PAETEC’s risky business

Contact: Ben Kolada

As the communications industry continues to consolidate and the pool of desirable targets dries up, the remaining buyers appear to be stretching a bit in their M&A moves. But even within that, PAETEC’s recent pickup of Cavalier Telephone looks to us like the riskiest telecom acquisition we’ve seen in the past year. The reason? Roughly three-quarters of Cavalier’s business is outside PAETEC’s focus.

To be fair, other telcos have also made challenging moves. Windstream Communications took big bites in the past 12 months, acquiring four companies that set the telecom provider back $2.7bn. (That figure includes the debt at the acquired companies that Windstream will be taking on.) The vendor’s spree boosts its top line by about 50%, a substantial increase that brings a not-insignificant amount of risk. Even Cablevision Systems, which is typically a stay-at-home company, inked a deal, reaching across the country to pick up Bresnan Communications for about $1.4bn.

However, the deals by Windstream and Cablevision made sense, if just because they expanded on each company’s existing strategy. Not so with PAETEC’s purchase of Cavalier. When we look at the transaction, we suspect that PAETEC was really only interested in Cavalier’s fiber assets. Understandably, the Richmond, Virginia-based competitive local exchange carrier wouldn’t have considered selling its fastest-growing division. Since it was unable to just get the part of Cavalier’s business that it probably wanted, PAETEC was forced to shell out $460m (including assumption of debt) for the whole company.

Cavalier had $390m in sales in the year leading up to the acquisition. However, the company’s fiber division itself generated only about $98m, or 25%, of total revenue. That means that a vast majority (75%) of Cavalier’s business appears to us to be an ungainly match to the business its buyer is in. PAETEC serves enterprises, which generate an average of $2,300 in monthly revenue. On the other hand, the majority of Cavalier’s revenue comes from consumer accounts and small businesses with monthly recurring revenue of only about $500.

Rather than spend to get this odd pairing, we think PAETEC would have been better off buying one of the number of fiber operators looking for a sale. A juicy target would have been Zayo Group. The company is on a $240m run rate for 2010. Based on recent valuations for Zayo’s competitors, we believe it could be had for roughly $500m – only slightly higher than Cavalier’s price tag, but without the unwanted baggage.

Cablevision breaks the mold with Bresnan acquisition

Contact: Ben Kolada

Marking a significant departure from its recent practice, Cablevision Systems said last week that it would hand over almost $1.4bn in cash and stock for Bresnan Communications. The deal by the Dolan gang is their first major telecom acquisition since they picked up a portion of Tele-Communications in 1998. And they certainly paid up for Bresnan.

Cablevision’s offer values Bresnan at about 3.4 times trailing revenue and just over 8x projected 2010 cash flow, according to our understanding. On a per-subscriber basis, the acquirer is paying $4,500 a head. Across the board, that’s a far richer valuation – in some cases, twice as rich – than fellow telco RCN got in its take-private in March. Buyout shop ABRY Partners paid $1.2bn for RCN, or roughly 1.6x trailing revenue (on an enterprise value basis) and $2,800 per subscriber.

Given the size of this deal, along with the fact that Cablevision used equity in the purchase, we don’t expect the Bresnan transaction to signal the beginning of a shopping spree. Indeed, Cablevision executives maintain that they are not looking for additional properties. After all, Cablevision doesn’t need to buy more systems – the Tele-Communications acquisition gave it sufficient economies of scale. The Bresnan buy is simply a rare opportunity to obtain upgraded systems with strong growth potential.

M&A: Cable comparison

Date announced
Acquirer Target Deal value Price-to-sales multiple
March 5, 2010 ABRY Partners RCN $1.2bn 1.6
June 14, 2010 Cablevision Systems Bresnan Communications $1.4bn 3.4*

Source: The 451 M&A KnowledgeBase *451 Group Estimate