Industry interest in itcd seems to have spiked lately – two relatively unremarkable bits of news (a refi, and some channel upheaval) have resulted in almost two dozen comments here on this site, and I have seen a marked increase in search queries on the subjects such as ‘delatcom rumors’. Could Deltacom be preparing to sell itself?? Of course it’s not really so simple, the things a company does maximize its potential as an M&A target are so often the things it ought to do anyway to improve its position in the market: improve the balance sheet, clean out the garage, etc. However, I thought I’d summarize in one place the cases for and against Deltacom being a prime takeover candidate, and who might and might not make a move.
While revenues are going nowhere, the company has clearly made steady progress on its margins. Because of their low profile and out-of-fashion business model, it’s often forgotten that Deltacom has higher EBITDA margins now than its fiber-lite brethren PAETEC or CBeyond. However, it’s taken a long time and there is a limit to what can be streamlined, and Dave Rusin’s comment “How does this garden grow?” is on target – it just isn’t easy to see where they go from here except sideways.
Assets: 1) a CLEC business selling mostly low speed connectivity and voice products to the SME, and 2) Almost 16,000 miles of longhaul, regional, and metro fiber across the southeastern US, 12,000 of it directly owned, and 3) 263 PoPs and 271 ILEC collocations
Pros for M&A: First, as a regional operator Deltacom simultaneously is neither tightly focused nor do they have extensive reach. They have overall scale in the form of $450M in annual revenue, but insufficient scale per market to actually turn a profit. Strategically they have far more weaknesses as a standalone asset than they do as a complementary asset. Second, Deltacom is inexpensive. Currently, their enterprise value hovers in the $400-450M range, or at an EV/EBITDA multiple around 5 – consistently lagging its peers. It just doesn’t take much in the way of synergies to make the numbers work if the business models mesh sufficiently.
Cons for M&A: As Peter Rad points out, Deltacom’s business is heavily focused on low margin T-1s across its region, a model that is rather out of favor with the market and which doesn’t lend itself much to M&A synergy. While it has some interesting regional fiber assets, its business model is heavily dependent on other people’s fiber and copper which limits the control it or any buyer has over its future. They don’t seem to have as much to gain from explosions in wireless data or over the top video.
Likely suitors: The criteria for likely acquirers are having 1) geographical interest in the southeast, 2) a similar SME-focused CLEC customer base or a desire to have one, and 3) reason to believe they can do better with these assets.
- PAETEC (news, filings) – The geographical overlap gives PAETEC good potential for synergies, and Deltacom’s fiber assets would fit well alongside those from McLeodUSA. They also have a long track record of operating fiber-light assets with more success than most. They have also been a frequent acquirer and seem ready for more if the market will fund it.
- Windstream (NYSE:WIN, news, filings) – Buy buying Nuvox, Windstream clearly signaled their desire to be more than a rural ILEC rollup. Combining those assets with Deltacom’s similar CLEC business and regional fiber network would give that effort substantially more mass throughout the region.
- One Communications – Rumors have them as both a buyer and a seller this year. Some sort of combination with Deltacom would bring complementary footprints together.
- Intellifiber/Cavalier – No, seriously. While they’re probably not actively looking for expansion behind their own footprint, I suspect that Intellifiber would enjoy adding Deltacom’s fiber network to their own, extending its influence to virtually the entire east coast. Similarly, Cavalier has an adjacent CLEC footprint, and buying Deltacom might offer them an intriguing route to expansion. Now, it’s probably not that likely, but I’ve been waiting for Cavalier’s CEO Danny Bottoms to make some more noise and you just never know.
- Zayo – I doubt Zayo would be interested in the CLEC business of course, but I do think they’d jump at the chance to get hold of Deltacom’s underutilized fiber network, which would add a whole region to Zayo’s reach and bring them one step closer to a truly national presence. That assumes the fiber and the CLEC business would be sold separately, but that scenario might be where Deltacom finds maximum value.
Others mentioned to me that aren’t likely to happen:
- TW Telecom (NASDAQ:TWTC, news, filings) – It just doesn’t fit very well. Larissa Herda isn’t likely to have waited so patiently for the right target just to jump at one that makes no sense.
- XO Holdings (news, filings) – Icahn isn’t going to buy anything right now. Even if he wanted to, with the legal fight with R2, the required ownership levels for his access to the NOLs, and the preferred refinancing looming large, funding any purchase would be much, much too messy.
- Any Cable MSO – Purchases of CLEC assets are likely to be focused on particular markets in which they have a major residential presence, Deltacom is too widely dispersed to fit any of their needs.
- Level 3 Communications (NYSE:LVLT, news, filings) – Such a purchase wouldn’t solve any problems for them but would probably create whole new ones. It just doesn’t fit; if Level 3 makes a move, it will be a big, transformative one – e.g. a Global Crossing or Sprint wireline, or a highly focused one for particular assets or technology. Nothing in between makes sense for them.
Summary: It’s cheap and it’s not likely to bloom soon without a big change of scenery. But they are cheap because their customer base is not highly prized, which will obviously limit enthusiasm. They do seem like one of the most available assets on the market this year.
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Doing a bond deal wouldn’t make any sense if you’re planning to sell. The tender premium would be huge — $40mm plus.
$40M? That seems like a large number, where did it come from?
Bonds are non-callable for at least the first half of the term of the notes. To take them out you have to pay the bondholders a tender premium equal the dcf of the foregone cash flows. $40mm is back of the envelope — if treasuries increased, the number could be smaller, though. The point is that if you were going to sell, you would keep the current deal, which isn’t due until ’12 or ’13 in place, b/c it is redeemable at par.
I understand the concept, but in this case I think you are incorrect. The debt Deltacom is refinancing is primarily the first lien credit facility, not actually bonds. And according to the most recent 10-K at http://sec.gov/Archives/edgar/data/1041954/000119312509055457/d10k.htm on page 54 :
“We may prepay borrowings outstanding under the first lien credit facility without premium or penalty.”
And most of the rest is the second lien credit facility for which they say
“Prepayment of borrowings outstanding under this facility before July 31, 2009 will require payment of a premium of approximately $750,000 if the borrowings are prepaid before July 31, 2009.”
They are currently on a road show trying to issue some bonds to refi the existing facility.
My point is that they wouldn’t be replacing the credit facility you’re talking about (which is prepayable), with non-callable debt (which is what they’re trying to sell.)
Ah, it seemed as if you were saying that they were paying a major premium for the refi, but what you meant was that a buyer wouldn’t be able to call the bonds…
I would respond that a buyer is not forced to call the bonds, and most of the likely buyers in fact would be happy to leave them as is and thus wouldn’t have to pay the premium.
But for Deltacom itself, the argument that they would refi first in order to eliminate those financial covenants and begin any negotiations from a position of strength would seem more important to them.
Since when is the T-1 business low margin?… Not fiber margins, but decent nonetheless. When you can lease DS1 UNE in the former Bell South territory for ~$60-$80, the margin is quite nice actually.
EBITDA margins of 25-30% are possible under the “smart-build” model. It just takes a highly efficient organziation to accomplish it (which there are very few of currently).
My vote is that PAETEC or Winstream as far as a suitor. Delta will have to sell eventually, but it might not come until later this year or 2011. PAETEC’s stock is too low to use as currency right now.
Look at Delta’s EBITDA margin and growth — going no where. Even PAET is capped by the ILEC – the ILEC controls your cost while driving a price squeeze whenever they wish … to much uncertainty with renting from the ILEC.
Look at fiber margins … 70-75% gross, EBITDA 40% and climbing … AboveNet — I put them at a buy … watch how they will keep growing … it’s about profits, margin growth and customer quality/loyalty (churn) not just the top line.
A lot of top line driven companies in the low end space went BK circa 2001-2003 … something like 700 of them Chapter 7, 11 and some Chapter 22…
Could a Integra/Deltacom combo be on the horizon. They seem to have a powerful player in common who has been making a few moves.
Last week, ITC^DeltaCom, Inc. announced that it has received a commitment from Tennenbaum Capital Partners, LLC for $239 million in debt financing split between a four-year, $209 million senior secured term loan and a $30 million “subordinated secured” term loan, according to the company
To help fix Integra’s balance sheet, Tennenbaum Capital and two other debt holders converted their financing into a combined 71 percent equity stake. Tennenbaum Capital’s $69 million holding was turned into a 21.9 percent stake
Tennenbaum also purchased Deltacom stock approx. 20 times during the last year in accumulating 13.5 million in common stock.
Hmmm, the problems I see with that combination are 1) they are not even adjacent geographically which limits potential synergies, and 2) neither seems to have the firepower at the moment.
However… Another possibility that just occurred to me is Kentucky Datalink (KDL) which actually might work strategically.
There is always overhead synergies for corporate and admin functions.
Most companies are seeing organic bandwidth growth that outstrips the T1/IAD play … I don’t see them for sale – they need to move upstream to improve margins …
i dont understand why anyone would buy a reseller of ILEC circuits… this strikes me, at best, as paying up for a “distributorship” (other people own the revenue producing assets) and at worse as paying for a depreciating asset. in 2015, who cares about T-1’s. most residences already have more then 1.5 mbps and if copper plant is favored, xDSL seems a better choice. basically, re-billed “OPC” (other people’s circuits) strikes me as the commercial counterpart to AOL (currently trading at 2.2x trailing ebitda)
Deltacom has been in talks with several buyers for years but intensively for the last 12-16 months. Buying a “distributorship” of T1s makes sense as long as the numbers work- and they do, furthermore that is not by any means the only revenue stream and/or assets one would get out of this deal, the least of which isnt access to a big part of the people on the other side of the digital divide. Also, this company’s facilities would match well with a larger and more advanced ISP that could bring bandwidth into a few key areas, money to extend the pipes further out into their network, data center capacity to run smarter Infra services, and in the end, move T1 customers over to a different, scalable connection seamlessly.
The thousands of little leases in telco closets and building basements that took years to accumulate and manage, in areas where the competition isnt as thick as many areas is pretty valuable as well. Supply and demand would say this is a profitable place, geagraphically, to operate.