August 14, 2006

US LEC, PAETEC Merger Sheds Light on Today�s CLEC Market

By Robert Liu, TMCnet Executive Editor

While investors may becoming disenchanted with the IPO market as evidenced by last week’s cancellation by high-profile web-hosting provider Go Daddy, a New York-based competitive local exchange carrier (CLEC) has figured out that there’s more than one way to go public.

PAETEC, a privately-held communications solutions provider that filed and then shelved its IPO last year, has entered into a definitive agreement to merge with US LEC, the IP, data and voice solutions provider based in Charlotte, NC, in a deal valued at approximately $1.3 billion, the two companies announced on Monday. The two CLECs will form a new company that retains the PAETEC brand, the Fairport, NY-based headquarters and most of PAETEC’s senior management.

While the deal creates a combined company with a complementary network over a considerable national footprint, it does also highlight the tempestuous nature of today’s telecom market, which has witnessed consolidation at every level (operators, equipment vendors, systems integrators, etc.) of the communications food chain.

“The industry is changing and it’s recreating itself. It’s much different than it was ten years ago,” said Jeff Kagan, notable telecom analyst. “The entire economic model of this business is changing.”

PAETEC filed to raise $150 million in the initial public offering market in April 2005. Based on the mid-point of the offering price range, the company would have been valued with a market capitalization of $428 million. By September though, the CLEC withdrew its registration statement citing “unfavorable market conditions.”

At the same time, US LEC languished along with its peers as a publicly traded telecom company, losing about 50 percent of its value over the course of 2005. On word of the deal, its stock on Monday popped up to a new two-year high, valuing the company now at nearly $160 million. But, due to those valuations, US LEC ended up with only one-third of the newly combined entity while PAETEC owns the remaining 2/3^rd of the new holding company. In the end, PAETEC probably retained a board seat or two by simply not going public.

“The CLECs have been struggling more and more in recent years,” Kagan told TMCnet during a telephone interview. Once pitted only against the regional Bell operating companies (RBOCs), CLECs (like their Baby Bell brethren) also have to deal with cable operators, wireless carriers and VoIP service providers as new competitors.

“The thing that I find interesting is they are mostly a telephone company. It's not a complete bundled service,” Kagan said of the newly combined company.

Despite the lack of revenue synergies, the two companies said they can still expect cost savings as a result of the merger. PAETEC and US LEC expect “highly achievable” cost synergies of $25 million in the first year after closing and $40 million annually beginning in 2008.

“That's why they are doing it. Will that matter in a few years is the question,” Kagan said.

Upon the close of the transaction, PAETEC’s Arunas Chesonis will become Chairman and CEO. Richard Aab will become Vice Chairman. Both Chief Financial Officer Keith Wilson and Chief Operating Officer EJ Butler will retain their respective titles. The combined company will have over 45,000 enterprise customers, consisting of medium and large businesses and institutions. It will operate in 52 of the top 100 Metropolitan Service Areas (MSAs) in the , with a leading presence in the Eastern U.S. , as well as several other major markets across the country.

Deutsche Bank Securities, Merrill Lynch and CIT Group will provide $850 million of debt financing for the transaction. The companies expect that the transaction will close in the fourth quarter of 2006.

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Robert Liu is Executive Editor at TMCnet. Previously, he was Executive Editor at Jupitermedia and has also written for CNN, A&E, Dow Jones and Bloomberg. For more articles, please visit Robert Liu's columnist page.

(source: http://news.tmcnet.com/news/-clec-merger-paetec-uslec-/2006/08/14/1793079.htm)