PathNet Wins Financial Backing

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PathNet Wins Financial Backing

By Bob Starzynski
Staff Writer

PathNet Inc., a Washington-based developer of telecommunications networks, landed $30 million in venture capital backing on Nov. 3 - the go-ahead signal for a debutant with a $2 billion plan.

PathNet, loosely defined as a carrier's carrier in the telecom world, has thus landed perhaps the largest venture capital deal in the Mid-Atlantic region this year.

"Deals that size are certainly not that common," said Larry Alleva, regional managing partner of Price Waterhouse's technology practice.

With 45 employees, PathNet has not yet graduated from early-stage development. But the company has a few things going for it:

Started a little over two years ago by local entrepreneur David Schaeffer, PathNet is upgrading existing microwave networks that are owned by other telecommunications carriers or large companies. Once it makes the digital upgrades, PathNet then will have access to those nodes or microwave hubs so it can sell capacity to a wide number of companies. These high-end networks will allow telecom companies to supply quality service to parts of the country that are not currently accessible by fiber optic lines.

For instance, AT&T could use PathNet's systems to route higher-quality digital service to a little town in Kansas. Or, a state agency or utility company that has its own communication network could update from analog to digital through PathNet without having to rebuild its system.

"No one is developing this wireless technology in this fashion that I am aware of," said Richard Jalkut, PathNet's new president and chief executive officer. One month ago, Jalkut joined the company after serving as president of Nynex Telecommunications, the regional Bell company that served the northeastern United States until this year's merger with Bell Atlantic Corp.

Jalkut said that PathNet, which had raised $6 million through two earlier venture capital rounds, landed its most recent $30 million from a number of venture capital firms, including New Enterprise Associates of Baltimore, Spectrum Equity Investors of Boston, Grotech Capital Group of Timonium, Md., and Toronto Dominion Capital in Toronto, Canada. Officials from each of those firms also joined PathNet's board of directors.

Several years ago, telecommunications companies could not land large financing deals very easily. Such companies that were developing new technologies had to bootstrap their operations. They had to grow slowly, reinvesting profits to build out from a local to a regional or national scope.

But today, it is not unusual for a fledgling telecom company to go public with a $125 million offering (as is the case with Vienna, Va.-based Teligent), or, better yet, buy another start-up company for $125 million (as WinStar Communications Inc. of New York did earlier this year with Milliwave of Washington). Investors realize such companies may not generate revenue for another two years and may not be profitable for five years after that.

"There is a significant amount of money out there to be invested, and a lot of it is going into telecom," said Dennis Patrick, former chairman of the FCC. "That says a lot about perceived value with these companies."

Patrick was the founder of Milliwave and is still the second-largest investor in WinStar. Furthermore, he is an investor in PathNet, although he declined to reveal the amount of his investment.

Companies in the telecom industry are building nationwide and worldwide systems, rather than regional and local systems, because of demand, Patrick said. To be competitive, a network needs to be built out quickly and needs to cover vast areas. And, if the financing is available, why not build out a bigger network?

Schaeffer, who is still PathNet's chairman of the board, said that the company has a total capital requirement of more than $2 billion over the next six years. The first phase of the network, which should take two years to complete, will cost $350 million. The venture capital backing will be used to leverage other types of investments to cover the first-phase costs. In the first phase, PathNet will upgrade 800 nodes around the country with digital technology. The final plan for the company is to put its technology on 5,000 microwave nodes and service primarily small towns and mid-sized cities.

Jalkut said that the company will receive a $165 million vendor facility from NEC Corp. of Tokyo. Another $150 million will be raised through the high-yield debt market. That offering, for which the company is currently seeking an underwriter, is planned for after the first of next year.

Upon completion of the network, Schaeffer estimates that PathNet will have more route miles than any interexchange carrier, including AT&T, the largest telecom company in the United States. Schaeffer previously started and built five companies, including a specialized mobile radio carrier and a paging business.

Some small telecom companies bring in big name players, as Teligent did with Alex Mandl, former president and heir apparent at AT&T. With experienced leadership, investors will jump at companies like Teligent, despite its uncharted future.

The same is true with PathNet, according to Schaeffer. "Dick [Jalkut] brings a lot of operational experience and he has been with the Bell system for 31 years," he said. Although Jalkut came on board after the venture capital financing was arranged, Schaeffer said that his credentials won't hurt the company's chances with further financing.

Washington Region's Largest Technology Venture Capital Deals
(First three quarters of 1997)
Company Headquarters Investment Quarter
PathNet Inc. Washington $30 million Fourth*
Gene Logic Inc. Columbia, Md. $20 million Third
Online Resources & Communications McLean, Va. $20 million Second
Telogy Networks Germantown, Md. $13.1 million Second
Lightspeed International Sterling, Va. $11 million Second
MainControl Inc. Vienna, Va. $10 million Third
Vista Information Technologies Inc. McLean, Va. $10 million First
MIL3 Washington $7 million Third
Note: According to Coopers & Lybrand, Global Tele Systems of McLean, Va., received $39.2 million in venture capital in the third quarter. However, GTS could not confirm the financing because the company is in a quiet period due to an initial public offering. The company's prospectus does not suggest or note any such financing.

*Information on PathNet was obtained by Washington Technology, not Price Waterhouse or Coopers & Lybrand. Although the financing was not secured in the first three quarters, it is used in the chart to compare with the information that was available.

Sources: Coopers & Lybrand, Price Waterhouse


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