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Zephion: Anatomy of a Debacle

Light Reading
News Analysis
Light Reading
6/4/2001
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Zephion Networks (formerly Domino Networks), a six-month-old data services carrier that employed more than 350 people, had ambitions to function as a high-end Internet backbone. Last week Zephion closed down and layed off the bulk of its employees, Light Reading has learned.

Zephion had the backing of the influential Kleiner Perkins Caufield & Byers venture capitalists Vinod Khosla and Kevin Compton, who several months ago tried to figure out a way to salvage their firm's investment in BroadBand Office Inc. (BBO), a BLEC (building local exchange carrier), by spinning out parts of that company into Zephion (see Kleiner Readies BBO's Rebirth). Their efforts appear to have failed on both fronts. Broadband Office filed for Chapter 11 bankruptcy protection on May 9, according to people close to both companies. And Zephion now appears to be headed for bankruptcy court, though it had yet to file as of Friday.

Both companies met quick and sudden ends that blindsided many of their employees. Like their colleagues at BBO, Zephion employees were told last week during a company-wide meeting that they would be losing their jobs and they would not be getting any severance pay, sick pay, or vacation pay, as the company was experiencing "severe financial constraints." Adding insult to injury, Zephion didn't even pay its employees for the work they did on Thursday, May 31, their final day, according to several former employees at the company.

On one small single street in southern Frederick County, Md., Zephion's closure affected five families, including one where a husband and wife both worked for the company. "I'm sure I'll get another job soon," said one employee who asked not to be identified. "But if it takes too long I might go back to bartending for a while."

Several Zephion employees told Light Reading that around 11 a.m. on Thursday, May 31, Zephion's managers emailed a note requesting that all employees meet in the company's warehouse at 1 p.m. They say some employees kept working as normal while others began emailing their goodbyes and contact information to friends, "just in case this is it."

At the meeting, Zephion CEO Heidi Heiden, president Johnson Agogbua, and human resources manager Leslee Booth somberly relayed the news that the firm's largest investor -- presumably Kleiner Perkins -- had backed out and the company would have to close. The following morning, employees lined up outside the company's warehouse so they could collect their final paychecks at 9 a.m. They received a list of all the Bank of America branches within five miles of the company's headquarters and were instructed to cash their checks at the recommended branches.

Though Zephion hasn't yet filed for bankruptcy, the detailed paycheck cashing instructions are a telling sign. According to several sources close to the company, when BBO closed its doors last month and let some 400 employees go, it had filed for bankruptcy protection just prior to handing its employees their final check.

It's possible that BBO's bank froze the company's assets after the bankruptcy filing, which is why some of the employees never got paid for their final days of work, let alone any vacation, sick, or severance pay. "It's as if those who had their whole heart in either BBO or Zephion just got punished for their loyalty," one former BBO employee says (see BBO Says BBye to 69 Employees, BBO Files for Bankruptcy Protection, and BBO's Bankruptcy and Bounced Checks).

The managers directly responsible for both firms and the venture capitalists who supported them were unreachable during Light Reading's investigation.

Zephion's founder and president, Johnson Agogbua, didn't return phone calls to his office on Thursday or Friday. Backers of both Zephion and BBO -- including KP's Khosla and Compton and James M. Smith of Pilgrim Baxter & Associates -- were unavailable for comment. (Khosla is away on sabbatical and Compton, through an assistant, declined to talk on the record.) Dan Chu, BBO's founder and president, was reached by phone, but he declined to comment.

Of course, Zephion's workers aren't the only ones stung by its demise. The investors are likely to have lost most, if not all, of their money. And Zephion's network has more than 30 hubs across the continental U.S. Those sites are full of networking gear that the company may not have finished paying for.

The equipment used most in Zephion's network included
Juniper Networks Inc. (Nasdaq: JNPR) M10 and M20 routers and some voice-over-IP (VOIP) gear from Sonus Networks Inc. (Nasdaq: SONS). There were also some Cisco Systems Inc. (Nasdaq: CSCO) 7513 routers and Redback Networks Inc. (Nasdaq: RBAK) subscriber management service devices for DSL aggregation. Also, gear from Advanced Switching Communications Inc. (ASC) and Extreme Networks Inc. (Nasdaq: EXTR) was used to hook Zephion's network to BBO's network.

The company has several peering points, where it exchanges traffic with other carriers, including Qwest Communications International Corp. (NYSE: Q), UUNet, and Level 3 Communications Inc. (Nasdaq: LVLT), say those familiar with Zephion's network.

Former employees at BBO say BBO's network contained gear from Juniper, Redback, ASC, and CoSine Communications Inc. (Nasdaq: COSN). In May 2000, BBO and ASC announced that BBO would spend $15 million on ASC's equipment over the next two years.

Several company sources say that Kleiner Perkins heavily influenced the purchase of gear from Zaffire Inc., another Kleiner Perkins company, but that gear was never used to carry live traffic.

A recurring theme with former BBO engineers contacted for this article is that often the firm's equipment choices went against their technical recommendations and would give preference to Kleiner-funded companies. "They forced engineers to go against their instincts; then we were left to manage a network that we would not have built in the first place," grouses one former BBO engineer, who hasn't been paid for his final weeks of work.

After Zephion was formed, BBO's network trucked traffic from corporate office buildings to outside, where circuits were handed off to the Internet. BBO had a $250 million contract with Zephion so it could connect its building customers to Zephion's MPLS (multiprotocol label switching) backbone. BBO, which owned more than 50 percent of Zephion, never paid any of its bills, say those familiar with both companies.

Zephion's network was technically impressive, say observers. Its mission was to build a "private" Internet backbone, which wouldn't carry public Internet traffic. This arrangement allowed for more easily controlled, high-speed connections. Indeed, Zephion would have been able to charge top dollar for advanced IP services, such as VOIP, if it had ever achieved its goal of providing specific levels of quality of service (QOS).

It must have come close. One employee recounts a test done for some video conferencing customers where endpoints in Washington D.C. and San Francisco were connected. "The quality was even better than broadcast television," he says.

But ultimately, Zephion's lack of funds kept it from switching on paying customers. Even though the company had some 150 orders in its sales system, its network had only 10 paying customers. The bottleneck was financial, observers say. Zephion's circuit providers, such as Qwest and WorldCom Inc. (Nasdaq: WCOM), put credit holds on its network, preventing it from turning on new customers.

Zephion was started with $50 million in funding, according to records from Venture Economics (see Kleiner Perkins Builds Backbone Carrier ). It had come close to securing a crucial second round of around $100 million, observers say. It was so close, in fact, that employees were told during the firm's final days not to worry about the state of its finances.

- Phil Harvey, Senior Editor, Light Reading
http://www.lightreading.com

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wimchatta
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wimchatta,
User Rank: Light Beer
12/4/2012 | 8:19:13 PM
re: Zephion: Anatomy of a Debacle
It appears from Phil's article that Zephion was close to delivering on what it promised to its customers, especially with respect to QoS for videoconferencing. If so, that would have been a first for the industry.

Why would Qwest and Worldcom pull the credit plug when their IP services groups are fully aware of the uniqueness of what the ex-Zephion folks have demonstrated?

Unless there were serious technology issues, wouldn't Qwest or UUNet have been better off acquiring Zephion?

Is there something else such as price of services, or demand for QoS (though there seem to have been more customers waiting to sign up)that tripped such an acquisition or was it just because of a financial environment that does not discriminate between good and bad tech companies?

-wim
switch02
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switch02,
User Rank: Light Beer
12/4/2012 | 8:19:13 PM
re: Zephion: Anatomy of a Debacle
if you were qwest or uunet, wouldnt you rather buy zephion's assets in bankruptcy, rather than pay a mark-up for some perceived enterprise value?
cfaller
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cfaller,
User Rank: Light Beer
12/4/2012 | 8:19:11 PM
re: Zephion: Anatomy of a Debacle
Providers like Qwest or UUNet will only buy deadbeat companies when either the bills are so huge that the writeoff would show up on an earnings call, or the assets of the company are too good to walk away from (e.g. lots of paying customers, as was the case with WorldCom buying ICI).

Neither applied to Zephion. Credit holds are for small time players, and 150 or so customers aren't anything for UUNet or Qwest to get excited about. 150 customers divided by its 30 POPs equals 5 per city. Whoop de friggin doo!

There's almost nothing to scavenge there, because there was almost nothing there in the first place.
lo_mein_noodles
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lo_mein_noodles,
User Rank: Light Beer
12/4/2012 | 8:19:10 PM
re: Zephion: Anatomy of a Debacle
Let's look at this for what it really is. A house of cards....the wind is ripping through our sector and the weak are dropping like flies. The KP pyramid is only as strong as it's weakest link. You crumble a few of the supports and BOOM..they all come crumbling down. KP was in the right place at the right time...and now it seems like the right place to be is on sabaticle....zaffire has got to be next. Whoever was thinking about buying zaff can now just wait and pick up the pieces at the fire sale...penny on the dollar. ( With BBO, Zephion and Fiber whatever all gone...does that leave anyone who bought Zaffire gear alive??) I wish all the out of work employees well..the same could happen to me overnight. Good luck.
flanker
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flanker,
User Rank: Light Beer
12/4/2012 | 8:19:10 PM
re: Zephion: Anatomy of a Debacle
There seems to be a fundamental misunderstanding of the value proposition. Anyone [repeat: anyone] with a dedicated circuit can attempt to offer "broadcast quality" video.

There are dozens of backbone carriers, most notably Global Crossing, offering high quality video conferencing.

The issue is that

1) purchasing enough bandwidth to offer broadcast quality video is expensive, because it includes not only a backbone but also high speed local loop, which is MOST CERTAINLY not owned by these two companies.

2) Troubleshooting/setup/maintenance are incredibly labor intensive and expensive.

Just because these two fine firms had a kickass video conferencing set up does not mean they had a cost effective business model. In fact, precisely because their network was over-engineered, it was too expensive to sustain.

I import no disrespect to the excellent engineers at these firms, I only refer to the cost-effectiveness of the solution.





bear
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bear,
User Rank: Light Beer
12/4/2012 | 8:18:58 PM
re: Zephion: Anatomy of a Debacle
Think of the comedy of errors Kleiner committed in the lives of BBO and Zephion. First, who would ever place a 20-something associate with zero operational or telecom experience in charge of a $500M (money raised) operationally intensive business? And then keep him in that role? My God! Zephion must have been Vinod Khosla's last-ditch effort to save face for the BBO debacle. He was crowing about Zephion's team and network but he hadn't a clue how to run a service provider.

Oh, mighty Kleiner. It must be high noon KPCB corral. Vinod Khosla has made so many poor personnel and business judgments in the past year you would have to think his peers are finally reveling in his demise.
flanker
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flanker,
User Rank: Light Beer
12/4/2012 | 8:18:55 PM
re: Zephion: Anatomy of a Debacle
Which brings us back to the eternal question as to whether the bigger used-car salesmen-fakirs-charlatans were the operators or the VCs themselves.

Ahem.
Half-Inch Stud
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Half-Inch Stud,
User Rank: Light Beer
12/4/2012 | 8:18:42 PM
re: Zephion: Anatomy of a Debacle
You got it flanker.

I think it is called "10% Beneficialy Director" I've seen how VCs have funded "companies" with their insertion of such advisory Officers...to get the liquidity out. Somehow, I believe the SEC can/will catch-up to the ones that are public.
flanker
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50%
flanker,
User Rank: Light Beer
12/4/2012 | 8:18:37 PM
re: Zephion: Anatomy of a Debacle
Five years ago VCs were saying the Wall Street investment bankers were idiots (ok, maybe that's half true) because they didn't know how to run a company.

It looks like the VCs - the ones without Wall St. experience (er, the ones with OPERATING - "har-har"- experience) - are the idiots now. These were the same people touting new paradigms , a new economy and the end to - duh - the business cycle.

Either that or the silicon valley VCs knowingly peddled shit to the Wall street investment community during the market run up in 1998 and 1999.

The problem here is now the optical industry is tarred with the same rep as "dotbombs" thanks to west coast VCs with no knowledge of the TDM world where QOS still exists.

Who are the geniuses now? GTE, Genuity, Verizon, SBC...



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