Cogent Communications Inc. today announced its intent to purchase Allied Riser Communications Corp. (Nasdaq: ARCC) in an all-stock transaction, the value of which was not revealed.

In fact, neither Cogent nor Allied Riser were willing to provide many details about any aspect of the deal at press time. But the two indicated that Cogent intends to make Allied Riser a wholly owned subsidiary.

"Cogent specializes in providing Ethernet and IP connectivity outside the building," says Helen Lee, Cogent's CFO, so it will be a good fit for Cogent to have the extra in-building connectivity offered by Allied Riser, which is a BLEC (building local exchange carrier).

The move is significant on several counts. It's the second time in a couple of months that a next-generation metro access provider has sought to draw gold from the ruins of a BLEC. The first instance came in July, when Yipes Communications Inc. bought the rights to provide service within a range of multitenant office buildings from Broadband Office, a Kleiner Perkins Caufield & Byers-funded BLEC now in Chapter 11 bankruptcy proceedings (see Yipes Gets BBO's Access Rights).

Like Cogent, Yipes was looking to shortcut the red tape required to get customers online with its service. After all, it's easier to sign up customers quickly if you've already got their landlord's permission to install equipment in the basement.

But industry sources say the jury's out on whether Cogent's not risking too much in order to gain access to coveted networked office space in the U.S. and Canada.

Since Allied Riser is a public company that's been in financial trouble, its purchase will effectively force Cogent to take on what remains of its monetary problems. Further, it will put Cogent into a "reverse IPO," making Cogent a public company.

Specifically, the two companies intend to convert shares and convertible subordinated notes of Allied Riser to shares of Cogent common stock when the merger happens. Cogent then wants to register shares of its common stock with the SEC and get approval for trading on Nasdaq or another securities exchange.

Lee says the SEC filings and prospectus related to the merger will be available in about ten days.

Can Cogent go public right now? Is the market ready for what it has to offer? Can it successfully benefit from Allied Riser's BLEC past without taking on the liabilities that were poisoning its future?

Some industry sources say there are several reasons to answer these queries in the negative. First, Allied Riser's been in bad shape, cited by most analysts as yet another casualty of the BLEC cave-in that's been going on all year.

Like Broadband Office and, later, Zephion (see BBO Files for Bankruptcy Protection, BBO's Bankruptcy and Bounced Checks, and Zephion: Anatomy of a Debacle), Allied Riser seems to have run up against a market turned hostile to its basic business model -- which involves working with real estate owners to install broadband gear inside multitenant office buildings, then offering access to tenants for a fee.

It's a plan that requires enormous capital outlays that can only be balanced by building customer volume on a grand scale. What's more, BLECs need to execute quickly, not only to meet their expenses and to keep expanding, but also to ensure that a slice of in-building revenues are available for the landlords whose properties they must enter to provide service.

"The BLEC model was ambitious, but... widespread adoption of this model [is] nearly impossible," wrote Scott Clavenna, director of research at Light Reading and president of PointEast Research LLC, in a column on this site earlier this year (see Dig This).

Allied Riser's recent struggles illustrate this point. The company's fortunes tanked over the past year and a half. Since April 2000, the stock has plummeted from the $40 range to less than a dollar. Earlier this month, the company reported a quarterly net loss of $291 million, which included a write-down of $262 million in long-lived assets. EBITDA (earnings before taxes, depreciation, and amortization), generally used as a gauge of liquidity, were a negative $28 million.

What's more, Allied Riser was in the process of getting its stock delisted by Nasdaq as a result of falling below $1 per share for too long. Clearly, Cogent will have a challenge if it's linking its fortunes in the public markets to Allied Riser's fallen star. Nevertheless, in early afternoon trading today, shares were up 0.07 (58.33%) to 19 cents.

For its part, Cogent is a privately held metro Ethernet service provider best known for its bold claim to offer 100 Mbit/s of bandwidth at $1,000 per month in about 20 cities nationwide. The company made news recently by boasting at Opticon 2001 of a hefty upcoming third round of equity and debt financing (see Cogent Bags $200M in Funding?). But Cogent says the final deal won't close for a couple of weeks.

Cogent also is heavily beholden to Cisco Systems Inc. (Nasdaq: CSCO), which has financed Cogent with $72 million of working capital and about $310 million in vendor financing. This situation has led some industry sources to speculate that Cogent's fate is tied to Cisco's and that the carrier will be limited in terms of the technology it can procure from other vendors.

Depending on one's viewpoint, it may be lucky or unlucky that Allied Riser is also a heavy user of Cisco gear.

Now for the industry arguments that favor the merger...



Then again, Cogent could significantly strengthen its value proposition through the ready-made access to office buildings that comes with the Allied Riser buy. But there are caveats. Cogent needs be be careful that it's not biting off too much in its appetite for access. In this regard, Cogent could take a page from Yipes, which purchased only a part of the assets of Broadband Office.

Specifically, Yipes bought only the rights of entry that belonged to Broadband Office. It did not assume any responsibility for BBO's customers or existing network infrastructure. What's more, Yipes says it renegotiated the revenue-sharing arrangements with landlords involved in order to fix Yipes' costs at a predictable level and limit the landlords' cut over the long term.

"This was a surgically directed move," says Yipes CEO Jerry Parrick. "We needed the building rights of way, but we didn't want to take on the BLEC model. I'm not equipping those buildings and then offering service like a BLEC would. But I do have the landlord's permission to enter buildings in order to meet specific customer demand."

For its part, Cogent refuses to discuss the details of the assets it's buying from Allied Riser.

Those might not include the extra baggage of many employees and service contracts. On July 24, Allied Riser announced plans to cut about 75 percent of its workforce of roughly 387, close its sales offices, and migrate existing customers to other service providers.

Extrapolating from company press releases and SEC filings, it looks like what remains of Allied Riser's assets are roughly 97 employees, plus network facilities covering approximately 310 million square feet of multitenant office space in the U.S. and Canada. This appears to be "rentable square feet" of networked space that Allied Riser wasn't able to sell to its small- and medium-sized business prospects.

If this is the case, and Allied Riser has been able to implement the streamlining it planned to do, Cogent could indeed benefit from the purchase of the defunct BLEC, since it would be getting good access without getting encumbered with too much old business.

Still, even with both pro and con weighed in, questions continue to pile up. Yipes clearly limited its liability in purchasing access rights from Broadband Office, but the numbers aren't in yet to show that the outlay was worth it. And with so many unknowns hovering around Cogent and Allied Riser, it's going to take awhile before the proposed merger can be called thumbs up or down.

— Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com