Cashing In

Posted: 08/1999

Cashing In
Agents Calculate Risk of Equity Play
By Khali Henderson

The real trick for agents is allying with the company most likely to succeed.

Amidst the stock market's longest winning streak, the telecom industry has been engaged in consolidation at all levels as service providers jockey for position. Mid-sized players are gathering steam--and their smaller brethren--while mega-players are merging and next-gen service providers are building sky-high market caps.To share in the wealth, telecom agents have been staking out the "hot" carriers and pumping minutes into them like so many quarters in hopes of accumulating equity for the big jackpot. Some are hedging their bets and playing two or more at once. Others are shoulder-surfing, looking for the first signs that equity participation is a worthwhile pursuit. So far? No equity events. No big payouts. Nothing to refuel the frenzy of last fall when agents were scrambling to ally themselves with a sure thing.

"Eight months ago at the AgENt Conference in Tampa there was a real panic in the air in the agent community," says Ted Schuman, president of master agency U S Telebrokers Inc., Scottsdale, Ariz. "They saw voice over Internet coming into play, [and] they saw rates [for long distance services] going lower and lower, and thought, 'Oh my God! I've got to hitch my ride to somebody. I've got to get an equity plan.' And in Las Vegas [at the AgENt Conference in April], you didn't see the same panic."

It's not that they are disinterested; far from it, agents say. It's just that they are taking a step back and evaluating or re-evaluating their options. And those options have broadened considerably in the last six to nine months, with dozens of new equity plans introduced by dozens of providers, making the equity value proposition a much more complex decision. What remains is a mix of confusion, skepticism and, among some, tempered optimism that payday soon will come.

The Deal

"When we first started advertising [our agent equity program] in 1997, we received an overwhelming response from agents that were interested in 'getting their piece of the pie,'" says Bernadette Richardson, president of long distance reseller TMC Communications Inc., Santa Barbara, Calif., one of the first companies to offer agents equity. "There weren't any other options out there at the time that did not require any buy-in fees to participate in equity. Some of these agents understood the concept and have become valuable partners with TMC; others never really did much. Although we did our best to educate them, I don't think they really understood why equity is so important to their future."

Today, Richardson says agents are more savvy about the financial opportunity represented by the equity play. On this point agents and carriers agree.

"Agents come in all different shapes, sizes and stripes. The more mature the agents, the more important equity is to them," says Greg Praske, CEO of master agency Association Resource Group (ARG), McLean, Va. "Over the years they have seen their vendors profit significantly [from the sale of businesses they helped to build]."

In January, Coastal Telephone, Old Orchard Beach, Maine, sold to IXC Communications Inc., Austin, Texas, for $100 million--some 13 times monthly revenue.

Agents are not only keenly aware of the upside of an equity play, but also what they are willing to do to get it.

"Agents are wiser about contracts generally and how they affect the residual commission or the equity they might receive," says Brian Twomey, senior vice president of sales and marketing, TransNational Communications International Inc., a Boston-based reseller. Twomey and other agent program developers have found that agents aren't willing to trade their ongoing commissions for an equity stake. Instead, they want and are getting both.

"In the beginning TMC thought they could lower the commission schedule in exchange for equity," says master agent Rick Sheldon, co-founder, Intelisys Inc., Petaluma, Calif., the largest participant in the TMC equity program. "But they soon found that agents need to have equal commissions and the bonus on the sale, so along with the market, they lowered rates but kept the commissions the same."

Wheel of Fortune
Agent Equity, Cash Options Run Gamut

As the early entrants, TMC and UniDial Corp., Louisville, Ky., often are criticized for the structure of their groundbreaking programs. UniDial, which offered the first agent equity program in 1994, is chided for its $25,000 "franchise fee" and unrealized promises for an initial public offering (IPO). TMC is attacked for its monthly revenue commitments ($50,000 per equity earnings level) and its multiple goals (10 times monthly revenue), both of which are considered by some to be unrealistic in today's market. While UniDial's program was closed to new applicants in April 1997, it and TMC's continue to be held up as benchmarks for those that have followed. And there are many. So many, in fact, that the equity option is becoming an expectation.

"I don't think you can compete as a small reseller without it unless you have some other unique advantage," says agent Sheldon.

On a Roll

One of the first copycats was a program offered by Telecorp Ltd., Hewlett, N.Y., which was uniquely developed by master agents Gene Foster, president, Communication Management Services (CMS), San Diego, and Daryl Heller, president and CEO, Premier Telemanagement Corp. (PTC), Lititz, Pa. Introduced in spring 1998 to a standing room- only crowd attending the AgENt Conference & Expo in San Diego, the program is built around the idea of selling the distribution channel rather than simply the customer base. Foster claims that more than 20 agents representing some $28 million per month in billing have committed a portion of their business to the program as of summer 1999.

Positioning the channel as part of the value equation has become a significant part of other equity programs as well. TransNational, for example, rolled out a program in April that includes what now is known as an "evergreen clause." An evergreen clause is a provision in the agent contract that ensures agents will continue to receive their residual commissions following the sale of the company. TransNational's Twomey explains that the provision assures the buyer that the channel is not going to abandon the customers it just acquired, minimizing churn that can result following an acquisition.

For some agents, the clause confirms their contention that even though the customers belong to the carrier on paper, at the end of the day their loyalties lie with the agents who service their account.

Nevertheless, some carriers question the logic of including such a provision. If you are bought out, you are bought out, they say. Furthermore, they add, as a form of equity, it amounts to being paid twice. "The person who invented the evergreen clause never dreamed of equity," says Brian Sledz, president of reseller Connect America, Naperville, Ill. "Getting paid forever was equity."

Others are wary that it may make them less attractive to a buyer, which may not want to continue to pay commissions that can be 10 percent to 15 percent right off the top. "I would look closely at any entity that offers an evergreen clause," says TMC's Richardson. "It is undermining their ability to gain a high multiple. That said, if a buyer just paid $30 million, they are going to do whatever it takes to keep that investment, even if it means continuing to pay commissions."

Lower Ante

Other programs lowered entry thresholds and incremental earnings requirements to meet the needs of smaller agents, or to answer objections from agents unwilling to put all their eggs in one basket. According to Randy Berlin, president of discountcall.com, Atlanta, and an agent for ATCALL, Vienna, Va., early programs were forcing medium-sized and small agents to ally with one carrier more than another. "You would normally divide your business equally among two or three carriers, but splitting 80/20 to qualify for equity makes me nervous," he says.

TransNational's Twomey says his company's program was designed with this in mind. "Our program focuses on new business brought in," Twomey says. "They can grow it with relatively small levels of incremental business. A number of plans have $50,000 increments. I don't believe it's realistic for most agents. We focus on what's truly attainable."

TransNational's program requires a minimum $60,000 monthly revenue commitment in exchange for up to 15 percent equity. However, each quarter, additional points are added based on incremental revenue, starting at 1 percent for $15,000 earned per quarter and a half percent for each additional $5,000 per quarter.

Another program, introduced by Connect America in conjunction with master agency Visioncom Inc., Minnetonka, Minn., allows for agents to combine small revenue levels to achieve a higher multiple percentage. If the group volume is $150,000 per month, an agent who turns up only the minimum required $20,000 per month still would receive the 50 percent multiple percentage earned by the group. Likewise, if the group volume was more than $250,000 per month, the agent would receive 60 percent of the multiple on its $20,000 sales volume. In addition, agents that can't meet the $20,000-per-month minimum can become a subagent for Visioncom to qualify for 70 percent of the achieved multiple percentage of the group.

High Stakes

Yet another group of programs has emerged that offers not a multiple percentage, but stock options themselves. The board of directors of multinational carrier PRIMUS Telecommunications Group Inc., McLean, Va., approved Dec. 16, 1998, an equity program for the company's agents in the United States, making it the first publicly held carrier to make such an offer. The company has reserved 500,000 shares for the program, which rolled out in January.

A spokesman for the company says PRIMUS offers agents a billed-revenue contract with a fluctuating commission schedule plus the ability to earn stock equivalent to 10 percent of the quarterly revenue share growth. Agents must cross a $75,000 quarterly revenue threshold to participate, and revenue growth must be $15,000 or greater than the previous quarter. For example, the spokesman says, an agent earning $75,000 in the first quarter and $95,000 in the second quarter would qualify for 10 percent of the revenue growth ($20,000), or $2,000 in stock. The stock vests after two years. The vesting period is accelerated if PRIMUS is purchased, so agents will not lose their unvested stock.

After its first full quarter in operation, the PRIMUS agent equity program already has several participants who have earned stock certificates, according to the spokesman. "It's not a multiple of the base. Agents get stock based on the value that it was at the time it was earned," he says.

A similar program debuted in April from PaeTec Communications Inc., a competitive local exchange carrier (CLEC) and interexchange carrier (IXC) based in Fairport, N.Y. PaeTec plans to issue approximately 800,000 warrants to agents before its IPO, which is set for the next eight to 12 months. Stock options are granted at the current stock price on the date agents achieve set performance thresholds. At $50,000 per month, agents receive 2,500 warrants; at $100,000 an additional 5,000 warrants and so on. Agents become vested over four years.

Calling the Bluff

Like a double-edged sword, the demand for equity has given agents dozens of different programs to choose from, but it also has made the decision more complex (see Bettering the Odds, below) and has piqued suspicions about the motives for me-too offers.

"Now that so many resellers have tacked on an 'equity' option to their agent program, there is a lot of confusion about which plans are really legitimate," TMC's Richardson says, adding that agents have a right to be skeptical since some are just "paper-based offers" not backed by the experience or the plan to make it happen.

A spring poll of agents conducted by the Independent Agent Network (IAN), Baltimore, and published in the June issue of PHONE+ found that most agents were confused by the equity proposition. One agent agrees. "Agents are confused by equity offers from carriers," says discountcall.com's Berlin. "Are they in line to be bought, or are they just begging for business?"

The IAN agent poll, which included responses from 604 agents, showed that more than half (54 percent) believe that equity participation would not pay off. More than one-fourth (27.3 percent) weren't sure, and only about one-fifth (22.3 percent) felt certain that the payoff would be there.

"Agents will remain somewhat cynical until a provider actually pulls off a sale," Richardson says.

So far there have been no sales, or IPOs for that matter. The closest thing to an equity event was a special distribution made by UniDial to its agents in October 1998. Following a $27 million cash-for-equity injection from the Williams Network, Tulsa, Okla., UniDial offered the distribution to agents participating in its original "Bonus Program," which offered agents 25 percent ownership of their base for a $25,000 agency fee. The program was discontinued in April 1997. Agents were offered the choice to remain under the original program or opt for an accelerated payout schedule and a reduced bonus upon the sale of its accounts to 21.875 percent. A third option eliminated an agent's rights to a bonus commission on the sale of its accounts in exchange for a refund of the agency fee paid. More than 200 agents were eligible for the special distribution, which UniDial estimated to be $8 million to $10 million.

UniDial's Director of Business Development Clay Masters claims that the company is attracting agents of a higher caliber as a direct result of the distribution. While the company itself no longer offers equity, UniDial has managed to convert the leads anyway by referring them to master agents who agree to bring subagents under their agreements with UniDial.

If the UniDial experience is any indication, a positive disbursement may buoy agents' confidence in the equity proposition. On the other hand, a negative outcome could send them running.

Not everyone thinks that a poor showing by an early-exiting reseller will have widespread impact. As in the stock market, says UniDial's Senior Vice President Henry Hunt, "When companies of like nature have trouble, there will be some degree of fear." But, "We don't have that fear in the telecom industry," he says, noting that the value of technological companies has been strong.

Still, says one master agent, "The first couple that go through will tell the story for the rest."

Winning Hand

The real trick for agents is allying with the company most likely to succeed. And that is no small undertaking, requiring an evaluation of the company's business plan, management team and financial status.

"The road is littered with many a reseller and facilities-based carriers that didn't make it," Richardson says, adding that this history may make agents wary. "If they do their due diligence and partner with someone that has a track record ... they are hedging their bets."

A track record, Richardson and others say, means prior experience building telecom companies for sale.

"If you are going to have equity in a company, it boils down to trusting that the company has the wherewithal, the contacts and the synergies to move forward and create value," Hunt says.

Are they a sinking ship or a rising star? That's the question agent Praske and partner Bill Power, ARG's president, ask themselves before hitching the future of their growing master agency with a particular company. In addition to evaluating the company's ability to deliver products, support, services and competitive commissions, Praske says he considers whether the company has a realistic chance of realizing its goal.

The goal itself can be a sticking point. Some resellers have been accused of peddling pie-in-the sky sales multiples. "There is rampant misinformation that resellers are going to sell for 10 to 15 times monthly revenue," says Connect America's Sledz, adding that he spends a lot of his time trying to dispel the rumors.

While it's true that values have declined in the past, the news isn't all bad. Value ranges for long distance companies are holding and are even better if the company has deployed other services, says valuation consultant Casey Freymuth, president of Group IV Inc., Phoenix, and publisher of "The Telecom Service Provider: How Much is It Worth?" "A year ago the question was, 'Where were values going to bottom out?' when, in fact, they already had," Freymuth says. "Bundling at the very least keeps companies off the floor [of the value range]. At the most, it represents an opportunity to recapture the value that was lost in this segment." (See The Bottom Line.)

In broad terms, Freymuth says the range of monthly revenue multiples is holding at between four times and 12 times, with the bulk of transactions falling in the five-times-to-nine-times range.

As Freymuth suggests, many resellers are adding additional services in an attempt to bump up their multiple. TMC, for example, has added data services such as private line, frame relay, dedicated Internet access and integrated access products to its portfolio in an effort to reach its target. "We are about halfway (or approximately 18 months) to the goal of being able to achieve the maximum possible multiple," Richardson says.

Agents remain concerned about what is going to attract a buyer, questioning the salability of resellers and carriers that continue to pay high (e.g. 20 percent-plus) commissions on low rates (7.9 cents per minute). "If a reseller has a book of business that's not profitable, why would you want it? I understand that question," Praske says, noting, however, that Telco Communications Group Inc., Washington, was in a similar situation when it sold in June 1997 for $1.2 billion. Today, a CLEC might be interested in acquiring the customers of a long distance reseller purely as a ready base for its local services, he notes.

In fact, the needs of the buyer do weigh heavily on the final multiple that is paid. But, says Chris Edgecomb, chairman and CEO, STAR Telecommunications Inc., Santa Barbara, Calif., those needs are changing. "The market has changed," he says. " It used to be with companies that were more regional, i.e. West Coast Telecommunications (Inc.) or even LDDS (WorldCom, now MCI WorldCom Inc.) and others, that we were acquiring bases around the nation to extend our reach. But they've already done that. Now when someone buys a base, they're looking for a new type of product ... they're looking to pick up a different distribution channel."

In addition, he says that fewer and fewer small customer bases are being purchased. "You don't see the giants buying $10 [million], $20 [million] or even $30 million companies; it just doesn't do them any good," he says. "Once you do $1 billion a year in revenues, acquiring a small company does not change your earnings one bit."

Perhaps because of such uncertainty, agents have gone in search of a sure thing. And many carriers and resellers seem willing to oblige. The fare ranges from bonus programs to guaranteed buyouts and, in one case, an arrangement called a "pre-buy."

Bonus programs are not new, but they've taken on new potency as an alternative to equity programs by offering agents a lump payment after a certain revenue threshold is reached. One such program was launched in April by One Star Long Distance, Evansville, Ind. Created by the company's new Agent Sales Manager Rick Ribas, a former master agent, the program offers agents a bonus after one year. For achieving monthly billings of $25,000 to $50,000, they are paid 25 percent of their billings--half at one year and half six months later. For billings of $50,000 to $100,000, agents receive 50 percent, and for billings more than $100,000 per month, they receive a dollar-for-dollar match.

Ribas says that because of its bonus program, One Star has signed more business in the past two months than in the previous six, and it has added back-office staff to handle the increase. "We had (and still have) an equity program, but no one jumped on it," he says, "because it only mattered if One Star sold."

That lack of control was cited by agents as a disincentive to equity participation in a survey commissioned by ATCALL in April. An independent research firm polled 40 agents and found that many had not yet allied themselves with an equity program because they are based not so much on the agent's performance, but on that of the reseller or carrier.

"We wanted to give agents as much control as possible," says ATCALL's Vice President-Subscriber Services Jason Schnur. "[With an equity program], they don't know what the multiple will be or what our profitability will be."

This summer ATCALL is rolling out its bonus program. Unlike One Star, ATCALL awards bonuses at $20,000 per month billing increments. So, at $20,000 per month, an agent gets a check for $5,000, at $40,000 per month, $10,000, and at $60,000 per month, $15,000 and so on.

Agent Berlin says he has opted for the ATCALL model. "No other company has been able to commit, [to give me] something concrete to build my business around."

In fact, some agents are doing quite well off bonuses. Praske, for one, says 20 percent of ARG's income last year was attributable to bonuses. He understands why a majority of agents would be attracted to the immediacy and control offered by bonuses, but says they "can't compete with what we could get on the equity play."

Agent Sheldon agrees, noting that at the equivalent of perhaps one-time-monthly revenues, a bonus does not come close to what he and his partner Rick Dellar expect to gain from their equity stakes. "We would not trade one for the other. We'd rather take the risk," he says. "We are building our business on the residual. The big win is a side-bet."

Minimizing Risk

Like performance-based bonuses, buyouts are offering agents a guaranteed payout that equity programs don't. Under its plan, for example, Connect America will purchase the revenue stream from an agent no later than October 2000 if Connect America is not acquired by another carrier. "I'm a built-in buyer," CEO Sledz says.

The purchase price is calculated at present value. "If an agent earns $10,000 per month in residuals, I determine how much he will have earned in the next three years," he says. "So, I look at the present value of the stream of cash, which is $10,000 times 36 months, and that ($360,000) is the payout."

STAR, through its retail arm ALLSTAR, also is poised to offer a buyout, or what it calls a "put" contract. "A put contract works in a similar manner to a put option in the stock market. The agent has the right to PUT the base to us at any time," CEO Edgecomb says. Therefore, with ALLSTAR's put option, the agent does not have to wait for the company to sell, go public or effect a material change of control to cash out.

In another twist, the designers of the Telcorp equity program are circulating the notion of a pre-buy. In this scenario, a buyer would be lined up, not for the agents' base but for Telcorp itself. The concept developed organically after Telcorp was approached by larger carriers interested in the distribution channel the reseller was developing through its equity program. (Telcorp's stated sales goal is $5-million-per-month billing, for which it expects to sell at a multiple of eight to 10 times monthly revenues.)

Foster says four of the seven largest carriers now have met with Telcorp to discuss the unique arrangement. By September, Foster expects Telcorp to have made public an agreement with a carrier or pair of carriers.

On the surface, the pre-buy model has a chicken-and-egg quality--the distribution channel is required to attract the buyer, but the buyer is required to attract the distribution channel--that seems to try to cheat the system, to circumvent the natural order of a consolidating marketplace.

Foster is not concerned about not having the traffic in hand and says neither are Telcorp's suitors. He says the pre-buy has performance-based triggers by which distributions will be made to the agents at one year, two years and three years after the acquisition at certain multiples, based on preset billing targets. "If we only reach $3 million a month in billings at one year, we get nothing," he says.

Besides CMS and PTC, ARG is one of the agencies signed on to the Telcorp program. ARG's Praske says it's one of three such alliances the agency has made. The others are with TransNational and a CLEC. "We fully expect to earn significantly more in equity than in commissions over the next five years," he says.

Agent Sheldon says he's also working for that million-dollar check, but doesn't expect to become a multimillionaire from its equity holdings. "Anyone who is expecting to get rich is nuts."

That reality pill is a little hard for many agents to swallow, however. Says reseller Sledz, "It's difficult to explain it to them, 'Look Joe Agent, customers you don't own aren't worth much.'"

Khali Henderson is editor-in-chief of PHONE+ magazine. Copy Editor Jill Collins contributed to this article.