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PAETEC and US LEC Bow to the Consolidation Trend, Building a Billion Dollar CLEC| August 15, 2006 | Business Network Services - U.S. | Competitive Intelligence Report Analyst: Brian Washburn
On August 14th PAETEC and US LEC announced their intent to merge, creating a new public company with $1 billion annual revenue, $187 million EBITDA, and $109 million free cash flow. The combined carrier will have 45,000 business customers and a presence in 52 of the top 100 MSAs. US LEC contributes its presence in the mid-Atlantic and southeastern U.S., while PAETEC also has a presence in eastern U.S. markets, plus Chicago and California. The merger is expected to close in Q4 2006. Analytical Summary • Current Perspective: Slightly positive on the merger between PAETEC and US LEC because, unlike many mergers where struggling CLECs combine forces hoping to turn around their fortunes, both CLECs have been financially healthy, expanding, and competitive in the marketplace. The two carriers share high customer loyalty, citing 99.3% monthly retention rates, another factor in their favor. The combined entity also inherits $751 million net debt, which will be a substantial drag on the carrier. • Vendor Importance: Very high to PAETEC and US LEC because the two providers join the consolidation trend to form a more powerful competitor; other top tier CLECs include XO Communications, Time Warner Telecom, and One Communications. The industry's answer to the mega-mergers of AT&T with SBC and Verizon with MCI appears to be to compete via economies of scale. A merger between PAETEC and US LEC brings together CLECs with similar business models and philosophies, which should ease the integration. • Market Impact: High on the market because the combination of PAETEC and US LEC stands to strengthen the geographic hand of both carriers. The combined network will still be a patchwork footprint, but it's one that now covers 25 of the top 50 and 52 of the nation's top 100 metropolitan service areas (MSAs). US LEC will be able to tout itself as a nationwide carrier, while PAETEC stands to gain particularly in the southeastern U.S. and mid-Atlantic states. Recommended Competitor Actions • Competitors that are financially stable can point at the “New PAETEC” with its $751 million in aggregate debt and suggest that it is a CLEC in trouble before it has even left the start gate. These competitors can also suggest that it wasn't a matter of the company buying itself out of its investment vehicles, so much as the investors wanting to cash out of the business. Competitors can cite examples of large investors that bought heavily into CLECs and then put them up for sale, though with less success of getting their money back. • Competitors can play up the potential for uncertainty in the wake of a merger or acquisition. US LEC customers may be particularly vulnerable to a message that their regional CLEC is being merged with some national entity based not in the southeastern U.S. but in upstate NY. Competing sales forces can inject doubts about whether the services and pricing packages will remain the same, or if they may go up in the wake of the merger. • Large incumbent carriers can describe the “New PAETEC” as having a fragmented and patchwork presence. They can cite that when it comes to serving enterprise customers with substantial need for a nationwide presence, having 25 of the top 50 or 52 of the top 100 MSAs still doesn't come close to matching the direct service reach of the top tier carriers. Recommended End User / Customer Actions • US LEC and PAETEC customers should not be overly concerned with the planned merger between the two carriers. The “New PAETEC” plans only to realize $25 million in “synergies” out of a billion-dollar revenue budget in the first year, and $40 million annually thereafter. In other words, the merger is about growth and expansion, not layoffs and reductions. • Customers looking to use services that cross the PAETEC and US LEC portfolios and/or networks should go with one carrier or the other for now, or sign contracts with each separately. The merger as planned will not take place until some time in Q4 2006, and additional time will need to pass before the two CLECs will begin to have their services integrated in any fashion. • Customers of US LEC and PAETEC that like their CLEC but don't have quite the right mix of services or footprint can shop between the two for now, and see which carrier can provide a superior package. Both US LEC and PAETEC have a similar service portfolio and a strong focus on customer retention, so a client that enjoys doing business with one carrier should find itself equally well served by the other. • Even after the merger, US LEC and PAETEC will not have a comprehensive nationwide footprint, or a direct international presence. Prospective customers that are either multinational or have scattered facilities nationwide will only be able to use the merged company as a solution in some – not all – of the business locations they need to connect. Business Network Services - U.S.
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