The general rule has been that a rail or utility can put a fibre-optic conduit in the ground for about $10,000 per mile. That is changing. It is just as easy to dig a trench and bury 10 conduits for $100,000 per mile. Charge four lessees $25,000 each and you reach break-even. Margins are better than hauling freight.

There are differences in strategy for entering the telecommunications industry that reflect a key difference between the two industry sectors: utilities already have entrée to retail markets by providing service directly to consumer residences. Railroads ? with no corresponding access to homes ? are better positioned to lease right-of-way to telecom companies or to partner with them on the wholesale level.

Florida East Coast Industries (FECI), parent of Florida East Coast Railway, has formed a telecoms subsidiary ? Epik. Based in Orlando, Florida, Epik is a ?carrier's carrier' providing high capacity telecommunications circuits, dark fibre and collocation services to competitive local exchange carriers (Clecs), wireless carriers, internet service providers, long distance companies and other carriers.

The business was started with $70 million in seed capital financed by the parent through cash flow and 350 miles of right-of-way. Epik recently signed on two customers, Network Plus and Global Map, both out of Cambridge, Massachusetts, according to Paul Split, vice-president of marketing for Epik. ?We leased dark fibre on an IRU (indefeasible right of use) basis. They don't take title.?

The company took another $70 million from the parent to extend Epik's reach to Atlanta. Epik lit the first 350 miles of this network in less than six months and will light the rest by year-end. Through fibre swapping arrangements with other carriers, Epik's fibre now reaches major cities in Georgia, Louisiana and Texas. ?We have a substantial investment of dark fibre. And we have joined with Enron from New Orleans to Texas, and with Broadwing from Atlanta to Orlando.?

Epik now has a revenue backlog of $60 million. Revenue backlog is a benchmark measurement and represents revenue contracted for but neither earned nor collected. ?We haven't looked at a joint venture yet. But we wouldn't necessarily rule it out, particularly if we encountered a company with technical proficiency and no network.?

One of the deals is a 10-year dark fibre lease agreement with a telecommunications company, allowing the New England company to connect its own facilities from Jacksonville to Miami, and every major city along that route. The agreement also provides for long-term access to Epik's fibre connecting Atlanta to Florida.

In terms of raising capital or divesting, Split says Epik and its parent are looking at a number of options. ?We may do a high-yield issue, go for an initial public offering or just spin off the company. We have started talking to the banks but haven't mandated anyone.?

Rail powerhouse Norfolk Southern (NS) jumped into the telecommunications business in mid-October 1999 to take advantage of 21,600 miles of rights-of-way, an extensive microwave network that includes 400 towers, and numerous sites and facilities throughout the eastern United States with a variety of telecommunications providers. The telecom unit will do business as Thoroughbred Technology and Telecommunications or ?T-Cubed.?

The company is currently negotiating with long-distance carriers, local telephone companies, competitive local exchange carriers, and cable companies. As deregulation in the telecommunications industry unfolds, these companies will be looking for efficient ways to expand their offerings for transmission of voice, data, video and cable signals. Charles W. Moorman, president of the new company, claims that high population density in the US north-east, coupled with the high price of real estate, provide the opportunity to optimise the value of NS's infrastructure assets.

As part of its agreement with the parent, T-Cubed has taken over management of all existing fibre contracts ? including 6,800 miles of fibre-optics along the company's right-of-way. ?Norfolk Southern basically provides a dirt lease for an annual payment. We will be paid a management fee. We also are broker for all new telecom deals. T-Cubed also has the right to license on a non-exclusive basis. Our original thought was to just go to telecom companies and work a partnership for our right-of-way,? says Moorman.

That thinking changed. ?When you do a valuation, right-of-way does not represent a high percentage of cost, and we wouldn't get much. The best way to leverage our assets was to move up in steps from the dirt ? from ownership of right-of-way to ownership of conduit, then to ownership of dark fibre.?

Moorman says T-Cubed seeks an ?anchor tenant? before making the decision to install conduit. ?The economics are such that we can install a substantial number of conduits, usually 10 to 12, and then offer an anchor tenant the opportunity to purchase two or three conduits at a fixed price which is very attractive to them, and yet offsets 60-70% of our construction costs. We then can offer the remaining conduits to other telecom providers at costs per mile which are very attractive when compared to the cost of acquiring right-of-way and constructing their own system. In today's market, most of the telecom players are reasonably indifferent as to whether or not other companies are in the same trench, so we are getting a lot of interest in the marketplace.

?We are employing a strategy which is less risk-averse than some of the other railroads and right-of-way providers, which we feel gives us a distinct competitive advantage. Having said that, our goal is still to make money from the start.?

NS officials have a right to be cautious. For the first period, the company posted an 88% quarter-on-quarter revenue slide, tied to rising fuel costs and difficulties integrating its Conrail acquisition. Net income fell to $14 million from $112 million for the corresponding 1999 quarter. Since June, NS's difficulties in integrating the portion of Conrail it operates have affected adversely both revenues and expenses. However, at year-end 1999, railway operating revenues were $5.2 billion, or 23% higher than 1998.

?If you look at a 3,000-mile network, it will cost you $300 million to build out conduits. Anchor tenants will account for $200 million prepaid. So, you may be looking at carrying $100 million probably for no more than two years. However, we won't commit to build a route, even with an anchor tenant, if we don't feel that there is a strong demand for further conduit sales. Our goal is to have any route completely paid for through anchor tenant and other pre-sales, and in fact that is already the case on one of our corridors. We don't anticipate a capital markets play, but we may have to access some bridge financing for construction through the parent company for those two years.?

Moorman says: ?We are trying to get corridors locked in so we can move up the chain from conduit provider to fiber provider. Our goal is to identify hundreds ? not hundreds of thousands of customers. We never want to be a retail player. And we also want to look at what we can offer the railroad business. We want to remain a carrier's carrier.?

In April, Pathnet, and its new parent company Pathnet Telecommunications, announced closure of its strategic investment transaction with Colonial Pipeline Co, Burlington Northern and Santa Fe Railway (BNSF) and CSX Transportation. Pathnet is a carrier's carrier providing high-capacity digital bandwidth and access to second and third tier US cities. The telecom company provides service to inter-exchange and local exchange carriers as well as internet service providers and cellular operators. Both rail companies refused to divulge the amounts or terms of their investments in the venture. However, Colonial Pipeline will provide $67 million in financing.

Pathnet Telecommunications received the right to develop over 12,000 miles of these investors' rights-of-way holdings. In addition to providing a portion of the rights-of-way access, Colonial Pipeline also made a first tranche cash investment of $43 million in Pathnet with a second tranche of $25 million expected upon the completion of Pathnet's Chicago to Denver fibre build, slated for the second quarter. The new investors received an approximate one-third equity stake in the telecommunications venture. Pathnet received an extensive right-of-way inventory with no cash outlay. Significant portions of these development rights are exclusive. The balance of a $250 million equity investment came from the two Class I railroads.

Canadian National announced in March that it had exchanged its minority interests in two joint-venture companies controlled by 360networks Inc for common stock of 360networks, formerly Worldwide Fibre Inc. The share exchange agreement was reached in connection with 360networks' planned initial public offering. The deal granted CN approximately 9.4 million shares of 360networks. According to the terms of the agreement with 360networks and securities regulations, it is not anticipated that CN will sell its holdings in 360networks within 12 months of the communications company's IPO. As a result of this agreement, CN posted a one-time $58 million after-tax gain related to the exchange of minority equity investments for common stock in 360networks.

360networks is developing a global fibre-optic network. CN and wholly-owned subsidiary Illinois Central Corp (IC) signed agreements last year to establish two fibre-optic cable joint ventures with 360networks. The agreements granted the joint ventures preferred access to CN and IC rights-of-way to develop fibre-optic transmission systems. The 360networks-controlled joint ventures installed more than 1,000 kilometers of fibre-optic network on CN rights-of-way last year. Key projects in 2000 are linking Quebec City and Halifax, and Chicago and New Orleans, with more than 2,500 kilometers of additional network.

As part of these two projects, CN is receiving fibre-optic strands for its own rail purposes. Once construction is complete, CN will have an uninterrupted North American fibre-optic-based communications network on its rights-of-way between Vancouver, Halifax and New Orleans.

The company's IPO and high-yield debt offerings, which launched in April, produced $1.5 billion, with proceeds earmarked to complete a previously announced plan to build a 56,000 mile network. Goldman Sachs and Donaldson Lufkin & Jenrette were co-lead underwriters of the offering. In addition, 360networks received commitment from Chase Manhattan and Donaldson Lufkin & Jenrette Capital Funding for a fully underwritten $1 billion senior credit facility.

If the US Surface Transportation Board reverses its March decision to impose a 15-month moratorium on rail mergers, CN will renew its push to merge with BNSF. That combination would be expected to spur an increasing number of big-ticket deals involving a much larger rights-of-way network.

In April 1998, Level 3 Communications Inc and Union Pacific Railroad Co (UNP) signed an agreement granting Level 3 the use of approximately 7,800 miles of rights-of-way along Union Pacific rail routes. UP spokesman John Bromley says details and terms of the transaction are ?proprietary.? But the agreement allowed Level 3 to construct, operate and maintain fibre network facilities along rights-of-way initially connecting 25 cities. Bromley says UP leased only right-of-way to Level 3. The railroad does not own the conduits. Level 3's network is designed to be upgraded to accommodate changes in both technology and demand. Level 3 designed the system with spare capacity. The company installed six to eight conduits along its network. Initially, fibre cable was installed in only one of the conduits, with the remaining conduits available for use as fibre technology and demand change.

The arrangement with UP followed a data network agreement with Frontier Corporation to lease capacity on Frontiers 13,000 mile Sonet fibre-optic network. The leased network encompasses approximately 8,300 route miles of OC12 network capacity, initially connecting 15 of the largest US cities and valued at approximately $165 million. In June 1998, Level 3 completed a similar arrangement with Burlington Northern Santa Fe to construct, operate and maintain multiple conduit fibre network facilities, which will be buried on leased right-of-way.

Utilities mainly retail oriented

Credit Suisse First Boston (CSFB) has been mandated by Delaware-based utility holding company Conectiv to find a partner for its expanding telecommunications services provider Conectiv Communications. If the New Jersey Supreme Court rules in favour of PSEG in its $2.5 billion stranded costs securitisation suit ? as is generally expected ? Conectiv will also proceed with a securitisation. The parent expects to securitise $1 billion of its stranded costs. The telecom unit's share of the windfall is predicated on what the partner brings to the table.

Publicly-held Conectiv, formed in March 1998 through the merger of Atlantic Energy and Delmarva Power & Light Company, is parent company for electric and gas utilities and a number of peripheral businesses, including retail telecommunications services. Subsidiary Conectiv Communications is a retail telecommunications services provider to both the home and business-to-business markets, generating about $60 million in revenues. The parent company has invested about $130 million in the telecommunications subsidiary.

?We are seeking a partner because the parent company wants to keep equity but doesn't want to be the sole provider of capital into the business,? stresses Richard Robertson, president of Conectiv Communications. ?There are a few ways to go. For example, we could end up with a financial partner that would use us as an anchor for an East Coast play. Or we could become part of a larger company that has a gap in the mid-Atlantic region.

?Conectiv Communications owns the fibre-optics, while the parent owns about 750 miles of right-of-way. We think the real asset is the fibre-optic network. As opposed to some other utilities, we are in the retail business. The product is different. We're not selling dark fibre. We're selling service. Last year we bought an internet service provider. We think the margins are better in this side of the business.?

Robertson realises that there is significant consolidation going on in the industry. ?You have to keep increasing your size and scope. You can't compete long term with Bell Atlantic and other very large companies. But right now the parent is not interested in getting out.?

Competitive local exchange carrier (CLEC) Reliant Energy Communications, an unregulated unit of Reliant Energy, announced in early March that it would acquire Insync Internet Services, a Houston-based business-to-business internet service provider (ISP). The acquisition includes a cornucopia of high-speed voice, data, and internet products.

Sister company, Reliant Energy HL&P, an electric utility serving the Houston area, has been providing internal telecommunications services associated with its core business for several years and has a 300-mile fibre-optic backbone and related telecommunications infrastructure. HL&P also has been building and leasing fiber capacity to communications carriers. The fibre-building business is operated on a pre-sold basis.

?We are concentrating on business-to-business products for small and medium-size companies in the Houston area,? says Mark B Slaughter, president of Reliant Energy Communications. ?In the summer we will expand the business to include the Houston residence market. Reliant has built-in credibility, having been in Houston for over 100 years. For households switching over, we can be the branded alternative to Southwestern Bell.? Slaughter stresses that Reliant Energy Communications will concentrate on the retail market because the margins are higher. ?We don't have equity partners. We are drawing capital from the parent company. But if the business grows to where it is warranted, we may go outside for funding.?

In late April, DukeNet Communications, the telecommunications subsidiary of Duke Energy, struck a deal with NewSouth Communications, a switch-based broadband integrated communications provider (ICP), to expand its fibre-optic reach throughout the southern US. In accordance with the pact, six-year old DukeNet will serve as primary fibre provider, using its 7,800-mile interconnected network.

Chip Smith, president of DukeNet, maintains that telecommunications is more of an extension of an existing business than a new pursuit. ?We see telecommunications as a means of leveraging our assets. We have no intention of getting out of the energy business ? which is our main business.? That strategy is in opposition to management philosophy at some other energy companies which look to telecommunications as a substitute for core business. ?We lease fibre from the parent company ? Duke Energy. We ultimately add electronics to that fibre to accommodate those companies that become anchor tenants.? However, DukeNet is not tied to the 65% to 70% of capacity demanded of Norfolk Southern anchor tenants. Smith says DukeNet's capacity requirement is not necessarily that high.

Smith says DukeNet has both equity stakes and joint venture arrangements as well as acting as a ?carrier's carrier'. ?We are in a joint venture with Bell South in North and South Carolina in which we have a 20% equity stake. Bell has 56% equity stake and Carolina Power & Light and independent telephone companies hold the remaining stake.? DukeNet has other joint venture arrangements, however, the Carolina deal is its only equity arrangement.

In early May, Potomac Capital Investment Corporation (PCI), an unregulated unit of Potomac Electric Power Co (Pepco), announced the acquisition of Maryland telecommunications contractor Severn Cable, one of the principal contractors supporting Starpower Communications' advanced network installation in the area. The new company will continue to specialise in the installation of strand, fibre-optic and coaxial cable. Officials declined to release details of the acquisition. Potomac Capital official Kevin McGowan says he is unaware of any further acquisitions being targeted. McGowan adds that the takeover of Severn was opportunistic in that it is becoming more difficult to get into the business from the ground level because of the dearth of qualified technicians.

With the distinctions between telco, utility and railroad blurring ? next year's telco project sponsors could be old hands at the project business.