in the Paradigm firm. When Paradigm disintegrated in 2002, he joined Pittco, an investment firm affiliated with retired AutoZone CEO Pitt Hyde. While there may be no direct financial links between Networx’ private investors and CII (like all new business environments, the wireless-infrastructure industry has quickly developed its own set of knowledgeable “insiders”), repeated claims by Networx representatives that CII just called out of the blue to see if the Memphis telecom was for sale seem implausible, given the relationship between the original Memphis Broadband group and Columbia Capital.

On July 5th, the day MLGW’s board voted to sell Networx to CII, Seamons made it clear that inquiries regarding the private investors’ holdings wouldn’t get very far. When asked whether any of the Memphis Broadband participants were invested in Level 3 Communications, the prominent infrastructure company that’s most likely set to acquire Memphis Networx once its financial situation is stabilized, Seamons explained that lots of people probably own a piece of Level 3, because “it’s a big company.”

Level 3 Communications isn’t directly connected to CII. But CII’s founder, Dan Caruso, was a founding executive of Level 3. Caruso was also the CEO of ICG Networks, which was owned by Columbia Capital and M/C Venture Partners and which was ultimately bought out by Level 3. When ICG was purchased from Level 3 by Columbia Capital and M/C Venture Partners, the Denver Rocky Mountain News reported that these two firms stood to “profit handsomely from the deal.”

Speaking on Seamons’ behalf, MLGW and Networx board member Nick Clark explained that, as an investor at Paradigm and Pittco, Seamons probably knew somebody employed by every group involved in the bidding process.

Possibly true. But what’s the real story? Is the telecom infrastructure business a tiny world where everybody’s in everybody else’s business? Or is it a big world where nobody knows much about anybody? Or is it, as Networx officials would have it, both?

It’s a Small World, After All

On the day the MLGW board voted to sell Networx, it was acknowledged that Networx CEO Dan Platko and Tom Swanson, the McLean Group consultant who was enlisted to aid in the sale of Networx, were anything but strangers. In 2000, the two telecom veterans were employed by Intira, a communications company founded in St. Louis by former Networx CEO Mark Ivie. Intira also employed former Networx controller Jeff Rice.

It was also noted that Platko signed a contract offering Swanson $2,000 a day to consult with Networx’ sales division through his personal firm, TJSwansonCo, almost two months before Networx approached the McLean Group to assist with the sale of the company.

According to Networx officials, the McLean Group was contacted in December 2006. Platko signed Swanson’s contract on October 5th. Previously, Swanson had only been identified in the record as a representative of the McLean Group. It’s unclear if Swanson consulted in both capacities simultaneously.

After MLGW’s vote to sell Networx, Swanson claimed that he and Platko hadn’t done business together since they worked for Intira. Several sources close to Networx, however, say Platko was trying — unsuccessfully — to bring Swanson in as a consultant before Platko was named CEO. Those sources have also told the Flyer that there was a falling out between Platko and his predecessor, Mark Ivie, just prior to Ivie’s departure in 2006. Platko and Ivie were friends from their Intira days, and Platko lived with Ivie after being recruited to Memphis. After Ivie’s departure in 2006, Networx elevated Platko to CEO.

So who is Dan Platko? Prior to being recruited by Ivie, Platko was employed by Infinium Labs, a video-gaming company out of Florida that became infamous in that industry for burning through tens of millions in investor capital without producing a product. Press releases dating from 2004 identify Platko as Infinium’s vice president of operations.

Infinium (later renamed Phantom Entertainment) was founded by Tim Roberts, who also co-founded Intira with Mark Ivie. Platko and former Networx controller Jeff Rice worked for both Intira and later Infinium.

Confused yet? It gets worse. Between his time at Intira and Infinium/Phantom, Platko was employed at a director level for Equant, a division of France Telecom. He worked at a similar level for Relera, a Denver-based managed-services company that launched in January 2000 and partnered with Level 3 Communications — the same company rumored to be Networx’ ultimate suitor — shortly thereafter. While there’s no evidence that Platko and CII founder and former Level 3 exec Dan Caruso ever met during this period, the incestuous nature of the high-speed infrastructure industry makes the absence of some contact seem unlikely.

What Does It All Mean?

The majority of CII’s $11.5 million bid for Memphis Networx goes toward the retirement of Networx’ $7 million debt, plus interest. The private investors involved in Memphis Broadband split the $2 million remaining (their original investment was $5.5 million), leaving only a modest $944,000 to be returned to MLGW coffers.

End of the story? Maybe not. Networx posted modest operating profits in 2005, and sources still inside Networx say the company has done better since. Those same sources suggest that the company’s outstanding debt — which will be eliminated once the CII deal goes through — is the only thing standing between Networx and sustained profitability. That makes Networx an excellent buy for a holding company like CII, whose plans for the future may well include minimizing overhead, maximizing revenue, and positioning the company for sale at a tidy profit.

Between debt retirement and significant reductions in Networx staff over the past year, it would appear that much of CII’s job has already been accomplished. Now money that might have been applied to debt can be used to infuse Networx with additional operating capital, so it can expand infrastructure, attract new customers, and, yes, make money.

Silence Is Golden

Somebody stands to make a lot of money as a consequence of MLGW’s $28 million loss. Maybe those people aren’t connected to Networx’ private investors, but clearly, the high-speed infrastructure business is an insiders’ game, and the evidence suggests that there are plenty of insiders on both sides of the Memphis Networx deal — a deal that was presented to MLGW and, more importantly, to the public as a “now or never” choice: Memphians were told that any delay in decision making could queer the deal and send Networx spiraling into insolvency.

Shortly after news regarding Networx’ sale was announced, Nick Clark admitted that he’d known the telecom was in trouble for at least two years but kept quiet for fear of scaring off customers. Former and current Networx employees have claimed that the board outlawed the practice of issuing press releases some time ago. No news, good or bad, came out of Networx from December 2005 until the sale was announced earlier this summer. Networx’ Web site, for example, hasn’t been updated since March 2005.

Intentionally or otherwise, Networx’ minority public owners and the city’s elected officials were actively shut out of the sale process. Apparently, no one in MLGW management or on the Memphis City Council (which in theory has financial-oversight responsibility for the utility) was aware that Networx was in such dire straits.

Why would the Networx board keep MLGW management and the Memphis City Council in the dark? Why wasn’t the council given at least an opportunity to protect the ratepayers’ interest in the company by reconsidering their earlier decision not to provide additional funding before being presented with a fait accompli this summer?

In the spring of 2005, at about the same time as Networx’ initial request for more money from MLGW, Doug Dawson, a consultant hired to determine a fair market value for Memphis Networx, cited high overhead, big commissions, and immediately vested retirement packages as contributing factors to the company’s anemic financial condition.

In reality, most of the concerns listed in Dawson’s report had begun changing as far back as 2000, when Mark Ivie replaced Networx founding CEO Ward Huddleston. But once the media started running with Dawson’s report, the damage apparently was done. Sources close to Networx say that the negative reports and political squabbling, along with the ripple effect of the 2001 telecom crash, scared off customers and investors alike.

By 2006, however, the telecom industry was in turnaround mode, and Memphis’ telecom had posted its first-ever operating profit. According to Networx insiders, debt was the only thing standing between the troubled company and substantial profits. Given an opportunity to explore their options, the City Council may have been more cooperative this time around than they were in 2005. Council members Carol Chumney, Barbara Swearengen Ware, and Henry Hooper have all said as much.

Where Are We Now?

When is a deal not a deal? When lawsuits get filed, of course. Immediately after the CII deal was approved last week, lawyers for New York-based American Fiber Systems filed a declaratory action lawsuit to determine who really presented Networx with the best bid. Ohio-based BTi Corporate, the other losing bidder, is also trying to keep its hat in the ring.

In an angry outburst at MLGW’s board meeting to approve the deal, BTi rep Dave McCabe called Networx’ bidding process a joke and claimed that the fix was in “from day one.”

But was it? Perhaps. Perhaps not. But at the very least, in a world as parochial and interconnected as this one seems to be, the line between insider and outsider trading seems little more than a hazy blur. Stay tuned.

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Cover Feature News

It’s Now or Never for Networx

CREDIT: Richard Thompson

Who made the best bid for Memphis Networx? Was it the well-funded seven-month-old holding company from Colorado — Communications Infrastructure Investments (CII)? What about New York’s proven infrastructure firm American Fiber Systems (AFS)? Or was it BTi Corporate (BTi), the darkhorse candidate that wants to turn Memphis into the bio-tech research hub of the Americas?

MLGW’s board says CII won the bid fair and square. The other bidders say the fix was in from day one.

It might be helpful for the City Council to hear all three companies explain why they think they made the best bid. But given the long, strange saga of Memphis Networx, such an occasion might distract from the unspoken question that loomed like a family curse over last Thursday’s vote by the MLGW board to sell Networx for a cash return on its $29 million investment of just $994,000: Namely, how in the world did Memphis Networx become lodged so inextricably between the frying pan and the fire?

Networx representatives made the case that delaying the company’s sale any longer will send it into a tailspin of irreversible loss. “It’s now or never” has been a reoccurring theme in the Networx debate. But when “now” is a paltry return of $994,000, “never” isn’t much of a threat.

The MLGW board meeting did reveal several apparent flaws in the bidding process. A presentation delivered by the McLean Group — the consulting firm hired to assist Networx through the sale — may have done more damage to the credibility of the consultants’ ultimate findings than anything brought to the podium by angry representatives of AFS and BTi.

McLean Group chairman Dennis Roberts and junior consultant Tom Swanson made the losing bidders sound so bad it became impossible to imagine how such nonserious bidders could have made it to the final three in the first place.

As the deal was explained to the media by Nick Clark — who sits on the boards of both MLGW and Memphis Networx — the bidding process was managed quietly through the McLean Group to weed out frivolous bidders and to avoid conflicts of interest. In a sneering assault on BTi’s credibility, one McLean Group consultant announced that a BTi principal had been making his living installing stereo equipment. (BTi founder and CEO Paul Allen has since stated that nobody in his telecom company has ever installed stereo equipment.)

The McLean consultants also said Allen’s company didn’t follow the rules and that its bank letters were unconvincing. They said BTi representatives didn’t show up for a scheduled due diligence meeting. (BTi has given the Flyer a letter from Thomas Murray of Fifth Third Bank reconfirming its interest in financing the Networx purchase based on a thorough process of due diligence.)

AFS’ problem, as identified by the McLean Group, was basically that they couldn’t show anybody the money. AFS has filed a declaratory action suit to prove their seriousness.

No BTi representatives were present when McLean consultants trashed their company’s bid, but AFS CEO Dave Rusin was visibly disturbed by the McLean Group’s findings. He shook with anger at times while explaining in measured words how his company survived the dot-com crash in 1999, weathered the telecom meltdown of 2001, and is a serious and reputable company.

He convincingly answered charges that his company wasn’t good for the cash by asking what was wrong with the $60 billion available to AFS’ historically cooperative financiers: Sierra Venture Partners, Lucent Venture Partners, North Atlantic Capital, and Hamilton Lane.

Dave Danchak, AFS senior vice president of corporate development, angrily said that the McLean Group’s figures didn’t look like anything he’d ever seen before.

Germantown resident David McCabe, a representative of BTi Corporate, arrived for the second half of the marathon meeting.

“They’re hiding something,” he insisted, accusing the McLean Group of spinning the facts.

McCabe also challenged the McLean Group’s assertion that BTi missed its due diligence meeting. He said that Networx representatives called unexpectedly on a Wednesday afternoon and asked if BTi could assemble its team and be in Memphis the next morning. According to McCabe, doubts were expressed on the front end as to whether or not his people could make it on such short notice, but they said that they would be in Memphis as soon as possible.

McLean consultant Swanson admitted that the due diligence process had been “accelerated,” a fact conveniently left out of the McLean Group’s original narrative, which alleged that the stereo-installing bunglers of BTi just couldn’t follow the rules. “Their story keeps changing,” McCabe declared.

After listening to McCabe’s indignant rebuttal of the McLean’s Group’s analysis, the MLGW board concluded that the McLean Group and BTi had had “a miscommunication.”

Although Rusin and Danchak of AFS had initially refused to comment on BTi’s proposal, the AFS reps returned to the podium and expressed sympathy for their competitor.

“Mr. McCabe talks about how the story keeps changing,” Rusin said. “Well, guess what? We come here today and find that the numbers have changed.”

Rusin and Danchak then unveiled their company’s lawsuit. MLGW board chairman Rick Masson expressed concern that the suit was part of an intentional ploy to further devalue Networx, which has only enough operating capital to survive for a month to 45 days.

CEO Dan Platko then delivered a grim assessment of Networx’ financial condition, and Clark described what might happen if the sale was delayed. Staff cuts would be necessary, he said, service would then decline, and customers would flee. According to Platko and Clark, it was doomsday eve for Networx, and the clock was ticking.

In spite of potential conflicts of interest, Clark maneuvered back and forth between his dual roles as MLGW governor and Networx board member. He spoke of the need for a transparent process and occasionally played the role of devil’s advocate, despite the fact that the Networx board had approved the sale to CII and had signed a binding agreement with the company.

Clark cited a Flyer story and asked a series of questions supposedly based on this newspaper’s ongoing coverage of the Networx sale. But Clark’s Flyer-based line of questioning left out the same embarrassing facts about possible conflicts of interest that were raised in the article that he’d omitted in a previous report to City Council chairman Tom Marshall.

After confirming that Platko had once been employed by Intira, a company co-founded by former Networx CEO Mark Ivie, Clark moved to another subject, without mentioning the fact that Swanson — the McLean Group’s allegedly unbiased third party — had also been a vice president at Intira. Nor did Clark mention that Swanson, prior to assuming his McLean Group duties, may have accepted a lucrative, paid consulting gig with Networx via his personal firm, TJSwansonCo.

After Clark’s omissions were noted, Platko and Swanson admitted that they’d worked together at Intira. Swanson later said that prior to the Networx deal, he and Platko hadn’t done business together since leaving Intira. However, a contract signed by Platko on October 5, 2006, suggests that Networx’ chief executive offered Swanson $2,000 a day for consulting with Networx’ sales division, a month before the McLean Group was called in to assist in Networx’ eventual sale.

The information becomes doubly troubling in light of Networx officials’ repeated failure to identify Swanson as having any duties above and beyond the work he was doing through the McLean Group. (Detailed questions submitted by the Flyer to Swanson and Platko have yet to be answered.)

“It was an imperfect process, but it’s an imperfect world.” This, more or less, was the opinion MLGW board members unanimously expressed prior to finally signing off on the sale of Networx to CII.

In a two-to-one vote with one abstention, the board passed a resolution to go forward with the sale of Memphis Networx to CII. In light of AFS’ lawsuit and mounting concerns within the City Council, it’s unclear what that resolution ultimately means.

Documents dating from 2004 show that Networx executives and at least one board member were actively negotiating to sell Memphis Networx to AFS in an unpublicized all-stock deal.

Although sources conflict on the details, it appears that Networx officials’ enthusiasm for closing the original deal may have faded when it was discovered that the offer would be small and paid in stocks, especially in light of the fact that MLGW, as a publicly held company, is prohibited from owning stock in a private company.

When asked last Thursday, Networx board member Andrew Seamons said it was highly unlikely that any of the private investors would have an interest in absorbing the AFS stock into their share of the sale. Seamons is professionally affiliated with Pitt Hyde’s Pittco investments. Hyde, who recently stepped down from his position as AutoZone chairman, is one of the original private investors in Memphis Networx.

Over the weekend, one highly placed proponent of the Networx sale to CII circulated news items intended to prove BTi was in over its head on the Networx deal.

Considering the board’s vote to sell Networx to CII, it’s hard to imagine what anyone stands to gain by further discrediting BTi. Unless it’s the fact that continuing the debate over who placed the best bid shifts focus away from the only questions that matter: When did Networx’ executives know the company was in a tailspin; and how were the company’s finances managed from that point on?

If the McLean Group was contacted to assist with the sale of Networx in December, as reported, serious concern over the company’s finances had to be growing by the time Platko offered Swanson $2,000 a day for services that have yet to be sufficiently explained.

Networx’ history of questionable decision-making ranges from disastrous technology purchases to a miscalculated deal with ServiceMaster that cost the telecom thousands of dollars a month for nearly a year. How did that history change when new CEO Platko found out that his company was in serious trouble? Did he tighten up the company’s belt or did he enable spending that further exacerbated Networx’ dire situation?

Platko and his predecessors had the advantage of using Networx’ private status to withhold information whenever anyone attempted to delve too deeply into the specifics of the company’s spending practices. The choice Networx executives have given its public owners — nothing or next to nothing — demands answers not available in the financial postmortems Clark has delivered to the press.

Epilogue: When Platko replaced his former colleague Mark Ivie as head of Memphis Networx in 2006, MLGW’s ratepayer/owners were not notified of the change. Clark, an appointed steward of the public’s interest in Networx, has described the lack of attention given to such changes at a company funded (in part) by public dollars as “fortunate.” To interpret his comment as “the less the public knows about what’s being done with its money, the better” may be unfair, but it’s also unavoidable.

Clark says he recognized that Networx was experiencing trouble when he joined the board in 2005. Ironically, given the final outcome, he says he kept quiet for fear of scaring off potential customers.

MLGW has fully enabled this disaster. Its board members have harbored concerns about Networx’ financial well-being for at least two years but allowed Networx to keep a low profile while the telecom was clearly wasting away. Silence and complicity in the name of maintaining Networx’ “competitive edge” precipitated MLGW’s recent “damned if you do, damned if you don’t” decision, wherein the only thing worse than selling its valuable telecom asset for a $28 million loss is not selling it right now … for a $28 million loss.

On Tuesday the Memphis City Council voted to discuss Networx-related issues at a meeting of the MLGW committee. Details of that committee meeting were not available at press time.

See MemphisFlyer.com for updates on the Networx story.

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News The Fly-By

Why the Rush?

The clock is ticking. On Thursday, July 5th, MLGW’s Board of Governors will vote whether to sell Memphis Networx to a Colorado-based holding company, Communications Infrastructure Investments (CII), for $11.5 million — a loss for MLGW exceeding $28 million. Networx representatives have cautioned that any significant delay could negatively impact a deal that, for MLGW ratepayers, is already negative.

Before the vote, however, some serious questions should be asked regarding potential conflicts of interest and the business practices that led MLGW to this juncture.

First, if MLGW is already prepared to eat almost all of its $29 million investment, what do the ratepayers stand to lose by delaying this decision long enough to ensure that the sale is on the up and up?

Question two: Who exactly is Tom Swanson, the McLean Group consultant who assembled the list of Networx potential buyers and helped facilitate the deal? Last week, when City Council chairman Tom Marshall asked that same question, Networx board member Nick Clark responded by quoting Swanson’s McLean Group Web bio, which leaves out an interesting piece of information. Swanson’s bio for his own private consulting business (TJSwansonCo) lists his involvement with a now-shuttered company called Intira, where, according to SEC records, he served as vice president of sales. Intira was co-founded in 1998 by former Networx CEO Mark Ivie and employed former Networx controller Jeff Rice as well as current Networx CEO Dan Platko. Given his background, should Swanson have been the broker for the deal?

An official contract signed by Platko and obtained by the Flyer suggests, and other sources verify, that late last year, Platko offered Swanson $2,000 a day to consult with Networx’ sales division through his private firm. Swanson’s compensation may have dropped by about one-third when he took on the job of assisting with the sale of Networx through the McLean Group in December 2006.

More questions: Who stands to profit from the sale of Networx? Certainly not MLGW ratepayers, currently taking a $28 million bath. Will any Networx executives have employment opportunities with the new ownership or with companies related to the new ownership? Have there been any arrangements made behind the scenes that may have tilted the scales in CII’s favor?

This isn’t the first time Memphis Networx has been positioned for sale. American Fiber Systems (AFS), the New York communications infrastructure company that submitted a bid for Networx valued at $13 million, has been trying to acquire the company since 2004. AFS’ initial bids involved no cash, but Networx execs and at least one board member showed substantial interest.

More recently, AFS placed a higher combined cash-and-stock bid for Memphis Networx than CII, but it wasn’t the highest. Ohio-based BTI Corporate, a communications firm looking to partner with Memphis Bioworks and strike a deal with MLGW that could allow the local utility to recoup some of its losses, submitted a bid valued at $20 million.

Whose best interests have been served in the rush to unload Memphis Networx? The ratepayers? The private investors? Or someone else? Ultimately, selling Networx — even at a loss — may be in MLGW’s best interests. But given the history, it’s important that MLGW’s ratepayers know who profits from the botched $29 million investment and why.

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Cover Feature News

Unplugged

Talk about your bitter ironies. Days after MLGW announced that it would eat a multimillion-dollar loss and sell its 49 percent share in the public/private telecom venture Memphis Networx, subscribers to Business Week were reading all about the telecom industry’s triumphant comeback.

The magazine’s cover story — “Telecom: Back from the Dead” — cited a growing body of research indicating that investments in high-speed communications play a more vital role in “stimulating economic growth and productivity” than money spent on “roads, electricity, or even education.” If all of this is true, how can MLGW even consider dumping its $29 million investment in Networx for the paltry sum of $994,000?

At least part of the answer can be found in the third paragraph of the story, in which Business Week cites the example of a video clip being uploaded in New Jersey. The video exits Google by way of Level 3 Communications’ 47,000-mile fiber-optic network, is then “handed off” to a “new fiber loop” run by Verizon, and “milliseconds later,” the video is showing in an apartment in New Brunswick. What does any of this have to do with Networx? Plenty.

Communications Infrastructure Investments (CII), the Colorado-based holding company that’s trying to buy Memphis Networx for $11.5 million, was founded by Dan Caruso, a founding executive of Level 3 Communications. Caruso is also the former CEO of ICG Communications, which Level 3 bought out in 2006, adding 2,000 miles of fiber in Colorado and the Ohio Valley to its already substantial holdings.

ICG’s backers — Columbia Capital and M/C Venture Partners — picked up $30 million in cash on the deal and $127 million in Level 3 stock. Columbia Capital and M/C Venture are two of the five venture-capital groups backing Networx’ potential buyer, Communications Infrastructure Investments.

The bottom line? Big venture-capital money is being invested in telecoms again. And it seems likely that Memphis Networx fiber-optic cable is destined to become just another piece of the increasingly valuable conduit for moving YouTube clips of bathtub farts and nipple slips from Google central to your computer.

If you build it …

In the film Field of Dreams, Iowa farmer Ray Kinsella (played by Kevin Costner) was told famously, “If you build it, they will come.” The analogy isn’t exact, but Memphis Networx built a broadband fiber network for Memphis, ran out of money, and now “they” — in the form of venture-capital communications companies — are coming.

It’s important to understand that the telecom failures of 2001 — the year Memphis Networx became operational — represent the largest industry crash since the Great Depression. The spectacular decline has been blamed, in part, on overaggressive investment in expensive infrastructure. And now, holding companies like CII and American Fiber Systems can acquire and resell ready-made infrastructure systems and customer bases of companies like Networx for a fraction of the build-out and maintenance cost.

“It’s interesting to me that [Networx] is where it is,” says Herman Morris, the soft-spoken mayoral candidate who served as president of MLGW when Networx was created. “It’s an asset that’s been built out with 50 or 60 years of life left in it, and probably less than 10 and certainly less than 20 percent of that asset is being used.”

Morris asserts that in spite of Networx’ failure to turn a quick profit for its private investors, the company has already achieved its primary goal, which was to improve Memphis’ communications infrastructure by building an underground loop of high-speed fiber.

“When we got the loop, it took us from a third- or fourth-tier city in terms of infrastructure to a tier-two,” Morris says. “We’re not New York, clearly … but we were doing what we needed to do in terms of building an attractive component for businesses looking to relocate or expand here. It’s kind of like building out an airport so FedEx can expand its operations. And it was important that we weren’t the last city with an infrastructure that would serve the high-tech sector in the 21st century.”

Morris describes Networx’ public/private partnership as “a marriage of convenience” and says he knew on the front end there would eventually be a “divorce.” “Venture capitalists are high-risk investors,” Morris says. “They want big fluctuations [in market value], and they want to catch [the market] on a high. We were kind of like savings-bond investors. When you’re investing for 50 years, the investment doesn’t have to kick out more than 1 or 2 percent a year. That’s a good steady return, and stability is important.”

The big payoffs in this kind of investment, Morris notes, aren’t necessarily measured on a spreadsheet listing Networx’ profits and losses.

“When [a business] relocates to or expands its operations in Memphis, [MLGW] gets more revenue from old infrastructure,” Morris says. “From the wires, the pipes, and the gas.

“It’s not just that a company comes to town and folks get jobs and all that good stuff. The utility company now has a customer that instead of having a 200-square-foot operation has a 20,000-square-foot operation or a 200,000-square-foot operation. And that operation is filled with computers and air conditioners and all the things it takes to run a business. It’s not exactly a self-feeding system, but there is a lot of synergy.”

The wisdom of Morris’ decision to launch a telecom venture at a time when every market analyst was predicting a crash is debatable. But in spite of a marketplace burned by everything ending with “com,” Networx survived and grew at a reported rate that was at or above anticipated levels. The company showed a miniscule profit for the business cycle ending in 2005 and seemed to be on its way to making the 1 to 2 percent return that would have made Morris happy.

Small, slow profits, however, are less meaningful to the private investors who assumed a majority stake in Networx in 2005, when the City Council turned down MLGW president Joseph Lee’s proposal to secure a $6 million loan and prevent MLGW from losing its superior equity status in Networx. Now Networx is on the auction block, and Memphis is positioned to lose big in what appears to be a winning field.

City Council Concerns

Last week, MLGW’s board decided to remove the vote to approve Networx’ sale from Thursday’s board agenda. The decision was made to satisfy concerns raised by the City Council, particularly that the $11.5 million offer made by Communications Infrastructure Investments was not the highest bid. According to MLGW commissioner and Networx board member Nick Clark, the delay is risky but shouldn’t impact the deal.

The council’s concerns come in light of a odd arrangement between Networx and CII: that Networx’ sale price will drop by $1 million if the Memphis City Council gets too deeply involved in the process. And although he agreed to provide the council with requested information about the top companies bidding for Networx, Clark offered words of caution:

“It’s like when you’re selling a house,” he said. Tipping your hand on the low bids might give the winning bidder second thoughts about the asking price.

The council’s stepped-up interest in the Networx sale comes in the wake of last Tuesday’s news that American Fiber Systems (AFS) of Rochester, New York, claimed to have offered a bid for Networx valued at $13.5 million. And it was recently revealed that another company submitted a bid valued at $20 million.

Clark was mildly dismissive of the council’s concern, noting that the AFS offer included stock. He drew a round of knowing laughter from observers by comparing AFS’ stock options to promises made by Memphis’ all-purpose bogeyman Sidney Schlenker, the smooth-talking chiseler from Denver who sold Memphis on The Pyramid, a rideless theme park on Mud Island, and, predating a memorable episode of The Simpsons, a monorail.

But, Clark’s dismissiveness aside, the venture firms behind CII were quite pleased to receive $36 million and $127 million in stock when Level 3 bought Caruso’s ICG. The Rocky Mountain News reported that the venture capitalists behind CII acquired ICG for $6 million, along with the assumption of $100 million in debt, adding that the firms “stand to profit handsomely from the Level 3 deal.”

Prior to last week’s council meeting, Clark held a digital “press conference,” where traditional media and bloggers such as Richard Thompson of Mediaverse-Memphis were given equal access to e-mail questions.

But Clark’s explanations about how Networx lost so much value in so little time leaned heavily on private business concerns, without explaining MLGW’s failure to control the company’s inexplicable spending or to find a business model that served both the public and private interest.

The Business Model Ate My Homework

There were moments last week when Clark sounded like a CD with a nasty scratch. “The ‘business model’ was failing,” he said repeatedly. “We realized we had to change the business model” … “The business model had to change” … “Changes to the business model weren’t working.” Etc.

Until we understand what Clark means exactly when he references Networx’ various misfired plans, his explanation explains … well, nothing. Meanwhile, the City Council has to mull over a deal they can’t stop, concerning an investment they could never control.

Herman Morris

For eight years, Memphis Networx had a basic pass to operate without media and rate-payer scrutiny. The company kept some rather large decisions under the radar, specifically to avoid the theoretically watchful eye of the City Council. There was no announcement made when original Networx CEO Mark Ivie left the company in 2005. Nor was there any public announcement of Ivie’s replacement, Dan Platko.

Clark has described the tight-lipped approach as “fortunate.” He said the decision not to publicize the departure of Ivie was political in nature, citing “the longstanding concerns [about] Networx’ financial strength,” “the negative press [Networx] tended to receive due to MLGW’s ownership,” and “politics at City Council.” Clark said “the desire was for a simple transition in executive management.”

Clark further explained that Networx made Platko COO because he was already employed in the Networx sales division, and the board didn’t think it was financially in a position to search for or attract a potentially better candidate.

In comments at Mediaverse-Memphis, a blog that parses what local media is and isn’t reporting, Clark claimed that secrecy about Networx’ various misfires and misfortunes was probably in the “best interests” of the ratepayer. If “best interests” means MLGW taking a $29 million bath without any public oversight, he would be correct.

In 2005, Doug Dawson, president of CCG Consulting, studied Networx’ fair-market value, and his determination was grim. According to Dawson’s report, the company was overstaffed, overpaid, and overvalued.

“Wholesale companies in any industry by definition live on slim margins,” he was quoted as saying. “It’s the nature of being wholesale … and Memphis Networx pays about the highest commissions I have ever seen anywhere.”

But Networx wasn’t only secretive about its generous compensation packages and its excessive overhead. The company’s marketing strategy was also a catastrophe — one that did nothing to earn public confidence. It was a partly municipally owned company that ate truckloads of money while doing nothing to woo or wow the public — a recipe for political disaster.

In addition to spending issues, there are also questions about the zeal with which Networx approached some potentially lucrative business relationships.

Conversations with Clark revealed that Networx may have missed out on some big opportunities … or liabilities, depending on whom you ask. Clark confirmed rumors that had circulated throughout 2006, that Networx had been approached by Atlanta-based Internet provider EarthLink concerning a potential build-out and municipal wi-fi deal. This is relevant, particularly if the deal in question was anything like the recent partnership struck between Earthlink and Wireless Philadelphia, a not-for-profit organization committed to making Philadelphia the most wired city in America.

In October 2005, about the time Networx stopped communicating with the public, Earthlink signed on with Wireless Philadelphia to create the largest wireless network in the nation. Shortly thereafter, Earthlink started building a 135-square-mile wi-fi mesh connecting the entire city. Earthlink’s investment in the Philadelphia project has been valued at $15 million to $18 million.

Clark was cagey in his descriptions of how such a deal might have affected the value of Memphis Networx and how it ultimately fell through. He cited various competitors in the wireless market as a potential reason for cold feet on both sides. But Clark’s final concern is somewhat puzzling in light of recent news. According to Clark, there was some concern that if a deal was struck with Earthlink, that company or some other competitor might eventually try to buy Networx.

“The challenge [was whether or not] Networx could control the muni wi-fi system so it could profit, or would an outside entity just attempt to buy Networx on the cheap for the benefit of its fiber ring and not recognize value elsewhere.”

There’s one tiny problem with Clark’s answer: By the time negotiations with Earthlink broke down in 2006, the decision to sell Networx on the cheap was only months, if not weeks away. The decision to hire a private consultant to broker the deal had likely already been made.

Morris says MLGW “planned for the utility to be in the equity superior position and have a super-voice in the decision to continue operations or sell or to accept a new partner.”

Clark says finding private investors who want to answer in any way to a public utility is hard. He has yet to show that Networx ever actually answered to the utility in any meaningful way.

The Deal

There are a number of questions that beg to be asked before this deal goes down. What high-profile investors like Fred Smith and Pitt Hyde made or lost in the deal may turn out to be less important than the value Networx infrastructure may or may not have brought to FedEx and AutoZone at a time when nobody else would build such a network.

From a public utility’s standpoint, Networx’ ability to attract companies like ServiceMaster may reflect a more substantial loss than the $29 million MLGW has invested in the project. These are just some of the things both the media and the City Council need to wrestle with before MLGW’s board puts Networx’ sale to a vote on July 5th.

Perhaps all the suspicious behavior surrounding the sudden anouncement and haste of the Networx sale amounts to nothing more than the death throes of a failing venture struggling to find a quiet exit strategy. But telecoms are back, MLGW is out, and such a spectacular crash couldn’t have come off better if it had been planned.

Categories
News

Networx: Will The City Council Get the Real Story? Will Anyone?

MLGW Commissioner and Memphis Networx board member Nick Clark should be commended for the tech-savvy openness he displayed this week. He managed a digital “press conference” where traditional media and bloggers like Richard Thompson of Mediaverse-Memphis were given equal access.

But Clark’s generous candor wasn’t always as candid or generous as it seemed. His explanations about how Networx lost so much value in so little time were often cloaked in the less than transparent language of business.

“The ‘business model’ was failing,” he said repeatedly. “We realized we had to change the business model” … “The business model had to change” … “Changes to the business model weren’t working.” etc. etc. etc.

Ah! It was the plan that failed, not its creators or executors. That explains … nothing. What, exactly, is Clark talking about when he references Memphis Networx’s various misfired business models? And how can an understanding of those models provide insight into the nature of the company’s impending sale to Communications Infrastructure Investments, a telecom-related holding company headquartered in Boulder, CO? Let’s take a look:

For eight years, Memphis Networx had a basic pass to operate without media and rate-payer scrutiny. Reporting by Andy Meek, in today’s Daily News, looks a little deeper into some of Networx excesses.

Meek’s reporting turns on the testimony of Doug Dawson, president of CCG Consulting, who studied Networx’s fair-market value in 2005 and determined that the company was overstaffed, overpaid, and overvalued.

“Wholesale companies in any industry by definition live on slim margins,” he was quoted as saying. “Wholesale companies typically pay low salaries all around — it’s the nature of being wholesale … and Memphis Networx pays about the highest commissions I have ever seen anywhere.”

But Networx wasn’t only secretive about its generous compensation packages or its excessive overhead. The company’s marketing strategy was also a disaster — one that did nothing to earn public confidence. It was a partly municipally owned company that ate truckloads of money while doing nothing to woo or wow the public — a recipe for disaster.

In addition to spending issues, there are also questions about the zeal with which Networx approached some potentially lucrative business relationships.

Conversations with Clark revealed that Networx may have missed out on some big opportunities — or liabilities — depending on whom you ask. Clark confirmed rumors that had circulated throughout 2006 that Networx had been approached by the Atlanta-based Internet provider, EarthLink, concerning a potential build-out and municipal wi-fi deal. This is relevant, particularly if the deal in question was anything like the recent partnership struck between Earthlink and Wireless Philadelphia, a not-for-profit organization committed to making Philadelphia the most wired city in America.

In October 2005 — about the time Networx stopped communicating with the public — Earthlink signed on with Wireless Philadelphia to create the largest wireless network in the nation. Shortly thereafter, Earthlink starting building a 135-square-mile wi-fi mesh connecting the entire city. Earthlink’s investment in the Philadelphia project has been valued at $15 to 18 Million.

Clark was cagey in his descriptions of how such a deal might have affected the value of Memphis Networx — and how it ultimately fell through. He cites various competitors in the wireless market as a potential reason for cold feet on both sides. But Clark’s final concern is somewhat puzzling in light of recent news. According to Clark, there was some concern that if a deal was struck with Earthlink, that company or some other competitor might eventually try to buy Networx.
“

“The challenge [was whether or not] Networx could control the muni wi-fi system so it could profit, or would an outside entity just attempt to buy Networx on the cheap for the benefit of its fiber ring and not recognize value elsewhere.”

There’s one tiny problem with Clark’s answer: By the time negotiations with Earthlink broke down in 2006, the decision to sell Networx on the cheap was only months, if not weeks away. The decision to hire a private consultant to broker the deal had likely already been made.

In December 2006, Memphis Networx hired the McLean Group, a private banking firm headquartered in McLean, Virginia, to create a list of 50 potential buyers. CII, who, according to Clark, had been systamatically approaching companies like Memphis Networx for some time, in an effort to increase its infrastructure holdings, was one of those potential buyers.

Cut to the present: Last week, as Memphis media chattered endlessly about snakes, strippers, and a mayoral sex tape that didn’t exist, it looked like MLGW’s decision to sell Memphis Networx for a $29 million loss would go unchallenged. It was something of a surprise when MLGW’s board decided to remove the Networx vote from Thursday’s board agenda, and reschedule the vote for July.

The decision was made to satisfy concerns raised by the City Council, particularly that the $11.5-million offer made by Communications Infrastructure Investments was not the highest bid. According to Clark, the delay is risky, but shouldn’t impact the deal.

Theoretically, the board was under no binding obligation to answer the City Council’s concerns, and their decision to do so comes in light of a odd arrangement between Networx and CII — that Networx’s sale price will drop by $1 million if the Memphis City Council gets too deeply involved in the process. But it’s unlikely that a cursory investigation into the bidding process by the council will yield anything definitive.

Although he agreed to provide the council with requested information about the top companies bidding for Networx, Clark offered words of caution:

“It’s like when you’re selling a house,” he said. Tipping your hand on the low bids might give the winning bidder second thoughts about the asking price.

The council’s stepped-up interest in the sale comes in the wake of Tuesday’s news that American Fiber Systems of Rochester, NY, claimed to have offered a bid for Networx valued at $13.5 million.

Clark was mildly dismissive of the council’s concern, noting that AFS’s offer included stock. He drew a round of knowing laughter from observers by comparing AFS’s stock options to promises made by Memphis’ all-purpose bogey-man Sidney Schlenker, the smooth-talking chiseler from Denver who sold Memphis on The Pyramid, a rideless theme park on Mud Island, and — pre-dating a memorable episode of The Simpsons — a monorail. Anything that can be compared to a bad guy like that must be extra radioactive. Right?

Maybe. MLGW and Networx did find CII via McLean Group consultant Tom Swanson. Swanson’s participation adds another layer to the onion, and at least suggests that MLGW’s decision to sell to CII rather than AFS is both impartial and justified. On the other hand, AFS is a serious company, and Memphis wouldn’t be its first municipal buyout. When Marietta, Georgia, decided to eat its $25 million investment in a Networx-like venture, AFS was there to take the tanking telecom division off the city’s hands.

While determining whether or not the Networx sale is on the up and up, the City Council needs to look beyond the technical process leading up to the sale. The company made a point of operating under the radar to avoid the theoretically watchful eye of the council. Clark has confirmed as much.

And as the Flyer has reported previously, Networx was never run like a business bent on success.

From December 2005, until the present — a period of total media blackout for the company — Networx seems to have been engaged in a process geared toward reducing value while preparing for an eventual sale. Neither the media or the City Council was notified when Networx CEO Mark Ivie stepped down in 2006. Nor did the company announce that Dan Platko had been named COO, specifically to run the company during the period leading up to and through its eventual sale.

Perhaps all the suspicious behavior amounts to nothing more than the death throes of a failing venture struggling to find an quiet exit strategy. But such a spectacular failure couldn’t have come off better if it had been planned. And if Networx’s ever-changing, ever-failing business models are any indication, it’s possible that it was.

— Chris Davis

Categories
Editorial Opinion

Learning from Networx

So it didn’t work out after all. That’s the indisputable bottom-line fact about Networx, the much-ballyhooed MLGW-backed enterprise that got under way back in 1999, funded partly by some blue-chip local investors but mainly — to the tune of some $29 million — at taxpayer expense. Most of that money has now gone south, thanks largely to the dot-com boom petering out just as the millennium turned.

But there were also some doubts, even at the time, about the wisdom of the telecommunications venture from both financial and technological viewpoints. That such concerns were not heeded — or for the most part even heard — owed a great deal to an unprecedented P.R. push for the investment. World-class entrepreneurs like Fred Smith, Pitt Hyde, William B. Dunavant, and the late Willard Sparks were enlisted as Networx partners, and, by lending their names and reputations (rather more than their pocketbooks), they gilded a very problematic lily.

Meanwhile, the taxpayers, who footed the bill, were never adequately consulted or informed.

The fact remains that some of the rationale behind the project was probably on target. One of the topics mentioned at the well-attended Conference for Media Reform, which met here last January, was the need for universal access to broadband technology. Critics of Networx have made an issue of the fact that its books were not made accessible to the public. Though that objection related mainly to the way the venture was managed, we would carry the logic of it a step further:

Perhaps the chief flaw in both the conception and execution of Networx lies in the way it was structured. In our time, Internet technology is as much a part of the fabric of life as light, gas, and water. What Networx should have been all along, perhaps, was a public utility itself, and in the wake of its failure, as well as the well-founded concerns attending the Hoops-FedExForum-Grizzlies issue, maybe it’s time for a long, close look at the question of public ownership in general.

A Seat at the Table

One of the most frequent allegations we hear at local political forums is the lament that the county wheel tax, originally earmarked for education during the administration of former Shelby County mayor Bill Morris, has been used to fund a variety of other purposes over the years.

Certainly the proceeds of the wheel tax were redirected this year, as several representatives of the city and county school systems noted Monday during a meeting of the Shelby County Commission. What the commission did, faced with an unexpected surplus, was divert some $11 million of already committed school operating funds to a separate fund for future capital improvement programs.

As all parties eventually agreed, the school systems were not robbed (indeed, they ended up better financed than earlier foreseen), but there were problems, both in the ex-post-facto nature of the reallocation and the lack of prior input solicited from the educators themselves.

“Give us a seat at the table,” several of the school spokespersons asked. We agree.