We continue our high-growth study with a look at XO Communications (Nasdaq: XOXO). Founded in 1994 and formerly called Nextlink, XO is building fiber-optic and wireless high-speed broadband networks in 21 cities in the United States and Europe. The company will spend over $1.1 billion in the next two quarters on these new networks in specific, and more than $2 billion this year on its network in entirety.
XO has been caught in the broadband and telecom spiral that has taken so many other fiber-optic and telecom companies up, and then down, as doubts emerged amid a build-out glut. The current doubts are many.
One large question is how profitable these companies will become given that so many companies are competing for limited customers in each market, and with profitability estimates so far down the road. Related to this, how much will these companies be worth?
Fancy-pants technology or not, what matters most is the amount of free cash flow that these operations finally earn on their massive capital investments. Having a large number in its "asset" column doesn't count for much if the company, or an acquiring company, can't generate significant wealth on those assets, and here I'm talking about expensive network assets. We don't know yet if broadband access will become a much more attractive business than long distance is today. Given all the competition, it could become an unattractive business with low profits.
XO Communications already holds $4.4 billion in debt and it has filed to raise an additional $2 billion in debt. It has $1.8 billion in cash and equivalents, but it lost $491 million in its recently-reported quarter. XO also lowered sales estimates for the first half of 2001 by 10%, although it is hoping that the pace will increase in the second half of the year.
Many companies are saying that, including Intel (Nasdaq: INTC). None of these companies actually has any idea if the economy will truly improve after June, so estimating that it will is just their way of trying to contain negative sentiment today. They're crossing their fingers and hoping against tomorrow.
XO expects to be profitable in 2004 or 2005, or about ten years after its founding. That isn't too unusual an amount of time, although XO will have invested billions of dollars more than most companies need to sink into their young businesses � and all of it at a large loss.
Overall, I'm skeptical of most young technology companies that are so high on investors' radars these past few years. Very few if any of these companies have proven that they have sustainable advantages, let alone staying power. Most great companies -- meaning companies that last and last -- are not based on a great technology or invention. They're based on an enduring organizational structure coupled with a clear vision of the value proposition behind their products. (I'll write more about this in Thursday's Motley Fool Research column.) How many young tech companies possess those qualities?
XO does not make the cut for our high-growth study, not having adequately met the criteria. XO already has a mountain of debt and it is too far from certain and growing profits for our comfort. That said the company has enough resources that it is expected to survive the cash crunch that is squeezing many of its peers today, and as observers we wish it the best. For us as investors, though, and for most at-home investors, this type of business is not one that can be well understood, easily followed, or highly predictable, and thus we wave it past.
Our original list of contending companies is narrowing, and before long we'll be able to begin focusing closely on our finalists. So far, our finalists are eBay (Nasdaq: EBAY), Paychex (Nasdaq: PAYX), Ariba (Nasdaq: ARBA), Openwave Systems (Nasdaq: OPWV), Millennium Pharmaceuticals (Nasdaq: MLNM), Genentech (Nasdaq: DNA), Redback Networks (Nasdaq: RBAK) and Mercury Interactive (Nasdaq: MERQ)
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Great companies are very few and far between, and despite all the excitement the past few years, as always, very few great companies are being created. Jeff Fischer hopes he owns a few. Of the companies mentioned, he owns Intel, eBay, Mercury Interactive, and Genentech. To see all his holdings, view his profile. The Motley Fool is investors writing for investors.
