Nov 19, 2007 12:02 AM,

Small telcos feel merger pressure

By Ed Gubbins

In the wake of major-carrier consolidation, merger activity among small and regional telcos is escalating and should continue next year. CLECs on the coasts are expanding toward the heartland, accepting that, whatever success they may have had thus far, they can no longer stay small or merely regional for long.

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After Northwestern CLEC Integra Telecom bought Electric Lightwave last year and Midwestern CLEC Eschelon Telecom this year, CEO Dudley Slater said this summer the company's newest investor, private equity firm Warburg Pincus, was “very excited” about future acquisitions. Southwestern CLECs that have bought their way into the Midwest lately — Paetec with McLeodUSA, Access Integrated Networks with Birch Telecom — hint at future M&A.

CLECs aren't the only small carriers combining. This month SureWest Communications, which serves mostly residential consumers, said it was searching for acquisitions to help scale its fiber-to-the-premises business. Rural telcos also have conceded consolidation is ahead, although with less competition, they aren't under as much time pressure to deal.

“You can only go so far in Rochester, N.Y.,” said Craig Clausen, senior vice president of New Paradigm Research Group. “After a while, you've captured what you're going to capture. Then what? The big boys will be able to undercut you. Being cornered is not an option. You have to look more broadly.”

Telco M&A hasn't increased much lately (NPRG counts 11 non-Bell service provider deals either closed or pending in the last six months), but it's become more “meaningful,” Clausen said. Whereas in the past, CLEC deals were about picking over assets of failed companies, the latest wave is about merging self-supporting businesses. The addition of Birch Telecom, for example, will more than double AIN's annual revenue and customer base (to $200 million and 100,000, respectively).

Particularly for telcos with residential customers, consolidation is a hedge against line loss. For others, it's a geography game, allowing access to their business customers' other locations. And for some, it's arbitrage, prompted by falling valuations in a slow economy. But they all face the same reality: scale or surrender.

“We're not looking to become a nationwide CLEC,” said Vincent Oddo, CEO of AIN. “We'll stay within AT&T's footprint.”