Shareholders Approve Deal, City Opposition Withdrawn

Since we last looked at Windstream’s (Nasdaq:WIN) pending $2.3b PAETEC acquisition on TDA, the deal has received key regulatory approvals, and Windstream has navigated some key opposition to the purchase, keeping it on track for its late 4Q11/early 1Q12 close.

In late August, PAETEC announced that it had received notice from the Federal Trade Commission of early termination of the waiting period for its merger. And on October 30th, PAETEC shareholders voted overwhelmingly (99% approval of voters present) to approve the deal, through which PAETEC stockholders will receive 0.460 shares of Windstream common stock for each share of PAETEC common stock.

While Windstream sailed through the FTC and PAETEC shareholder approvals, garnering support from PAETEC’s hometown, Rochester, NY, and New York state proved more difficult (and costly). On September 29th, the city decided to wage war with Windstream, filing its formal opposition to the PAETEC deal with the FCC. The subject of the complaint: concern that Windstream would renege on a PAETEC commitment to relocate its headquarters to downtown Rochester.

This past January, Arunas Chesonis, ceo of PAETEC, along with then mayor of Rochester, Robert Duffy, signed an agreement that would see PAETEC construct its corporate headquarters in downtown Rochester, creating what would be the flagship building in the city’s redevelopment. In what was dubbed “The PAETEC Project,” Rochester invested $60m of state and city funds to create a shovel-ready building site for PAETEC. In return, PAETEC's commitment was to construct a new building, to move existing jobs downtown, and to occupy the 225 square foot facility for 20 years. To fund the construction, PAETEC committed to obtain $34m in loans and use $5m of its own equity.

When Windstream announced its merger with PAETEC in August, the initial reaction in Rochester was that “The PAETEC Project” was dead before it even started. After Chesonis confirmed that 800 Rochester-area workers would lose their jobs post-merge, it became even more evident that Windstream didn’t plan to make good on PAETEC’s commitment. As job threats loomed, animosity towards the deal built.

The city filed its comments with the FCC and the New York public service commission, arguing the deal would adversely impact Rochester residents. US Senator Charles Schumer joined the city, putting pressure on Windstream to honor PAETEC’s commitment. Initially, Windstream and PAETEC fired back at city and state’s criticism, filing a joint response to the FCC.  The pair argued that concerns about the city and job losses were not within the FCC’s power to review, and that efficiencies (job losses) are created in every merger and couldn’t be used to block the deal. Political pressure however mounted, and Windstream decided to compromise.

At a press conference Monday, Windstream ceo Jeff Gardner announced that the company will move 335 employees to downtown Rochester. It will occupy 67k square feet of office space under a 15-year lease with annual payments around $1.2m, compared to the initial PAETEC agreement of a 225k square foot building and a 20-year lease.  

The city subsequently withdrew its complaints from the FCC and New York Public Service Commission. While Gardner maintains that the agreement to stay in Rochester was not a political move, the lease agreement included a stipulation that the city withdraw its complaints and support Windstream’s efforts to get regulatory approval. The New York Public Service commission is set to weigh in on the deal during its session on November 17th.

With the end of the regulatory hurdles in sight, the real work for Gardner and Windstream is set to begin after the deal’s close. Both Windstream and PAETEC turned in lackluster 3Q11 results, and Windstream has set aggressive cost synergy targets following the deals close—$50m in the first year and $100m per year after three years.

PAETEC reported a loss of $17.1m in 3Q11, on revenues of $536.3m. While its revenue was up 31% YoY in 3Q11, the gains were due to its acquisition of Cavalier Telephone. PAETEC, like Windstream, has generated top line growth through M&A in recent years, but the company has been in the red since 2007. In that time frame, PAETEC has spent $2.65b on its six acquisitions, but the deals have not benefited PAETEC’s bottom line.

We recently reviewed Windstream’s 3Q11 results in Phone Numbers, and the story once again was: where’s the growth?  Pro forma revenue was down at Windstream YoY in 3Q11 to $1.02b, as earnings and operating margins dropped as well. Acquisition and merger related costs, not cost synergies appear to be having the largest impact on Windstream’s earnings.

The struggle and compromise between the city of Rochester and Windstream reveals just how difficult (and ugly) a road Windstream has ahead of it in order to meet the $100m cost savings it projects. Windstream is set to invest around $18m into the Rochester development, and take on around $1.2m in annual lease payments—costs it had not factored in when projecting the PAETEC deal’s synergies. And while the city’s opposition to the deal was ultimately withdrawn, the root of the city’s complaint and the main driver of the deal’s synergies— the loss of 800+ jobs at PAETEC—is still likely to occur.