AboveNet deal could buoy Louisville's Zayo to leadership position
Apr 15, 2012 (Daily Camera - McClatchy-Tribune Information Services via COMTEX) --
Since its founding in 2006, Louisville's Zayo Group LLC has made a business out of collecting fiber-optic, colocation and telecommunications providers and building up a nationwide infrastructure for bandwidth.
Minding a pace of roughly five acquisitions per year -- and raising more than $1 billion in equity and debt in the process -- Zayo quietly ratcheted up to more than $287 million in revenue for its last fiscal year, which ended on June 30, 2011.
By the end of 2011, Zayo had acquired 18 companies.
But it's the company's 19th purchase that could be the biggest game-changer.
Last month, Zayo announced it reached an agreement to buy AboveNet Inc. -- a larger and publicly traded competitor -- for $2.2 billion.
If the deal closes as projected, the move would vault Zayo to a leadership position in the telecom business alongside such players as tw telecom, Level 3, CenturyLink, AT&T and Verizon.
"Zayo could be one of the Top 5 (telecom) companies in the U.S.," said Chris Larsen, a Piper Jaffray analyst who covers AboveNet. "(Zayo) has gone from being the small little guys that nobody ever heard of to, 'Hey, listen to us.'"
Zayo's climb also is occurring at a very opportune time, say Larsen and other analysts, who note how the seemingly boundless demands for bandwidth have put the industry on an unprecedented growth spurt.
"If the last three years are any indication, the ceiling seems much higher than we already are," Larsen said of the industry.
Zayo officials say the broader trends combined with the competitive positioning gained as a result of combining with AboveNet put the local firm on solid footing to become a long-term player. However, for that to come true, analysts and others caution that Zayo will need both continue to diversify its customer base and be extremely mindful of its debt load.
"As Zayo diversifies to address other customer sets, they'll have to work on both developing their sales force
more and making sure that their provisioning system is equipped to handle a lot of smaller orders," said Donna Jaegers, a Denver-based senior research analyst for D.A. Davidson & Co.
The March 19 announcement that the privately held Zayo reached an agreement to acquire AboveNet -- a White Plains, N.Y.-based firm with nearly double the revenue of its suitor -- for $2.2 billion came as a surprise to Larsen, Jaegers and other analysts.
Some also speculated that Zayo's offer could be at risk of another firm sweeping in with a competing bid before the end of the 30-day "go-shop" provision.
Earlier this month and less than two weeks before Tuesday's go-shop deadline, Zayo's executive team spoke with cautious confidence about the transaction that could result in a firm with about $850 million in revenue. The concerns, no matter how slight, were enough to cause sleepless nights, Zayo CEO Dan Caruso said.
However, Zayo's financial backing and its history of acquisition and integration were enough to keep Caruso and his team laser-focused on the future, he said.
"You'll end with an extraordinarily unique fiber footprint across the U.S.," Caruso said of AboveNet and Zayo's combination.
AboveNet's fiber network includes thick webs in hubs such as New York, Chicago, San Francisco, Los Angeles and Dallas, and stretches into markets in Europe and Canada, he said. The companies will have a combined 8,000 buildings, with an overlap of only 150, said Glenn Russo, Zayo's executive vice president of corporate strategy and development.
In a March 19 research note to investors, Raymond James analyst Frank G. Louthan IV projected the two firms would be able to "realize a significant amount of synergies" based on overlapping assets as well as management overhead.
The assets and their revenue-generating potential could put Zayo in a solid position for the future, say Caruso, Russo and CFO Ken desGarennes -- but the three men also say the know it's critical for them to remain focused and not stray too far from the company's core competencies.
"We remind ourselves to not take for granted anything," Caruso said.
They went through the "dark days" of the telecom meltdown and saw the importance of not spreading the business too thin by dipping their toes into telecom sectors other than fiber bandwidth infrastructure, Caruso said.
Adding AboveNet and further exploiting and growing the combined company's holdings will be keys to future success, he said.
"We're likely one of the long-term survivors in the rapidly consolidating industry," he said.
As of late last week, the chances of another AboveNet bidder emerging seemed to have dropped, said D.A. Davidson's Jaegers.
"It's pretty likely that they'll win this ... the fact that no one has stepped up with a bid yet," she said. "One of the likely bidders would've been CenturyLink, but the recent reorganization that they announced sort of shows that CenturyLink probably needs to get a handle on its own enterprise sales efforts first before they muddy the water by making an acquisition in this space."
The AboveNet buy would be a "shrewd move" for Zayo, which would eliminate a main competitor in future efforts to acquire some of the smaller metro fiber providers that potentially are up for grabs, Jaegers said. After the acquisition, Zayo could probably swing back at its leisure and pick up the smaller companies with better prices than if AboveNet were involved in the bidding process, she said.
In addition to the network growth and gains in its competitive position, Zayo also should benefit from adding AboveNet's enterprise customer base, Jaegers said.
"If there's one thing to pick on about Zayo, they didn't have much of an enterprise presence yet," she said. "About 55 (percent) to 60 percent of sales come from the carriers. Since the carriers are bigger and they can sort of beat you down on pricing, it's always good to try to diversify out more to enterprise customers. They don't have as much pricing leverage as the carriers do."
The industry trends also bode well, she added, noting the AboveNet acquisition could give Zayo increased credibility among Wall Street investors if the company does execute an initial public offering in the next year or two.
"Right now, the wind's at their back," she said. "Everybody needs more bandwidth."
That's not to say the waters couldn't grow choppy for Zayo, Jaegers said.
One potential challenge comes from the execution of integrating a higher number of enterprise customers, she said, referencing Broomfield-based Level 3 Communications Inc.
Level 3 stumbled after its acquisition binge of smaller operations from 2005 to 2007 created bottlenecks in its provisioning systems, she said. The woes negatively affected Level 3, which in recent years has gotten on more solid footing after its acquisition of Global Crossing, she added.
"Enterprise (businesses) tend to have a lot more orders, but they have smaller increments of bandwidth," she said. "That's what can easily blow up a provisioning system and did so for Level 3.
"As Zayo diversifies to address other customer sets, they'll have to work on both developing their sales force more and making sure that their provisioning system is equipped to handle a lot of smaller orders."
Another possible negative is that Zayo most likely will have to lever up further, Piper Jaffray's Larsen said.
After the AboveNet announcement, credit rating agency Moody's Investors Service placed Zayo's ratings on review for downgrade. The AboveNet deal would further increase Zayo's execution risk, which was heightened by the $345 million acquisition of 360networks, Moody's officials said.
"The post-merger combined company will have greater scale, broader reach and wider capabilities," Moody's officials said in the announcement. "However, Moody's estimates that leverage will increase by approximately 1.5x (Debt/EBITDA, Moody's adjusted) and the company's transition to positive free cash flow could be delayed beyond the rating horizon."
That "horizon" is in the range of 18 to 24 months.
Additional terms of AboveNet's financing -- including the amount raised from Zayo's investors GTCR and Charlesbank Capital Partners -- have yet to be disclosed, but Jaegers anticipates that probably $1 billion to $1.2 billion can be financed on the balance sheet of AboveNet, which has no debt, Jaegers said.
As of Dec. 31, 2011, Zayo had about $682.7 million in long-term debt, according to Securities and Exchange Commission filings.
Contact Camera Business Writer Alicia Wallace at 303-473-1332 or firstname.lastname@example.org.
Memphis Networx 2007 $9.789 million
PPL Telecom 2007 $56.734 million
Indiana Fiber Works 2007 $23.134 million
Onvoy--2007 $77.167 million
Voicepipe 2007 $3.25 million
Citynet Fiber Networks 2008 $102.183 million
Northwest Telephone 2008 $6.897 million
CenturyTel Tri-State Markets 2008 $2.7 million
Columbia Fiber Solutions 2008 $12.161 million
CityNet Holdings Assets 2008 $3.35 million
Adesta Assets 2008 $6.43 million
Northwest Telephone California 2009 $15,000
FiberNet 2009 $104.083 million
AGL Networks 2010 $73.666 million
Dolphini Assets 2010 $235,000
American Fiber Systems 2010 $114.5 million
360networks 2011 $354 million
MarquisNet 2011 $15.9 million
AboveNet*--2012 $2.2 billion
Arialink*--2012 $18 million
*Spun off in fiscal year 2010
**Acquisitions announced, but not yet closed
Sources: Securities & Exchange Commission filings, Zayo Group
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