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Chapter 11 in the Rearview Mirror

Carrier Hotels Staff Posted Mar 11, 2004

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For much of the data center industry, the last two years felt like a bad case of literary deja vu. No matter how many times you tried to turn the page, you kept encountering Chapter 11.

Few landlords or service providers were untouched by the flood of bankruptcies, which peaked entering 2003 with WorldCom, Metropolitan Fiber, Exodus, PSINet and Global Crossing all operating in Chapter 11.

By year-end, all but WorldCom had emerged, some with new ownership. Pundits predicted that Chapter 11 survivors would slash prices to rebuild market share, but that scenario hasn't materialized.

"It seems to have been less disruptive (than expected)," said Ed D'Agostino of CRG West, which owns a portfolio of telecom buildings, including One Wilshire in Los Angeles. "The changing of hands of facilities seems to have gone smoothly, irrespective of whether they were bankruptcy-driven. The weak have fled and left some nice assets in the hands of the committed."

As providers sold surplus facilities, many data center buyers and tenants became focused on finding bargains in distressed sales, both in and out of Chapter 11.

"Bankruptcies have created our competition by providing lots of raised-floor busted colo for the market," said Alex Twining, the CEO of MetroNexus, a New York-based developer of carrier hotels.

But not all facilities are alike. With surplus inventory, investors and customers have focused on the best-engineered properties, especially data centers built by WorldCom, Exodus and AboveNet. Older facilities and those in disaster-prone areas have struggled as disaster recovery became the primary focus for buyers.

Many carrier hotel landlords found several of their largest tenants in Chapter 11 at the same time. Properties with a larger tenant base fared best in this scenario, while it was make-or-break time for buildings' whose profitability hinged on one or two large providers.

The bankruptcies "have illustrated the difference between mature established carrier hotel facilities housing critical infrastructure and those less-established latecomers," said Robert Guller of Bandwidth Exchange Buildings in St. Louis.

"Where bankrupt tenants maintain economic value, the leases have been continued through bankruptcy and after to the new, better credit successors," Guller added. "Where raw or even improved space was unused, leases were terminated and placed back on the market. Those landlords with a balanced mix of tenants have been able to survive the temporary cash flow interruptions of bankruptcies relatively unscathed."

That's not to say the Chapter 11 filings had little effect. Financial stability became a key selling point, and prospective customers wanted to see more than promises.

"I'm sure every operator has had to bend over backwards in regards to sharing financials that they normally wouldn't have in order to secure business," noted Rich Lee, CEO of of Springboard Managed Hosting in the Research Triangle market.

"The first set of bankruptcy filings in 2000-2001 created a search for financially secure data centers," said J.P. Balajadia of 365 Main in San Francisco. "There was a lot of movement in the industry from one provider to another, with shorter contract terms and provisions written in for automatic out provisions if there was change of ownership."

As more providers entered bankruptcy, the urge to flee the sinking ship diminished somewhat, and providers got better at reassuring skittish customers.

"As colocation companies continued to file for bankruptcy, they also became more aggressive at customer retention - getting court stays and threatening with legal proceedings if leases were broken," said Balajadia. "Customers also became more callous to the fact that their providers were in Chapter 11 protection and did not want to bother with the pain of moving colocation spaces."

Fears of price wars turned out to be largely overdone, according to John Wilson of eXchange @ 200 Paul in San Francisco. "We do see lower circuit pricing from post-Chapter 11 telecoms, but these formerly bankrupt companies seem to be lacking (operations) personnel and capex budgets to be truly price-disruptive competitors," said Wilson.

Rory Cutaia, the CEO of New York's tel^x, said that over the long run the bankruptcies will be seen as "disruptive in a positive sense."

"It forced management to prove their business models, drive toward near-term profitability, and in turn, create stability for the foundation - the infrastructure - of the world's communications systems and networks," said Cutaia. "Without such stability, without a foundation, the development and introduction of some the most exciting and promising communications products and services would be delayed indefinitely."