Earthlink on Monday said that it is acquiring regional competitive local exchange carrier (CLEC) One Communications for $85m in cash or stock, plus the assumption of $285m in debt. The deal is Earthlink’s second telecom play of the year, and from our view, it looks like the beginning of a strategy that’s already playing out at Windstream Communications.
The One Communications announcement came just three weeks after Earthlink closed the purchase of southeastern US CLEC ITC Deltacom. Both One Communications and ITC Deltacom are fairly large, as regional CLECs go. ITC Deltacom generated $451m in revenue in the four quarters before its sale, and we understand that One Communications came in at $575m in trailing sales. However, both companies’ sales were declining, and we suspect that the deals were primarily done to build out Earthlink’s facilities-based presence and lay the ground for an eventual hosting play.
If that’s correct, then the ISP will be setting itself on a similar track to the one laid by Windstream Communications. The Little Rock, Arkansas-based company picked up six telecom service providers before announcing last month that it was buying hosting provider Hosted Solutions. At least three other telcos have scooped up hosting companies just in the past two months. The reason for the shopping spree is pretty simple if we consider the relative growth rates of the two sectors: While the core telecom market continues to decline, hosters are putting up fairly solid growth – and that should continue. In their 2010 ‘Multi-Tenant Datacenter North American Market Overview’, our colleagues at Tier1 Research project that the sector’s total North American revenue will hit $11.1bn in 2013, up from an estimated $6.8bn this year.
Select recent telecom-hosting transactions
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Source: The 451 M&A KnowledgeBase
]]>As the retail wireline communications industry loses steam, valuations for competitive local exchange carriers (CLECs) have flatlined. Regardless of whether or not the firms were growing their bottom line, CLECs are being sold at just north of one times trailing revenue. We don’t see much that would change this metric.
EarthLink’s recent purchase of ITC DeltaCom is the third instance in the past year in which a regional CLEC was acquired by a larger provider. The deal was announced shortly after PAETEC picked up Cavalier Telephone and just under a year after Windstream Communications bought NuVox Communications. Of these three providers, we believe only NuVox was growing its revenue, while Cavalier was experiencing losses and ITC DeltaCom was lying stagnant.
Yet all three firms were valued nearly the same. EarthLink’s offer for ITC DeltaCom values the Huntsville, Alabama-based company at just 1.1x trailing sales, including debt, while both Cavalier and NuVox went for 1.2x. (As a side note, we would add that both Cavalier and NuVox were owned by M/C Venture Partners.)
We wouldn’t be surprised to see other similarly sized CLECs – such as Cbeyond, TelePacific Communications or Integra Telecom – fetch roughly the same valuation in any sale. For example, take Cbeyond, which is similar in size to ITC DeltaCom. The firm is currently priced at 0.9x trailing sales, nearly mirroring the 0.8x valuation ITC DeltaCom had in the day before EarthLink announced that it was buying the company.
Recent CLEC valuations
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Source: The 451 M&A KnowledgeBase *451 Group estimate
]]>Subscriber count at the legacy AOL division fell to 8.1 million subscribers from 10.9 million a year ago. This continues the trend of a year-over-year decline of an average 20-25% since 2003. For the first time in AOL’s history, revenue from advertising tops revenue from its subscription business ($530m and $491m, respectively). Operating income for the AOL division is $230m, one-third of which we estimate comes from subscriptions. This is in contrast to Earthlink (ELNK), which has seen its operating income steadily increase quarter-over-quarter for the past year. EarthLink’s operating income from its most recent quarter was $64m, despite having only 3.3 million subscribers. Clearly, AOL is failing to properly make money from its subscribers. We suggest the company turn the business over to someone who can do that as soon as possible.
Fortunately, there appears to be a suitor for the AOL legacy business. EarthLink CEO Rolla Huff has said he’s ready to discuss a deal. Time Warner should take him up on that immediately. If AOL’s subscriber base continues to decline (and there is no reason to believe it won’t), by the time Bewkes is ready to negotiate a sale, it will be in the six million range. Our advice to Bewkes: Put together a deal book on AOL and get out of the subscription business while you can.
AOL ISP divestitures
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Source: The 451 M&A KnowledgeBase
]]>In April we speculated that AOL (TWC) might be close to shedding its legacy ISP access business. We pegged the most likely acquirer as Earthlink (ELNK). In an earnings conference call this week, Earthlink CEO Rolla Huff echoed that sentiment, stating that he was bullish about combining its business with the AOL division.
Of course, interest from one party does not a deal make. But, given AOL’s burning desire to shed this dinosaur and completely rid itself of its ancient and tumultuous past, it is safe to assume that if the two parties can agree on terms, a deal might just materialize. The real question is how struggling Earthlink can come up with the estimated $1.5bn-$2.5bn it would take to acquire the AOL unit and its roughly nine million subscribers. Since Earthlink is one of few companies able and willing to make that acquisition, AOL does not exactly hold a lot of bargaining power. We think Earthlink might just get this at a bargain basement valuation closer to $1.5bn, just two times AOL’s cash flow from its ISP division.
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