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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