By 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 (PAET) 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 (CVC), 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.