Google Fiber in Kansas City Makes Hollywood Nervous

Of all the media industries dragged kicking and screaming into the brave new digital world—news, music, publishing—Hollywood has held up comparatively well. Although physical sales of DVDs and Blu-ray are falling, no single Web company dominates the online video realm, and consumers mostly still get their programming via pricey cable bundles. Poky Internet speeds—the U.S. average of about 5 megabits per second ranks 26th globally—means that pirates can’t swap bulky video files with the same insouciant ease as they do MP3s.

Google (GOOG) might change that. In 2010 the company announced plans to bring super-high-speed Internet access to select communities in America and in 2011 picked Kansas City to start. The search giant has said it hopes to spur innovation among cable companies and Internet service providers by demonstrating what’s possible with Internet speeds 100 times faster than the U.S. average. The project could also foreshadow dramatic changes for Hollywood, both because of the specter of piracy and Google’s possible experiments with new ways to distribute content legally.

Photograph by The Kansas City StarKansas City Internet speeds will increase hundredfold with Google Fiber

Google has already strung more than 100 miles of fiber-optic cable along utility poles in Kansas City, Kan., and Kansas City, Mo., and expects to connect its first homes in the next few months, says Google Fiber spokeswoman Jenna Wandres. Its test network of about 850 homes in a faculty neighborhood near Stanford University in Palo Alto, Calif., already provides blistering download speeds of 922 megabits per second and upload speeds of 883 Mbps. At those speeds, Web surfers—or pirates—can download a DVD in under a minute or a high-definition Blu-ray in five.

Wandres stresses that Google Fiber isn’t meant to empower pirates: “We hope higher speeds will actually make it easier to deliver and download more authorized content,” she says. Nonetheless, Howard Gantman, spokesman for the Motion Picture Association of America, notes that piracy is always a concern of the entertainment industry. Google Fiber “could be a great opportunity for consumers whose access to creative content is often hampered by slow speeds,” he says. But in South Korea, “the home entertainment marketplace was decimated by digital piracy” enabled by the widespread availability of high-speed Internet.

Google doesn’t have the intent or money to build a nationwide fiber network, which is a prerequisite for apocalyptic piracy. Such a project could cost $350 billion, according to the Federal Communications Commission. Still, there are signs that Google’s experiments could affect Hollywood. In December the Wall Street Journal reported that Google was in discussions with Walt Disney (DIS), Time Warner (TWX), and Discovery Communications (DISCA) about offering their content via Google Fiber. Google subsequently obtained licenses from Kansas and Missouri state regulators to offer video services over its fiber-optic network. In February the FCC gave the search company permission to operate a satellite farm, pulling down transmissions that typically carry TV signals, near its data center in Council Bluffs, Iowa. The state’s economic development authority has approved tax breaks to Google for a planned $300 million expansion of that data center.

Such evidence fuels belief that Google will become a content distributor, although the company won’t comment on its plans. Craig Moffett, an analyst at Sanford C. Bernstein (AB), speculates that Google could use its raw data processing power to store TV programming, essentially creating a giant, searchable DVR in the cloud and distributing programming—live or on-demand—to Android smartphones, iPads, and TVs. It could also use the network to develop more targeted ways to sell and deliver TV advertising.

In short, by creating its own pipe, Google can play with new ways to allocate bandwidth between Internet and TV services and see what Kansas City denizens adopt. Mitch Singer, the chief digital strategy officer for Sony Pictures Entertainment (SNE), believes media companies can’t ignore such experimentation. “Google Fiber will definitely be a disruptive force,” he says. “The studios know that if we stick our heads in the sand, we will fail, pure and simple.”

The bottom line: Regulatory licenses and other evidence point to Google considering video distribution as part of its Kansas City fiber project.

Lopez is a Bloomberg Businessweek contributor.

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AboveNet in Play as Fiber Creates 43% Verizon Premium: Real M&A

May 26, 2011, 10:13 AM EDT By Justin Doom, Alex Sherman and Tara Lachapelle

May 26 (Bloomberg) -- There may never be a better time for AboveNet Inc. to put itself up for sale.

The owner of optical fiber networks that hedge funds, exchanges and social media companies use to send data in cities rose to a record this week on speculation it is looking for buyers. With the most profitable business among its biggest rivals and less debt, White Plains, New York-based AboveNet may command a premium of almost 30 percent to fiber deals struck at 9.3 times earnings before interest, taxes, depreciation and amortization last year, according to Dougherty & Co.

AboveNet, which exited bankruptcy in 2003, is profiting as a projected tripling of Internet traffic strains networks and prompts businesses to seek faster connections. With more cash than debt and cash flows that more than doubled in the past three years, AboveNet may attract interest from private equity firms, Cowen & Co. said. Verizon Communications Inc. and AT&T Inc. could also be buyers, according to Dougherty’s Mark Kelleher, who says it may be worth $100 a share in a takeover. That’s 43 percent more than AboveNet’s price yesterday.

“Whoever is going to buy AboveNet would have to write a very big check,” said Colby Synesael, a New York-based analyst at Cowen, who has an “outperform” rating on AboveNet. “In terms of public companies, I think AboveNet makes the most sense because they’re a pure play and an infrastructure provider.”

Jeffrey Garte, a spokesman at AboveNet, said the company doesn’t comment on market rumors or speculation. Peter Thonis, a spokesman for Verizon, declined to comment, as did Mike Buckley for Dallas-based AT&T.

Relative Value

AboveNet, led by Chief Executive Officer William LaPerch, generated a 71 percent return for the company’s owners in the past year, which included a $5 per-share dividend in December. That outstripped the 48 percent gain for technology companies in the Russell 2000 Index, including payouts.

The company owns fiber networks in more than a dozen of the biggest U.S. cities, including New York, Washington and San Francisco, according to AboveNet’s website. Revenue has climbed 86 percent over the past five years, driven in part by more businesses using remote data centers to run their software and store their data.

Worldwide demand for so-called cloud-computing services may more than double to $148.8 billion in 2014 from $58.6 billion in 2009, according to Stamford, Connecticut-based Gartner Inc. AboveNet connects companies to data centers using its network of optical fiber, which is made from bundles of flexible glass that can transmit more data over longer distances than metal wires.

Fiber Highway

AboveNet’s conduits typically contain about 432 fibers, about three times the market average, according to Cowen’s Synesael. The company’s shares jumped 9.3 percent on May 24 after DealReporter said it hired New York-based JPMorgan Chase & Co. to find a buyer. AboveNet rose 1.1 percent to $70.07 yesterday, giving it a market value of $1.81 billion.

Today, the stock advanced 3.1 percent to $72.25 as of 9:46 a.m. in New York.

With $15.6 million more in cash than debt, AboveNet is valued at about 8.6 times its estimated Ebitda of $209 million, data compiled by Bloomberg show. For fiber deals in 2010, buyers paid an average of 9.3 times Ebitda, according to Cowen.

In an acquisition, AboveNet may be able to ask for as much as 12 times next year’s Ebitda, according to Kelleher, a Boston- based analyst at Dougherty. That’s equal about $100 a share, according to his estimates.

“You’ve got this movement right now to cloud computing,” said Kelleher, who recommends buying shares of AboveNet. “All of this information is being moved out to these data centers. Fiber is the highway. It’s how you get data in and out.”

Profitability

A deal for AboveNet would then cost more than the 6.4 times Ebitda that Broomfield, Colorado-based Level 3 Communications Inc. agreed to pay for Global Crossing Ltd. in an all-stock deal last month. Both compete with AboveNet.

While AboveNet has made money in the past five years, Level 3 lost $622 million last year and hasn’t been profitable since 1998. Global Crossing, based in Hamilton, Bermuda, and run out of Florham Park, New Jersey, lost $172 million in 2010 and last had a profit in 2003, the year it emerged from bankruptcy.

The two companies are also burdened with more debt than AboveNet. Level 3 and Global Crossing had a total of $7.2 billion in net debt as of March, while Washington-based Cogent Communications Group Inc., another rival, had $151 million more in borrowings than cash, data compiled by Bloomberg show.

AboveNet generated 25 cents in operating income for each dollar of revenue in the past 12 months, the highest of the four fiber companies and more than three times the operating margin of Cogent, the data show.

Potential Bidders

Cash from operations at AboveNet has also increased by 134 percent in the past three years, more than double the rate of Cogent. Level 3 and Global Crossing both reported declines in operating cash last year, the data show.

AboveNet is a “very attractive asset from a balance-sheet perspective,” said Robert Dezego, an Atlanta-based analyst with SunTrust Robinson Humphrey Inc. “You’re not buying a declining- revenue asset. You’re buying a growing-revenue asset. They have a good infrastructure. It’s a well-run company.”

Dezego, who rates AboveNet a “buy,” estimates the company may be valued as high as $88 a share in a takeover.

Its ability to generate cash and profits makes it a target for private equity firms, according to Cowen’s Synesael.

“Quite frankly, fiber is a great place for PEs to put money,” he said. “It’s a low-risk business with recurring revenues and high margins.”

Deal Rationale

Dougherty’s Kelleher favors Verizon as the most likely buyer after the New York-based wireless carrier acquired Terremark Worldwide Inc., a cloud computing provider, for $1.7 billion including net debt last month.

AboveNet already connects Terremark’s Culpeper, Virginia- based data centers with Washington, which could help Verizon compete better in the area. AboveNet is also expanding its fiber network in Miami, where Terremark is based.

“AboveNet has very high density of fiber within the cities they focus on, and those cities tend to be where the big data centers are,” Kelleher said. “If Verizon asked Terremark where to go for metro fiber, Terremark would point to AboveNet.”

Overall, there have been 9,985 deals announced globally this year, totaling $967.8 billion, a 21 percent increase from the $797.6 billion in the same period in 2010, according to data compiled by Bloomberg.

--With assistance from Katie Hoffman, Greg Bensinger and Sarah Rabil in New York. Editors: Michael Tsang, Daniel Hauck.

To contact the reporters on this story: Justin Doom in New York at jdoom1@bloomberg.net; Alex Sherman in New York at asherman6@bloomberg.net; Tara Lachapelle in New York at tlachapelle@bloomberg.net;

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Peter Elstrom at pelstrom@bloomberg.net.

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