PAETEC Completes Acquisition of McLeodUSA, Creating One of the Largest U.S. CLECs

| Feb 12, 2008 | Business Network Services - U.S. | Competitive Update

| Analyst: David Hold

Current Perspective: Positive/Neutral
Vendor Importance: Very High
Market Impact: Moderate

Event Summary

February 8, 2008 – PAETEC has completed its acquisition of privately owned McLeodUSA Incorporated. The closing occurred today following approval of the transaction by the stockholders of both companies at special meetings. PAETEC now has nearly 4,000 employees and will have a presence in 82 of the top 100 metropolitan statistical areas by the end of 2008.

Analytical Summary

• Current Perspective: Slightly positive on PAETEC’s plan to acquire McLeodUSA, because this acquisition will turn a regional carrier into a full fledged national competitive carrier with a physical presence in markets extending from coast to coast. In addition, PAETEC was able to purchase the distressed carrier with an all-stock transaction, assuming only a small amount of debt. But McLeodUSA has a long history of losses despite shedding most of its debt, and PAETEC will be challenged to keep the acquired company from dragging down its overall earnings.

• Vendor Importance: Very high to PAETEC, because the acquisition would give the carrier an access presence in 82 of the top 100 MSAs in 40 of the 48 continental U.S. states, turning the eastern regional carrier into a full-fledged national service provider. The acquisition would yield not just economies of scale to PAETEC, but an ability to bid on large enterprise contracts that require a national market presence.

• Market Impact: Moderate on carriers serving business customers of all sizes, but mainly in the SMB market where the two carriers had the majority of their customers. Competitors among the major ILECs as well as regional and national CLECs need to recognize PAETEC as a rising competitive threat in many U.S. metropolitan areas, especially in those markets where McLeodUSA had previously been viewed as vulnerable.

Recommended Competitor Actions

• AT&T and Qwest, two largest incumbent carriers in whose territory McLeodUSA principally operated, need to be concerned that the acquisition by PAETEC, which has a track record for good management and profitable operations, will revitalize the sales and services of the former CLEC. Because any change of ownership can be disconcerting to customers, the ILECs have a window of opportunity to target McLeodUSA customers with win-back programs.

• The ILECs should look for any opportunity to pick up additional access line customers in the face of ongoing line losses. The smallest of McLeodUSA’s business customers using dialtone and broadband are likely to receive even less attention and support as the new owners concentrate on improving profitability. These small customers would probably be better served by their local incumbent operator, which is providing the physical access lines anyway.

• Top tier carriers that have carefully architected their networks from scratch and built up enterprise business services through their own sales efforts can describe PAETEC as an overgrown regional CLEC with a hodge-podge of acquired networks and services that are not fully integrated nor rationalized. Since it is not yet clear what will stay and what will go, the established carriers can tout stability and predictability in the face of uncertainty.

CLIENTS ONLY

Competitive Positives and Concerns

Recommended Vendor Actions

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