This year, several well-known prepaid companies have filed for Chapter 11. Other companies have avoided reorganization and have drastically scaled down their operations.
Court bankruptcy documents from prepaid companies read like chapters from the same book. While the paths to demise differ somewhat, each includes millions of dollars owed to major carriers like Verizon, Qwest and Sprint. Other debts listed include hundreds of thousands of unpaid dollars to distributors, printers, software providers, as well as peripheral companies like Federal Express.
Analyzing the scene
It's not that bankruptcies are a shocker in the prepaid industry. The market has had more than its share of fly-by-night companies that have gone out of business. But when larger companies go down, many begin to wonder: Is this a sign of bad things to come for the industry? What will happen to those left standing? The answer to those questions is very different depending on who you ask.
"Prepaid is still a very good business," says Ariel Charytan, vice president of VCG Telecom and Epana Networks, an international carrier, New York-based CLEC and provider of prepaid cards. "But it's a nontraditional business, and you have to have technical complexity to be successful."
He says companies go down because they grow quickly with strong marketing teams and rock-bottom prices, but they don't have the systems in place – technological and back office – to keep the business profitable. The bottom line, Charytan says, is that many companies are not making cost-efficiency changes that will save money as sales increase. Still, for the businesses who do business right, there is plenty of market share to be gained, he says.
Market forces
On the other hand, Mark Rubenstein, CEO of EZ Rewards, says these bankruptcies are a sign that the industry can't and ultimately won't hold up under cutthroat price wars and attrition in the domestic market due to competitive wireless services. "I think you are going to see three to five major companies making serious moves into consolidation of market share," Rubenstein says. "We have been forced into offering mostly cellular, which is a very low-margin item. Prepaid phone card volume has dropped by significant percentages."
The fact that many companies don't maintain fair accounting practices just makes matters that much worse, yet that's been a problem that has existed since the first handful of companies hit the streets with cards in the early '90s, he says. "When you sell a product at a discount," says Rubenstein. "The right way to deal with the money is to take it and put it in the bank. Then whatever is left after the expiration is profit. Carriers are not actually doing that. It ends up they are playing one dollar against the other."
Lessons to learn
Whether it is poor business practices or a shrinking market causing the most recent shakeups, most in the industry agree that survival means understanding where their colleagues fumbled along the way.
In reviewing court documents from various companies, there are common scenarios. In some cases, staffing ramped up to handle sales, but anticipated sales never resulted. Inevitably, industry rumors started swirling, and confidence eroded among distributors and retailers.
Some companies invested heavily in switch equipment and software – the list of unsecured creditors tells the tale. At some point, cash flow can't keep up with unpaid bills. Then there are the carrier bills – usually large sums are owed. By this point, there is little choice left but to file for bankruptcy protection.
One thing that remains clear in the prepaid industry is that customers look for specific brands that they know, says Dr. Judy Reed Smith, CEO of the market research firm Atlantic-ACM. That's proven by the fact that companies that buy smaller businesses often maintain the brands they buy.
Companies that continue to operate under Chapter 11 reorganization have to gamble that they haven't burned too many distributors and customers to retain street credibility on their brands. They have to convince distributors that the problems stemmed from honest miscalculation and misguided business planning, rather than deliberate deception. As one distributor describes card providers in general, "In this industry, you never know who is trying to pull one over on you."
Star's decline
One established master distributor, Star Telecom Network Inc., was brought down through its relationship with Enhanced Global Converged Systems (EGCS), which was a wholly owned subsidiary of TECNET. When TECNET filed for bankruptcy, Star at first believed it could survive by paying the carrier bills directly to the courts, which it did, according to an ICN interview (July 2004) with David Eisenstadt, CEO of Star. The company knew the important thing was to keep the brand alive for its distributors and customers on the street. During that interview, Eisenstadt reported that he had just barely saved his company and had switched its minutes to a more stable Global Crossing.
Yet somewhere during the switch, something went wrong because Star filed for bankruptcy on July 14. Repeated calls to Star's Woodland Hills' office yielded endless ringing without voice mail available to leave a message.
Star's story is especially surprising as the company has been around since 1995, and Eisenstadt had a good reputation as an established master distributor. According to observers, one thing that Star clearly got wrong along the way was not checking the financials of a provider before jumping into a deal.
Speaking generally about the business of telecom, Rubenstein cautions, "Pay attention to who the network service provider is. Check its books. See if they really have any money or if they have contingent liability accounts."
Placing trust too easily in partner companies can be a problem in the telecom industry as a whole, says Rubenstein. "Our company has narrowed down to using one carrier. We've thoroughly reviewed its balance sheets. The company is profitable, and it's a diverse company. I have had two (providers) fail over the years, but we have never had a card die."
Remains of the day
While bankruptcy stories are harrowing, they are not necessarily bad news for remaining players. For distributors, there are fewer providers, but those who remain may turn out to be the reliable ones. Charytan says the providers that can survive will gain more market share and build more reliable businesses. "From day one, we have done business in an honorable way. Every time one of these companies leaves the market, we end up gaining market share. There are other companies that remain as well, most notably IDT. They have a very strong presence."
Staying in business requires paying the bills to carriers and distributors alike. It also means having a savvy enough business to tread international terrain. While cellular eats away at the domestic prepaid card industry, cards are still a main source of communication internationally. Among the long list of unsecured creditors in numerous filings are many European telecom carriers including France Telecom and Telenor Global Services of Norway.
"It's easy to run a U.S. phone service," says Charytan. The trick that many companies don't get, he adds, is how to cost effectively and technologically deal with serving different countries with different financial and reporting systems while still maintaining a margin.
"There are a lot of international regulatory issues," Charytan says. "You might be a good marketer, that is, sell cards on the streets with good campaigns, but if your back end is not strong, you won't make it. It's important to run an organization that can manage millions of details effectively.
"When we got into the prepaid market," Charytan continues, "India was selling at 28 cents per minute, and there was no mobile. There was little room to screw it up. Fast forward a couple of years, now you can get it for 6 or 7 cents. Volume has gone up, but you have all these different carriers there. An outsider would not understand that."
Rubenstein agrees that dealing in the international market is hard, but necessary. "The international marketplace is a dangerous game," he says. "Prices from the master carriers change, and cards go upside down overnight."
Atlantic-ACM's Smith agrees with Charytan and Rubenstein. "While prepaid wireless is expanding, prepaid cards will not grow over the next few years," Smith says. "But if prepaid carriers do clever partnerships and consolidate, they can survive and do well in the prepaid market."
Smith also points to the success of IDT and says the company is an example of how to survive in the industry. "IDT continues to grow through internal leveraging of its telecom and distribution networks combined with opportunistic external purchases," she says.
However, if consolidation is inevitable, those companies that will either buy or be bought will have to stabilize now, avoiding the pitfalls along the way.
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