McLeodUSA Incorporated

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McLeodUSA Incorporated

6400 C Street SW, P.O. Box 3177
Cedar Rapids, Iowa 52406-3177
U.S.A.
Telephone: (319) 790-7800
Toll Free: (800) 896-8330
Fax: (319) 790-7767
web site: http://www.mcleodusa.com

Public Company
Incorporated: 1991 as McLeod Telecommunications, Incorporated
Employees: 7,800
Sales: $604.14 million (1998)
Stock Exchanges: NASDAQ
Ticker Symbol: MCLD
NAIC: 51331 Wired Telecommunications Carriers; 513310 Telecommunications Networks, Wired; 511140 Telephone Directory Publishers

McLeodUSA Incorporated is a major provider of integrated telecommunications services to businesses and residential customers in 12 Midwestern and Rocky Mountain states. It is one of the nations’s fastest-growing telecommunications companies. The core business of McLeodUSA is to provide “onestop,” integrated communications services including local, long distance, voice mail, paging, and Internet access services, all from a single company on a single bill, tailored to the customer’s needs. The company derives its revenues from the sale of telecommunications services, the sale of advertising space in telephone directories, and telemarketing sales. McLeodUSA Publishing prints and distributes nearly 24 million telephone directories in 22 states.

Anticipating Industry Deregulation: 1990

McLeodUSA was founded in 1991 by Clark McLeod. In the year prior to his formation of the company, Clark McLeod sold Telecom USA, which he and several partners had built into the nation’s fourth largest long distance company, to MCI Communications Corporation for $1.2 billion. In the early 1980s the telecommunications industry had been monopolistic and services were inadequate. Typically designed to accommodate only one service, the infrastructure could not handle the highspeed computing traffic that consumers required, and pricing was prohibitive. Increased competition in the long distance market was the first step toward improving the situation—and McLeod’s Telecom USA had reaped the benefits of deregulation in that market. McLeod became interested in trying the local phone market, planning to create a “super-regional” phone company offering local, long distance, paging, and Internet access on one bill. He was aware of consumer demand for a broader scope of high-capacity telecommunications at a lower cost. Legislators, regulators, and consumers were demanding that the industry be opened up to more competition, and McLeod anticipated sizeable opportunities for the future.

In 1992 the company began providing fiber optic maintenance services for the Iowa Communications network. In the following year, McLeod Telecommunications, Inc. was reincorporated as McLeod, Inc. The company began offering local and long distance services to Iowa and Illinois businesses in 1994. McLeod planned to concentrate on second- and third-tier cities in Midwestern and Rocky Mountain areas because no one else was focusing there. The company identified a 12-state area from the Great Lakes to the Rockies for expansion. With the help of managers who had contributed to Telecom’s success, McLeod began his assault on two entrenched regional Bells: U S West and Ameritech.

Following regulatory approval, revenues soared 417 percent, from $1.6 million in 1993 to $8 million in 1994, reflecting in particular an increase of $1.9 million in revenue from the Iowa Communications Network Maintenance Contract and its commencement of local and long distance services. Positioning itself for rapid growth, McLeod launched its PrimeLine service, its first bundled telephony product for residential customers, and completed its initial public offering in 1996, adding $258 million in equity capital, followed by a second offering which added $138 million. Clark McLeod commented: “This is probably the largest sum ever raised in the shortest amount of time by an Iowa-based company,” according to Knight-Ridder/Tribune Business News. The funds allowed for the accelerated hiring of personnel, construction of its own fiber optic communications network, the construction of a technology park at its corporate headquarters in Cedar Rapids, Iowa, and for service expansion into new areas.

The federal Telecommunications Act of 1996 was enacted during this period. It pushed for deregulation and increased competition among local providers. McLeod worked to assemble an executive management team with decades of experience in telecommunications, while establishing a network to support the enhanced services it wished to provide. While building its network the company had long-term contracts with two regional Bell operating companies, allowing it to lease lines and switches. Once a customer chose McLeod, the Bell company would assign a line and telephone number. From there, McLeod controlled local line features, long distance service, voice mail, and Internet access for that customer. McLeod entered the local service market by doing an end-run around U S West, reselling the incumbent’s own product, Centrex, according to the Denver Business Journal, which was a vehicle to provide local connections. Centrex avoided “many of the issues plaguing new competitors trying to enter the local market, especially the complex problem of interfaces.” Centrex was basically an electronic PBX (private branch phone exchange), connecting callers via a switch at the phone company’s central office rather than through an operator at a switchboard. It was capable of being loaded with features such as call waiting, voice mail, and caller ID. When U S West understood what McLeod was doing, it began a state-by-state regulatory offensive to withdraw Centrex from service. McLeod argued that U S West’s regulatory actions created an unlawful barrier to competition, an argument which prevailed in every state petitioned through 1997. Following the construction of its own network, McLeod served customers without leasing capacity from U S West Communications and other carriers, selling its own network capacity to other telecommunications providers.

1996: Creating Brand Awareness

McLeod purchased one of the largest non-Bell publishers of white and yellow page directories in 1996, forming a subsidiary, McLeodUSA Publishing. The directories were a means of creating brand awareness by showcasing the company’s name, logo, and telephone services. McLeod also acquired a telemarketing company, Ruffalo, Cody & Associates, a company which sold long distance services for a major telephone company and was ranked as the 26th fastest-growing private company in the United States, according to Inc. magazine. McLeod converted the experienced sales team into a long distance sales team to sell PrimeLine service. By this time, the company was serving residential and business customers in Iowa, Illinois, Minnesota, and Wisconsin.

McLeodUSA and AT&T signed an agreement to provide dedicated access service within 30 Midwestern cities. The agreement provided an alternative connection to the local telephone company for AT&T to serve business customers. According to Knight-Ridder/Tribune Business News, “This agreement allows McLeodUSA to provide dedicated access service to AT&T in key second-and-third-tier cities,” adding: “Currently, AT&T is using the networks provided by the local incumbent telephone company to serve its customers.” The McLeod network was constructed to meet AT&T specifications, enabling both companies to utilize current technologies within a high quality network. AT&T had announced various agreements with seven alternative access providers allowing businesses in 130 cities to connect with its network as an alternative to access provided by incumbent local phone companies. At McLeod’s annual shareholder meeting in 1997, shareholders approved changing the company’s name to McLeodUSA Incorporated.

Analysts estimated that the telecommunications revenue potential in McLeod’s 14-state area should approximate $23 billion by the year 2007. Bolstered by projections, the company emphasized market penetration rather than geographic expansion. Its employee base had grown from 400 to over 4,500 within two years, with about 25 percent of that force devoted to sales and marketing services. McLeod completed a merger with Consolidated Communications Incorporated (CCI) of Mattoon, Illinois, creating the first Super Regional CLEC (Competitive Local Exchange Carrier). As a result of the merger, the company took ownership of all former CCI subsidiaries, including ICTC, an independent local exchange carrier serving east central Illinois; CCTS, a local exchange carrier offering integrated local, long distance and other services to customers in central and southern Illinois and in Indiana; CCD, a telephone directory company; an operator service company; an inmate pay-phone company; a full service telemarketing agency; a majority interest in a cable television company; and a minority interest in a cellular telephone partnership. The acquisition positioned McLeod for expansion in the targeted markets. As of late 1998, the company served almost 367,000 local lines in 267 cities and towns. Other opportunities were also seized, including mergers with Dakota Telecommunications Group (DTG) of Irene, South Dakota, and Ovation Communications of Minneapolis, Minnesota.

Company Perspectives:

Our mission is to become the number one provider and most admired company in the communities we serve. The principal elements of the Company’s business strategy include: Providing integrated telecommunications service; Building market share through branding and customer service; Expanding our fiber optic network; And, migrating existing customers to our own network.

Westward Expansion: 1999

Encroaching deeper into U S West’s territory, McLeod purchased two Salt Lake City, Utah, telecommunications businesses, Access Communications, Inc. and S.J. Investments Inc. Access provided voice and data long distance services to 30,000 customers in nine states. A major selling point for the company was Access’s special 800 service for local and national accounts. The technology allowed the programming of incoming toll-free calls to “behave” differently depending on where the call originated, the time of day, and other variables. Steve Gray, McLeod president and COO, stated in Knight-Ridder/Tribune Business News that “We believe this is just the beginning for this new technology,” adding “From a futuristic perspective, the same logic built into the enhanced 800 routing platform can be adapted to direct e-commerce applications.” Under terms of the deal, the owners of Access Long Distance received about 1.9 million shares of unregistered McLeodUSA stock and about $50 million in cash. McLeod also assumed about $97 million in Access debt. Following the acquisition, the company began planning expansion into Arizona, New Mexico, Oregon, and Washington, increasing its market area to 16 states—and increasing McLeod’s market by 23 percent.

Anne Bingaman, former assistant U.S. attorney general in charge of the antitrust division, was elected to the board of McLeodUSA, becoming the first woman to serve on the company’s board of directors. While working for the Department of Justice, Bingaman had focused on telecommunications, international antitrust, and intellectual property. She left the government in 1997 for the private sector to serve as senior corporate vice-president and founding president of the local services division of LCI International Telecom, Inc., in McLean, Virginia. While at LCI, Bingaman was responsible for regulatory affairs, filing numerous petitions with the Federal Communications Commission and testified before the Senate Commerce Committee to promote local service competition under the Telecommunications Act of 1996. She left LCI when the company was acquired by Qwest.

Bingaman’s expertise was, indeed, needed. One of McLeod’s major competitors, Ameritech, sought legal sanction allowing it the freedom to set its own rates for local telephone service, claiming that it faced ample competition to justify its claim. The Citizens Utility Board, along with “at least one of Ameritech’s competitors” argued that there isn’t enough competition in those markets to warrant rate deregulation, according to Knight-Ridder/Tribune Business News. The Citizens Utility Board argued that Ameritech’s move to free itself from price regulation in 19 communities was improper because many consumers had no choice other than Ameritech for local phone service. In the Champaign-Urbana, Illinois-area, the principal alternative to Ameritech was McLeodUSA. Ameritech had begun reclassifying residential phone service in the 19 communities as “competitive.” That meant that the company could raise rates in those regions when it wanted to. An Ameritech spokesperson argued that the company was regulated by the Illinois Commerce Commission under a 1994 “alternative regulatory plan,” allowing the company to declare its services “competitive” when there was an alternative in the marketplace—and argued that the prices for Ameritech’s phone services had actually decreased since 1994. McLeod argued that there still was not enough competition, and that Ameritech still held the upper hand. At press time the matter was still pending.

Former White House Chief of Staff Erskine Bowles joined the board of directors of McLeod, following a $ 1 billion investment in the company by Forstmann Little & Company, giving the firm a 12 percent stake in McLeod. Bowles was a general partner in Forstmann Little, along with fellow director, Theodore Forstmann, senior partner of the New York private investment firm. As general partner, Bowles focused on the firm’s portfolio companies and on the development of new investments. He was involved in the firm’s decision to invest in McLeod and to fund its business plan. Bowles told Knight-Ridder/Tribune Business News that “One of the most compelling reasons for selecting McLeodUSA for this substantial investment was the quality of their leadership team and their track record of outstanding execution.” The investment was one of the largest individual investments made by Forstmann Little. McLeod planned to use the capital to develop its fiber optic network and to penetrate new markets to add new customers.

In the autumn of 1999, McLeod dedicated an 80,000-square-foot facility in the Missouri Research Park in Weldon Spring, Missouri, consolidating three St. Louis-area offices. The company invested approximately $30 million in development in the region, having captured 32 percent of the business lines. Mc-leod contracted with Network Management to provide engineering services and lay 75 miles of fiber optic network in the St. Louis area, an area which company managers considered an emerging center for technology in the United States.

At it entered 2000 McLeod had consistently met or surpassed its goals since the company’s founding, succeeding in developing customer bases in targeted secondary markets. Speaking for the company, Clark McLeod has boldly stated that “We want to be the number one provider in every market that we’re in,” adding “Our strategy has been to enter a marketplace, gain share in the marketplace and then build fiber networks to get closer and closer to our customers.” So far, favorable legislation and the company’s grass-roots approach has positioned McLeod for continued growth.

Principal Subsidiaries

Consolidated Communications Directories Inc.; Consolidated Communications Telecom Services, Inc.; Illinois Consolidated Telephone Co.; McLeodUSA Diversified, Inc.; McLeodUSA Media Group, Inc.; McLeodUSA Network Service, Inc.; McLeodUSA Publishing Company; McLeodUSA Telecommunications Service, Inc.

Principal Competitors

U S West, Inc.; Ameritech Corporation.

Key Dates:

1992:: Company begins providing fiber optic maintenance services for the Iowa Communications Network.
1993:: McLeod reincorpórales as McLeod, Incorporated.
1996:: McLeod completes its initial public offering.
1997:: Company merges with Consolidated Communications, Incorporated.
1998:: Company acquires Access Communications, Inc.
1999:: McLeod negotiates a long-term partnership with Forstmann Little & Co.