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Insights: Big M&A expected among ILECs this year
By Ed Gubbins

Jun 18, 2008 12:00 AM


LAS VEGAS -- Consolidation is inevitable and imminent in the independent telco sector, according to panelists at Telephony’s INSIGHTS event for next-generation ILECs. But although universal forces are driving the trend, differences among the carriers will direct how consolidation takes place.

Facing top-line pressure and access line loss, the largest ILECs are likely to be active acquirers, both of smaller assets and of one another, and major deals are expected this year, speakers agreed.

“Windstream, Embarq, CenturyTel and Citizens need to do something or they’re not going to grow,” said Bill King, president and managing principal of JSI Capital Advisors. They might find small rural telcos relatively easy to scoop up for incremental scale increases, he said, “But they’re going to start running thin on those, and they’re going to start looking at each other.”

Embarq and Windstream’s M&A options have been severely limited thus far by tax restrictions imposed upon their spin-offs from Sprint and Alltel, respectively, that limit the amount of shares they can issue to fund a deal. But Embarq’s restrictions expired last month, and Windstream’s will expire in July. In the second half of the year, said Francis Gallagher Jr., managing director of Stifel Nicolaus, “They’ll be free to use stock as currency. I wouldn’t be surprised to see some larger deals.”

Though small telcos will continue to feel many of the same pressures as larger ones, selling out to acquirers may not be an easy exit for them. “For those with 1,000 or 1,500 access lines, it’s hard to tell them to sell their companies for $4 million or $5 million,” King said. “It doesn’t buy you all that much anymore. By the time you pay the bank off, pay taxes and lose your job, there’s not a lot left. It almost makes more financial sense to drive it into the ground.”

Just as last year’s private-equity purchase of Alltel is this year’s Verizon Wireless purchase of Alltel, acquisitions are now more likely to be driven by carriers rather than the private equity set, Gallagher said, pointing out that the Carlisle Group’s rocky purchase of Hawaiian Telcom has been a cautionary tale for such investors. Though private equity players once held a lot of interest in the ILEC space, he said, “That time has largely come and gone.”

With carriers doing the buying, valuations will likely appear inconsistent across the sector, depending more on the strategic value of a given telco’s physical location in some cases than on the company’s financial health, Gallagher said. “Increasingly, geography is destiny.”

However, different formulae apply to cooperatives, whose members are also its customers. Because their motivations are different (connected largely to the service itself rather than financial returns), they are perhaps least likely to be tempted by buyout offers, panelists said.

“The last customers for co-ops will be the roaches,” King said. “They’ll be around for a long time.”

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