Entries in ILEC Deals (8)


2011 ILEC Deals Few and Far Between: Has the Ship Sailed? 

Will a Little Regulatory Certainty Kick-start this Tepid Market in 2012?

Despite fervent deal activity in most telecom sectors in 2011, ILEC deals were incredibly slim. Sixteen deals were announced in 2010, but JSI Capital Advisors only tracked 6 new deals in 2011—plus one more that didn’t quite make it to the finish line. Although there could be a variety of reasons why ILEC deals were so few and far between in 2011, the single most likely culprit is regulatory uncertainty surrounding USF and ICC. The question is:  did small ILECs miss the boat on a good deal before USF/ICC took a dark turn, or will there be a revitalization of ILEC deals once the fog clears and companies (hopefully) have a somewhat brighter future?

Of the 6 small ILEC deals in 2011, less than half were RLECs buying other RLECs, one involved an RLEC buying a telecom utility, and two involved investment firms on one side or another:


2011 was not the first year for a decrease in ILEC deals, but definitely the first year for such a steep decline- JSI Capital Advisors reported 16 deals in 2010, 18 deals in 2009, 19 in 2008 and 20 in 2007 (The Deal Advisor: ILEC Sales Closing in 2010 Approach $10b). Many of you may remember “The Great Dallas Debate” at the 2011 NTCA annual meeting where National Broadband Plan director and Aspen Institute fellow Blair Levin faced off against RLEC duo Randy Houdek (Venture Communications Cooperative) and Delbert Wilson (Hill County Telephone Cooperative). This debate became notorious for a lot of things, but Levin did make one point that even the most dedicated RLEC advocate would have a hard time denying—the “deal” that the rural industry could have gotten with USF/ICC reform a few years ago would have been relatively better than the deal they got in 2011, and the deal we ended up with in 2011 is probably better than the one we would get in the future. Can the same logic be applied to ILEC mergers and acquisitions?

If so, can we expect less than 6 small ILEC deals in 2012? It may depend on how the USF/ICC changes impact the value of these companies. Even though the sheer fact that USF/ICC reform has technically been achieved (assuming the pending appeals cases don’t change anything significantly), it sure doesn’t seem like there is a whole lot of “regulatory certainty”—at least not the level of certainty that could help increase valuations and make RLECs attractive to buyers as they were back in the day. An industry that was once considered safe, profitable and solid as a rock is starting to look like anything but when you factor in the regression analysis-induced “race to the middle,” reduced access revenue, declining landline connections and myriad competitive forces.

A couple of 2011 deals, like La Motte Telephone purchasing Andrew Telephone (both in Iowa) and Otelco acquiring Vermont-based Shoreham Telephone Company were fairly straightforward examples of convenient deals that would boost the buyer’s footprint and create various operating and strategic synergies. Interestingly the Otelco-Shoreham deal reflects the issue mentioned above—that RLECs have possibly missed the boat on a good deal—as Shoreham was reportedly offered three times more from a prospective buyer in 2003 than what Otelco offered in 2011 (The Deal Advisor: Otelco to Acquire Shoreham Telephone for $4.5m).

Also interesting is that the FCC has made no effort to hide its desires that small RLECs merge—consolidated switching is strongly recommended in the ICC section of the Order. The FCC may not have considered that its very own actions on USF/ICC are prohibiting a vibrant market for high-value small rural telephone company deals, but there are more factors to consider than just regulatory uncertainty. The almost-merger between small Minnesota RLECs Farmers Mutual Telephone Company and Federated Telephone Company illustrates this point quite effectively. It was the members of one of the cooperatives who killed a deal that (on paper at least) appeared to be a perfect match (The Deal Advisor: Farmers Mutual Fails to Approve Merger with Federated Tel.).

Is there any optimism for an upswing in ILEC deals in 2012? If prospective buyers are willing to accept the regulatory risks and if ILECs can figure out how to build value in this environment, then it is certainly possible. But will we look back at the 6 deals of 2011 as an unusually low outlier simply because of the year’s heightened regulatory uncertainty, or are single-digit deals the new norm?


Warwick Valley Acquisition Expands Web-Based Services

Alteva Sells for 3.1x Revenue

Recently I wrote a piece for The Deal Advisor detailing M&A activity in the cloud. June was a busy month for cloud-based acquisitions, and thus far two ILECs have carried that momentum into July.  Last Thursday, Warwick Valley Telephone Company (Nasdaq:WWVY) announced it will acquire Philadelphia-based Unified Communications provider Alteva for $11m cash, $4m common stock, and $2m in performance-based payments; this news came on the heels of TDS' announced plan to buy OneNeck IT Services. Warwick Valley says the Alteva acquisition is an important part of its CLEC expansion strategy, and compliments its US Datanet business which it acquired in 2009.

Alteva started up in 1996 as a tech consulting firm with two people and later began offering managed services for Microsoft products. In 2003, Alteva launched its hosted VoIP services business and today is North America's largest enterprise provider of hosted VoIP. Its hosted VoIP services are similar to those provided by US Datanet, and both target the same small business and enterprise markets.

Given the strong performance of US Datanet relative to its ILEC segment, WVT’s strategy to expand its web-based communications and business customer base comes as no surprise. US Datanet has grown its VoIP customer base 32% annually for the past two years, and its wholesale and conference service revenues were up 81%.  

Growth from US Datanet, while strong, has not made up for the declines at Warwick Valley’s ILEC segment, leading WVT to grow its CLEC business through acquisition.  “Organic CLEC revenue growth is just not sufficient to replace ILEC revenue loss,” stated Duane Albro, WVT president and ceo.  In addition to the revenue that Alteva will provide, Albro added that “the anticipated synergies and complementary attributes of the combined CLEC businesses (US Datanet and Alteva) will provide cost saving and operational benefits.”

Time will tell exactly how much incremental revenue and cost savings Alteva will generate. Given that it was a private company, there is no public record of its revenues. Albro however provided a glimpse at Alteva’s past performance, allowing us to make some future projections. 

First, we know that Alteva was purchased for $17m in cash and stock.  Albro during the conference call offered that Alteva was acquired at 3.1x revenue, and that he expected revenue growth to drive the run-rate multiple much lower.  A deal at 3.1x implies TTM revenue for Alteva at $5.5m. Albro went on to note that Alteva has grown its top line 60% annually since 2008. If business grows at a similar rate in 2011, estimated revenue may come in at near $9m, implying a run-rate multiple of 1.9x revenue.

Given Alteva's growth profile, the price tag of the deal seems very low. Although the TDS purchase of OneNeck came in lower at 2.6x 2010 revenue, its projected 2011 revenue multiple of 2.2x is higher than the possible 1.9x in the Alteva deal. Granted the companies are not perfect comparisons, but both offer managed cloud services to business customers. 

Overall, WVT stated that the acquisition will increase its annual consolidated revenue by 30%, to around $32m.  While these revenue projections are healthy, some perspective on the company’s current financial position and the overall impact of its cloud strategy to date is of value.

Warwick Valley's operating revenues have suffered despite the 2009 US Datanet purchase. WVT’s ILEC and CLEC segments operated at combined losses of $4.7m in 2009, and $8.7m in 2010. Purchasing Alteva will aid WVT’s financial position, but will not cure all that ails it.

After buying US Datanet in 2009, WVT called it “a step in the execution of our business beyond our regulated franchise area.”  The purchase of Alteva marks a bigger step in the same direction, as Warwick Valley increasingly targets business customers with cloud-based communications services. Past performance and revenue estimates suggest that Alteva will help fight help the tide of ILEC revenue losses, but the verdict is still out on WVT's growth strategy.


United Telephone Sold for More than 4x Revenue!

Clearly Investors Gene Johnson and Partners See Upside

About a week ago I published an analysis estimating the value of the United Telephone Company sale to MSEquity Partners. It was admittedly based on a lot of assumptions, but I felt the rationale was sound. As it turns out most of my assumptions weren’t far off, EXCEPT I dramatically overestimated annual sales for the company by adding $5.5m in USF receipts to my $12m base revenue estimate. The $12m figure was based on monthly ARPU of $80 per access line, which in turn was based on our annual study of monthly revenue per unit for all of the public ILECs (as well as wireless and cable providers). I also ran the numbers using ARPU of $100 and $120 per month per access line. Based on recent deal multiples in the 2x revenue range, I figured the deal to be worth between $30m and $50m.

Well, the good thing about sticking your neck out is that it invites those in the know to react and point out your errors! A little birdy has since shared some additional information on the deal with me, and it turns out that the implications are (potentially) very bullish for ILECs. Either that, or very bad for MSEquity Partners…

Here’s what I’ve heard.  The price is actually near the top end of my estimated range, so let’s call it $49m.  But adding the substantial USF income to my base revenue estimate was a mistake—the trailing revenue is pretty close to the $12m figure I got using $80 per line per month.

That’s right—United Telephone Company sold to a newly formed investment vehicle for telco industry veterans Gene Johnson and William Bradford for (drumroll please) 4.1x revenue!  That’s twice the level of recent deal multiples; in fact—I checked our historical deal database—the last time we analyzed an ILEC deal that commanded more than 4x revenue was in 2003, before that pesky trend called ‘cord-cutting’ really gained traction.

That makes the value per access line nearly $4,000—and rising based on recent trends.  If you assume (there I go again) that broadband penetration is around 40% of access lines, there would be another 5m broadband connections and an implied deal value of $2,800 per connection.  At broadband penetration of 30% or 50%, the implied deal value per connection ranges from $3,000 down to $2,600.  

WOW! is right! So what are Johnson and Bradford thinking? We know from the filing with the Tennessee PUC that the buyers are eager to close the deal sooner rather than later (by September 1), and that they intend to immediately begin work on upgrades and "additional market opportunities."

But MSEquity will have to buy an awful lot of exchanges to make the economics appear attractive to me. Given that revenue is $12m, and $5.5m or so comes from USF (for now!), that implies just $6.5m in customer revenue--about $43 per access line per month.  Maybe that broadband penetration is well below my estimate...

Nevertheless, I still believe the move on the part of experienced industry players should be taken as a net positive. Only time will tell if it works out to be a positive for the buyers.


United Telephone Co Selling to Johnson-Backed Investment Group

Gene Johnson and William Bradford Pony Up North of $30m for Tennessee RLEC 

These are challenging times for rural LECs, made even more so by the uncertainty surrounding Universal Service Reform…as a result, M&A activity for smaller telcos has been spotty this year.  But like the maverick that he is, industry long-timer “Green” Gene Johnson is bucking the trend and getting back in the saddle.

Johnson, along with fellow FairPoint alum William Bradford, has joined forces with private investment firm MSouth Equity Partners to create a new company, dubbed United Communications Holdings (UCH), which agreed earlier this year to acquire central Tennessee-based United Telephone Company (UTC), as well as UTC’s long distance arm.  Terms of the deal were not disclosed, but I’ve had so little opportunity this year to crunch numbers on ILEC deals, I decided to get creative and do some guesstimating…more on that below.

First, let’s review recent ILEC deal activity. Of course, CenturyLink’s (NYSE:CTL) buy of Qwest, which closed earlier this year, was the big headline for the past twelve months, but what about RLECs?  We’ve seen a handful of transactions between neighboring RLECS, and in the one recent deal where pricing was announced, Otelco (Nasdaq:OTT) picked up Shoreham Telephone Company for about 1.9x revenue. That’s also the multiple CenturyLink paid for Qwest.  Most of the deals listed below, however, involved small or mid-sized companies looking to spread their overheads across a broader base—Ace Communications' buy of Peninsula Telephone or North State’s buy of Timberline Telecom, for example. We don't have any solid pricing data for these deals, but I fear many may have closed at multiples below those we've seen announced publicly.

But in the case of the UTC deal, we see a group of savvy investors starting from scratch and acquiring a rural LEC whose access line count has fallen dramatically over the past several years.  As recently as year-end 2009, public documents indicate that UTC had more than 14,000 access lines, but in its transfer filing with the Tennessee PUC the count was put at 12,500, implying a double-digit percentage loss. Based on our annual Phone Lines survey, most rural telcos are losing lines at about half that rate or even less. UTC offers DSL service within its exchanges but it does not have a video offering at this time, though I’ve heard that an IPTV effort was undertaken a few years ago and failed.

So where did the price come in on the UTC deal?  It’s tough to say but my analysis indicates that at least $30m was spent, possibly as much as $50m.  Here’s my logic: 

First, we did a study just last month that calculated the average monthly revenue per connection for all of the public ILECs.  UTC hasn’t disclosed the number of high speed Internet customers it serves, only access lines, so I used  the data from our study to back into an average total monthly revenue figure per access line.  I excluded wireless revenue and connections from the calculation where the ILEC has wireless operations.  The public companies generated anywhere from $75 - $130 per access line per month, with the mean and median value coming in just under $100.  For simplicity I used $80, $100 and $120 to estimate total UTC customer revenue of between $12m and $18m.

Next, I looked at USF receipts. Based on a recent report, it looked like UTC received around $5.7m in high cost support last year.  I added $5.5m into my calculations, which indicates total company intake of between $17.5m and $23.5m.

Now, both recent comparable deals which I have multiples for came in at 1.9x revenue, though as I mentioned, some of the unpriced transactions in our database may well have been done at lower levels.  Nevertheless, I estimated the deal multiple to be between 1.8x and 2.2x revenue.  The resulting hypothetical value matrix is shown below.

In its filing, the buyer requested that approval be granted in time to close the deal by September 1, 2011, to “ensure that UTC will be able to implement its plans to improve the telecommunications services that United offers to its customers.”  It also indicated that it will keep UTC’s current workforce of 44 employees and maintain its office in Chapel Hill.

The filing also makes it clear that Green Gene et al plan to invest substantively in the properties:  “The Transaction will provide United with greater financial flexibility, access to capital, and enhanced management expertise that will add long-term value to the company and the communities United serves.  The Transaction also provides United with greater financial flexibility to capitalize on marketplace opportunities, diversify revenues and expand services and networks that will also add long-term value to the communities United serves.”

"Marketplace opportunities"? Hmmm. Is Johnson gearing up to create the next FairPoint via acquisition and consolidation?  About ten years ago his activities, under the name MJD, gave us lots of fodder for our newsletter...hopefully another run is on the way.  Certainly the deal provides a  bullish sign for the industry in general...Green Gene coulda just put his money in LinkedIn stock and called it good!

UTC has ILEC operations in Bedford, Coffee, Davidson, Franklin, Marshall, Maury, Rutherford and Williamson counties, in central Tennesse.  Its eight exchanges are all served by digital switches and interconnected by over 400 miles of fiber optic cables.  Along with Johnson and Bradford, Mark L. Feidler of MSouth Equity Partners is also a principal in the newly formed acquiring company.


CenturyLink Completes Merger with Qwest

Combined Company is Third Largest ILEC

On April 1, 2011 CenturyLink (NYSE:CTL) and Qwest (NYSE:Q) completed their merger.  The deal, which we valued at $22.3b back when it was first announced, is the largest ILEC deal since AT&T bought Bell South for $54b in 2006. In the year since the deal was announced, although the companies did agree to a number of concessions with federal and state regulators, as well as competitive LECs who were initially opposed to the deal, overall the transaction faced much less scrutiny than Frontier’s acquisition of lines from Verizon.  The combined company will provide a range of communications services to consumers and small businesses across its 37 state service area, and to business, wholesale and government customers via its nationwide 190,000 route mile fiber network.  During 4Q10 the two companies combined served 15.4 million wireline voice connections, down from 17.3 million during 4Q09.  But, access line losses are par for the course for ILECs these days; the key to success might just be targeting small and medium sized businesses with services provided over the fiber network.

Under the terms of the deal, Qwest shareholders will receive 0.1664 shares of CenturyLink stock for each share of Qwest stock they own at closing, plus cash paid in lieu of fractional shares.  Pro forma combined revenues for 2010 were $18.6b, adjusted EBITDA was $8.1b and adjusted free cash flow was $3.1b.  CenturyLink is anticipating $625m in synergies, though it is expected to take 3 to 5 years to realize those synergies.

As we noted when the deal was first announced, deal multiples “reflect a buyer’s outlook for a company’s growth prospects, and despite the economies of scale one always anticipates in a large merger, the fact remains that the ILEC business is a mature, some say declining, business.”  We calculated the multiples at 1.9x revenue, 5.0x OIBDA and $1,782 per connection; the multiples are generally in the range of what we’ve seen since the Great Recession.  One fear some investors have mentioned: CenturyLink is assuming a substantial amount of Qwest debt— $12b as of 4Q10—which will bring total long-term debt of the combined company to more than $19b.

The increased scale of the combined company should enable it to compete against larger AT&T and Verizon, but those companies have both looked to shed traditional access lines recently.  By combining CenturyLink and Qwest, Glen Post has succeeded in creating a larger “melting ice cube.”  He now faces the challenge of finding revenue sources to replace revenue lost to declining access lines.