Falling prices tempt RLEC consolidators

While integrating its acquisition of CT Communications, executives of Windstream Communications reiterated the case for future acquisitions this week, and some analysts say recent changes in the market could encourage further consolidation among rural carriers.

“Consolidation in this space makes a lot of sense,” Windstream Chief Executive Officer Jeff Gardner said on the company’s third-quarter earnings call this week. “Given the continued decline in access lines, this is a business that demands scale. Accordingly, we continue to believe it’s important to maintain the capacity to pursue strategic opportunities that are free cash flow-accretive, should they arrive.”

One analyst on the call asked if the environment for mergers and acquisitions in the rural telco sector has improved in recent months. “When we looked at the landscape earlier in the year, it seemed like some of the smaller public RLECs that could potentially make attractive [acquisition] targets were trading at a decent premium to where you guys were trading--that made M&A difficult,” said John Chaplain, JP Morgan analyst. “But over the course of the last quarter or so, there’s been an adjustment in valuations, and a lot of those RLECs are now trading at a decent discount to where you guys are trading on a free cash flow basis. Does that make it a lot easier for a consolidation to take place with larger scale deals than some of the ones we’ve seen over the course of the last few months?”

The stock of D&E Communications is down about 15% from the end of June. Fairpoint Communications’ stock is down about 10% in the same period. Similar trends are seen among larger public RLECs. Embarq’s stock price is down about 20% from the end of June. Citizens Communications’ stock is down about 15%. And CenturyTel’s stock is down 12%.

Gardner responded that a mix of factors influence the M&A environment, such as the state of the credit market, which he said in September could delay more RLEC consolidation until next year. “Smaller companies that were contemplating possibly selling their companies will pull that in and think about doing that next year as opposed to this year,” he said at an investor conference then. “It’s going to be sellers determining there’s a better market environment for them to get the best price in 2008 versus now.”

“When markets get difficult, one thing that has been good is we’re beginning to see differentiation based on results,” Gardner said this week in response to Chaplain’s question. “The larger-scale, better-cost-structure companies doing a better job growing revenues and producing cash flow are beginning to get recognized. In the long run, that will be good for M&A.”

Windstream expects to complete the integration of CT Communications, including billing integration, by next year’s first quarter.