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Jack McMaster of KPNQwest -Unloved but unbowed

Investors have lost their infatuation with European alternative network providers. Jack McMaster is hoping that by delivering on its promises, KPNQwest can rekindle the spark.

Investors have lost their infatuation with European alternative network providers. Jack McMaster is hoping that by delivering on its promises, KPNQwest can rekindle the spark.

By Andrew Capon
June 2001
Institutional Investor Magazine

Investors have lost their infatuation with European alternative network providers. Jack McMaster is hoping that by delivering on its promises, KPNQwest can rekindle the spark.

Times have gotten tough for former stock market darling KPNQwest, the Hoofddorp, Netherlands-based alternative network provider, or data carrier, and its American CEO, Jack McMaster. Though McMaster maintains that the outlook for broadband services in Europe is rosy, investors are not so sure. They have been dumping alternative carrier stocks wholesale, and KPNQwest's share price has dropped sharply, from a high of E92 ($81) in February 2000 to less than E13 in mid-May, well below the company's November 1999 IPO price of E20.

The chariness of investors, who have soured on virtually all technology, media and telecommunications stocks, is not shared by analysts, most of whom remain convinced that KPNQwest is well positioned to be a big beneficiary of the broadband revolution. Schroder Salomon Smith Barney has rated the company one of its "top picks" in the European alternative carrier sector.

Broadband communications and Internet protocol services are KPNQwest's two major revenue sources, derived from a collection of large and small data centers and its mostly completed fiber-optic communications network. In 2000 the company notched E461 million in sales but lost E185 million because of construction expenses.

The irony is that KPNQwest's stock price is falling just as the company's business seems likely to explode. Having spent E2.4 billion to build infrastructure, McMaster is about ready to exploit that asset. By autumn the company will have completed a 20,000-kilometer network that connects 50 European cities and is linked to Qwest Communications International's U.S. network. Three CyberCentres in London, Munich and Paris will also be up and running.

Each E60 million CyberCentre is the size of two football pitches, built to accommodate computers, servers and routers. They'll provide Web-hosting facilities and such Internet services as virtual private networks, which provide password-protected access for secure communications by groups. Though such value-added services currently account for only about 15 percent of revenues, KPNQuest expects them to be a significant complement to its basic broadband sales. McMaster says he is on course to post positive earnings before interest, tax, depreciation and amortization in this year's fourth quarter.

KPNQwest was established in November 1998 as a $700 million joint venture between Dutch telecommunications group KPN and Qwest Communications International, the fast-growing U.S. telecom company. After the 1999 IPO, each founder retained 45 percent of KPNQwest.

McMaster has an MA in international politics and an MBA in international business, both from New York University. Before becoming KPNQwest's CEO in 1999, he was executive vice president of Qwest's international operations. He is also a 20-year veteran of AT&T Corp., where he headed the $23 billion consumer markets business.

McMaster, 44, discussed the prospects for KPNQwest with Institutional Investor Senior Editor Andrew Capon.

Institutional Investor: Joint ventures in the telecommunications sector have a checkered history. What makes KPNQwest different?

McMaster: A joint venture that is a department of two other companies is doomed to fail. No one has any vested career interest in the newly established company. Managers and employees are on rotational assignments back to the corporate mother ship. We heeded that lesson from day one. In our case, KPNQwest is a separate, stand-alone corporate entity. The people here work for KPNQwest. KPN and Qwest review milestones and progress as any shareholder would, but they are not involved in my day-to-day decisions or how I run the company. The reason KPNQwest has flourished is that we have our own culture of accountability.

What are your targets for 2001?

There are three things we have to deliver on this year: the completion of the network on time and on budget in the fourth quarter, positive ebitda in the fourth quarter and continued strong revenue growth. We doubled revenues last year, and the analysts are predicting close to a further doubling this year, to E780 million. I am comfortable with that number. Positive ebitda will be very significant for us. These are difficult times in this sector, and it will provide an enormous psychological boost.

Do you worry about your share price?

Yes, but only to the extent that it tells us how investors perceive the company. It hasn't been fun watching the valuation collapse, but at these levels I think our valuation is artificially low. I think we deserve some rerating.

How will you manage the transition from building the network to operating it?

So far investors have entrusted us with money to build a network. That will come to fruition in the fourth quarter. Then everything changes. We then have to make money with the asset. That requires a very different skill set. Of course, I think we can make that change. Our sales growth so far gives me cause for optimism that we have marketing know-how. But I would not deny that at these pivotal points some companies have stumbled. What I tell my staff is that building a luxury hotel is not the same as running it.

Are you concerned that there will be a glut of bandwidth?

No. I honestly believe that optical switching systems represent a technological revolution. Our investment bet is that this technology will be as important in the next 20 years as the computer revolution of the past 20 years and the petroleum effect a century ago. The increasing quality and quantity of bandwidth will mean huge disruption in all existing distribution channels as software and services become available. In 1992 Bill Gates said that he could see no reason why anyone would need more than 60 megabytes of hard-disc capacity on a PC. I have a gigabyte in a computer the size of my hand today. The applications and software have expanded as fast as the memory has become available. The same economic effect will happen in our industry. The availability of networks like the one we are building will release the latent creativity that will use it.

Is KPNQwest better positioned than its rivals to meet this demand?

In this market environment probably the most important thing of all is our strong financial position. We have E800 million in cash, as of the end of 2000. This time last year I was beginning to worry about the proliferation of competitors. But over the past nine months, many have withered away, and there certainly haven't been new entrants taking their place. The market is effectively shut for capital raisings for many companies in this sector, and many of those that have issued bonds have seen them drop to levels associated with defaults. The competitive frame has narrowed considerably.

Is that why bandwidth prices have stopped falling in Europe?

I think that is certainly part of it. Companies like PsiNet looked like they might be formidable competitors for us, and now they are in trouble. People are looking for quality providers with strong financials that are going to be around for the long term.

Why did you step back from the digital-subscriber-line market?

We reached the conclusion very quickly that DSL is not a stand-alone industry and made the decision not to try to compete before we committed much investment. People have voiced the criticism that we should never have gotten involved, since we walked away so quickly. That's fair. But others who made the choice to continue are also now retreating, so I feel somewhat vindicated that at least we made the decision quickly.

Have you found it difficult to adapt to a European corporate culture?

My job is certainly made more complicated by the fact that we are operating across 15 different countries and cultures. What we are engaging in is a grand experiment. Most pan-European businesses are structured like holding companies, and there is still a corporate center and a dominant home market. The liberalization agenda of the European Union allows start-up companies like ours to be truly pan-European. The question is whether it is possible to develop a culture that can take advantage of that opportunity.

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