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NeoNova Places Rural Bets

Venture capital firms have spun off a startup that's delivering services to rural ISPs, a small deal that reflects big hopes for a growing rural telco market.

NeoNova Network Services Inc. , based in Morrisville, N.C., has been acquired out of Digitel Corp by Azure Capital Partners and Bridgescale . The new owners also gave NeoNova an extra cash infusion, spending $11 million on the two transactions combined. (See NeoNova Spins Out.)

To wrap it all up, NeoNova secured an undisclosed amount of debt financing from Hercules Technology Growth Capital .

It's the second time NeoNova has changed hands. The company started life as a division inside Nortel Networks Ltd. in 1994 and was sold to Digitel in 1999.

For Azure, the deal is part of a conscious effort to tap the potential of rural telcos. The firm already has an investment in Calix Inc. (NYSE: CALX), which sells to second- and third-tier carriers.

Similarly, Azure backed Cerent, which is mostly famous for getting acquired by Cisco Systems Inc. (Nasdaq: CSCO) for billions during the dot-com craze. Before that happened, though, Cerent had been getting traction with rural telcos, says Azure partner Paul Weinstein.

"It's sort of an under-penetrated, overlooked market," Weinstein says.

Azure expects service providers -- especially rural ones -- to step up their efforts to deliver features through the network. NeoNova's outsourcing is one way it could happen. Equipment vendors could increasingly get into the game too, with boxes akin to the recently announced Cisco ASR. (See Cisco Takes Hold of the Edge and Appliance Vendors Don't Fear Cisco.)

"We're trying to get in front of that trend, where the equipment suppliers have to be more than equipment suppliers and the service providers look for a complete solution," Weinstein says. "We've seen SaaS [software as a service] in the software market for seven or eight years. We think the same thing is going to happen in the telco market."

Apply those ideas to the rural market, and you get what Azure considers an attractive investment possibility. Rural telecom is highly fragmented, with hundreds of operators to serve. And the rural telcos are feeling pressure to upgrade their networks.

NeoNova's services include data hosting, virus filtering, customer service -- even plain email. The key is that the company has built up its own back-office tools for getting all these features to go.

Its competition, like the rural market in general, is fragmented. Some smaller operators provide services like NeoNova's but don't have the full suite, Weinstein says. There's also the National Rural Telecommunications Cooperative (NRTC) , which helps link up telcos with outsourced services.

NeoNova has about 65 customers that have put its services on 200,000 access lines -- about 10 percent of all the rural access lines in the U.S., Weinstein says.

"This is a business that doesn't have the scale to go public today, but it has the profitability," Weinstein says, noting that NeoNova has been growing at a 30 percent clip per year. Azure and Bridgescale aim to boost NeoNova's customer base substantially and get it to that IPO-sized scale.

— Craig Matsumoto, West Coast Editor, Light Reading

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