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2010 was a year of great progress for the company. We welcomed many new customers, and grew our relationship with existing customers. We added some great people to our team, grew our sales and revenues significantly, and we demonstrated real diligence in our management of our costs whilst driving our operational capability forward. I wanted to reflect on some of these matters whilst looking forward to our prospects in 2011.
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Just to reacquaint you with euNetworks, who we are and what we do, we are a bandwidth infrastructure company. That is a facilities based telecommunications company ("telco") with strong metropolitan assets. Our company is founded in its deep metro networks. We have fifteen Western European city networks in Germany, the Netherlands, France, the United Kingdom and Ireland, of which thirteen are fully operational. In each of these cities we have a duct network of between one and six ducts, through which our fibre optic cables travel. We operate a very thin slice of the overall communications stack. We sell Dark Fibre, Dedicated Fibre, Wavelengths, Ethernet and Internet Protocol (IP) services to enterprises and wholesale customers. Hence we are a horizontally integrated company.
Being a horizontally integrated company is an important fundamental of our business. There are many successful companies who offer a full vertical stack of telecommunications services. Our premise is just different. Our major assets are our network of metro fibre and duct. I noted in my letter last year that the bandwidth infrastructure sub-segment in the communications market was an increasingly defined and attractive one. I think that accelerated in 2010. Shayndi Raice wrote in the Wall Street Journal in December 2010:
"After the telecom bubble burst a decade ago, fibre was a dirty word. Now, the fibre-optic network business is enjoying a resurgence, particularly for metro fibre, the high-capacity lines that connect a city's office buildings, data centres and cellular towers to the Internet. There have been 14 acquisitions in the industry this year alone and 45 since the fibre market began its turnaround in 2006, according to investment bank Cowen & Co."
A metro fibre company that connects a 'city's office buildings, data centres and cellular towers to the Internet‘ is exactly what we are and what we do. What these companies have in common is high growth, high gross margins and high EBITDA margins when they are at scale. They generate significant operating cash flow and tend to spend a relatively high percentage of revenue as capital relative to the more services based telcos. The bandwidth infrastructure segment shares many of the same characteristics as the data centre and cell tower segments, which have both been kind to investors in recent times. I labour this point because the fundamentals of the business are different from what caused the telecom crash around 1999-2000. Demand is different and the underlying economic model is attractive. At scale we believe that we can generate adjusted EBITDA margins of 40+%. This is not unusual in the bandwidth infrastructure space. At scale we believe we will deliver operating cash flow margins in the region of 15%. We believe that is an exciting business for all our stakeholders. This implies capital expenditure of around 30%. I am often asked about capital expenditure and how to constrain it. Again, we don't see our business like that.
Warren Buffett has said:
"The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine." (1)
We seek to deploy capital. It fuels our growth. Growth will take us to scale and that will deliver the returns I laid out above. The crucial point about capital is that you measure and manage your expenditure to generate high returns. I will return to this point.
We saw good sales growth in 2010, up 76%. Our strongest segment was the financial services vertical, particularly driven by our euTrade low latency services. There is a school of thought that this is a somewhat transitory business. I feel differently. I think that the idea that high-frequency trading will be regulated out of the market is unlikely and agree with Felix Salmon who wrote on wired.com in January 2011:
"Over the past decade, algorithmic trading has overtaken the industry. From the single desk of a startup hedge fund to the gilded halls of Goldman Sachs, computer code is now responsible for most of the activity on Wall Street. (By some estimates, computer-aided high-frequency trading now accounts for about 70 percent of total trade volume.) [...]
Algorithms have become so ingrained in our financial system that the markets could not operate without them."
Our view is that the more likely development would be different asset classes being traded in this way, such as foreign exchange and derivatives. That doesn't mean that it isn't a highly competitive space, but the idea that it will just evaporate doesn't reflect our thinking.
We have seen growth across many other sectors too. I commented last year that the tipping point for our services tended to be at the Gigabit level and that was probably still a little beyond the European market, but was well established in the United States, and that we tended to trail them by 18-24 months. The growth in the United States goes from strength to strength but certainly the progression has been marked in Europe in 2010. The institutional finance industry is well established, and we have also seen demand from many other segments. We will serve parts of most verticals directly, but indirect channels are a very important part of our mix. That is particularly so in Germany where companies who take our products and package them into broader solutions represent a growing proportion of our business, and are particularly important in our newer markets. These partnerships work well for us.
I would also like to reflect on two of the forces that dominate the technology industry at this time, cloud computing and mobile data, and what they mean to euNetworks.
Cloud Computing
There is much said of cloud computing to the point that it is actually quite difficult to find two people who would define it in the same way. Terms such as software as a service, platform as a service, virtualisation, hosted services, and managed services are frequently used. As I have previously noted, we are not a cloud computing company. It is not the same business as running a bandwidth infrastructure company. But whether it is using Gmail and Google Apps rather than PC loaded Exchange and Office, or force.com instead of Siebel or Oracle, through to a Fortune 100 company virtualising their .Net architecture, all of these shifts have a positive impact on our business. They rely on a distributed architecture and significantly larger amounts of data being moved. The capacity and security of dedicated fibre offers customers and vendors real peace of mind when moving mission critical applications to a cloud or virtualised environment. Guarantees around latency, security and availability are critical elements to the proposition. This is a positive trend for us.
Mobile Data
There were 94 million smartphones sold in 2010 and there are now 5 billion mobile subscriptions worldwide(2). When I wrote this letter last year, the mobile companies were already struggling to manage the surge in data growth. The iPad was not even launched then. Mobile video is now here to stay. Cisco project all mobile data growing twenty-six times by 2015, with mobile video growing at a staggering thirty-five times. The US experience suggests that the mobile operators believe that fibre is the way to manage that, and increasingly that trend is playing out in Europe. Whilst other technologies such as microwave are being utilised, there is a point at which you need fibre to carry the sheer weight of traffic. That growth in traffic is exponential, which increases the demand for that fibre. Our deep metro networks position us well as a partner to those companies.
You can read more about our operations elsewhere in this document. There was an advertising campaign that was run in our industry several years ago saying that the provider was the least bad in the industry: "We drop less calls than anyone." We just don't think that way. We are a 21st century telco. The standards to which we wish to be held are to be the best in the technology industry. To do that we need our operations to be ‘friction free'. Our data and our systems need to underpin that. Data is everything to a business like euNetworks. No amount of systems development will mask bad data. We have a long way to go, but we have made significant progress. We manage our business end-to-end from the identification of a prospect to an output to billing in force.com. We define our processes, measure how we perform, baseline that performance and then work tirelessly to drive out variation. Our relentless pursuit is to link good data to processes to systems to platforms in a way that is without friction. The net outcome is that we will scale effectively, but also deliver a fantastic customer experience.
Ultimately what matters to you, our shareholders, is that we manage your investment in euNetworks with care and discipline. To this end, we aim to spend the majority of available capital on a success basis (i.e. on new or upgraded customer contracts). Network development capital investments are currently a higher percentage than we would like but when done, they further leverage the uniqueness and depth of the in-place networks. Further, we have significantly improved the rigor behind capital deployment decision making, actual spending approvals and assessment metrics which improves confidence that we are investing properly.
We entered 2010 with 272 buildings on-net and exited with 365 on-net and 58 in progress. We were relatively happy with the progress, despite the normal implementation difficulties faced day-to-day, particularly in London. Bringing buildings on-net is core to our strategy. As such, euNetworks has developed a new building add core competency. On-net buildings allow us to sell on-net services. This gives us a much lower cost of goods sold because we are not paying out large proportions of our revenue to other telecom providers and can hence drive high adjusted EBITDA margins.
In 2010, the proportion of success based capex spend to network development capex spend was 2 to 1. Our network development enabled us to add over 15 kilometres of fibred duct to our metro networks in London, Frankfurt, Munich, Hamburg and Berlin and create a low latency fibre route from London to Frankfurt. Adding kilometres to our network puts us closer to more buildings, adding new targets for our sales teams. As our sales teams close deals with customers, we place their building on-net via success based spend. Once a building is on-net, we are able to quickly target other customers within the building via our direct and indirect channels.
The value creation we drive from this process of expanding our footprint via network development kilometres and success based building additions is best measured by the payback against incremental revenues.
In 2010, the payback for services sold into on-net buildings against our success based spend was approximately 6 months. The payback of sales against spend associated with success based building additions and network development was around 11 months. Given the average customer contract for the period was 27 months, and considering the long asset lives associated with this spend, the value creation is clear. Over time, the value from increasing our footprint and adding buildings will drive an increasing addressable market that we believe we can continue to penetrate with very attractive, short payback sales.
We strengthened our team significantly during 2010. John Franklin joined as our Chief Operating Officer in 2Q 2010. James Thomas joined the company in 3Q 2010 as our Chief Financial Officer and was also appointed as an Executive Director to our Board of Directors.
Finally, the values we hold as a company are fundamental. I appreciate that there is repetition in this year's letter from last. But, we do believe our values are fundamental. They guide the way that we make decisions. However great our assets, our data, or our processes, without everyone in our company living and breathing the same core beliefs, we will never maximise the value we could create. Our values are these:
I consider that we have made a great deal of progress in 2010 and are building a great business for our shareholders, our people and the communities in which we operate. That work will continue and accelerate in 2011. We all thank you for your support.
Chief Executive Officer
