The Deals Drive On

In 2007, executives in the rural telecom space decreed that, given the rocky credit market at the time, much-needed consolidation in the space likely would pause until late 2008, when they believed markets would be friendlier. Of course, late 2008 saw an unprecedented collapse in the global financial industry. But the pressure on rural telcos to consolidate remained, and M&A activity throughout the past year was high, even when unseen.

CenturyTel, which typified the conflicted state of the industry by managing to buy a carrier twice its size, revealed in regulatory filings that 2008 actually was rife with private merger proposals of seemingly every possible combination of major RLEC. At least five other companies engaged in some form of serious M&A discussions with either CenturyTel or Embarq last year. On more than one occasion, CenturyTel even explored a three-way merger involving Embarq and another unnamed carrier.

While Embarq insisted on stock-based deals only (no doubt due to the depressed value of stocks across the sector), other carriers found ways to finance smaller acquisitions despite economic unrest. In perilous October, for example, Otelco — an Alabama-based telco that also serves Maine and Missouri — announced it had secured $188.5 million in debt financing for an acquisition of Country Road Communications.

Iowa Telecom (one of the highest-priced stocks in the sector) made two non-stock-based acquisitions in last year's harrowing second half, spending a combined $125 million. Last summer, it acquired Bishop Communications, a small telco northwest of Minneapolis, for nearly $44 million ($33 million in cash and $13 million in assumed debt). And the week before Thanksgiving, it added Sherburne Tele Systems, a triple-play provider in the same area, for $80.6 million. (Sherburne is perhaps better known by its ILEC brand name, Connections Etc., and its CLEC brand name, NorthStar Access.) The two deals gave Iowa Telecom a solid foothold across its northern state border; in addition to a 66% stake in a 2500-mile fiber network there, Iowa Telecom now has a total customer base that is 15% outside of Iowa.

Otelco's deal, led by CoBank and GE Capital Markets, is what Gerald Granovsky, vice president and senior analyst for Moody's Investors Service, calls a “club deal”: a lower-risk situation in which a group of six to 10 banks know the industry (and the borrower) very well and pool their efforts so that each bank's contribution is in perhaps the low double-digit millions. Even in an economic hailstorm, Granovsky said, “a club deal can still get done.”

Iowa funded its latest deal with help from the Rural Telephone Finance Cooperative, a nonprofit lender that typically funds network upgrades and acquisitions for its more than 500 rural telco members. The RTFC was created by a larger nonprofit, the National Rural Utilities Cooperative Finance Corp., which focuses on electrical power utilities but nevertheless extended more than $1.7 billion in credit to telecom companies in its most recent fiscal year. The RTFC arranged $75 million in incremental loans for Iowa's purchase of Sherburne, vowing to fund it fully if needed and leaving Iowa to fill in the other $5.6 million with its own existing credit.

To that end, Iowa Telecom was fortunate to be able to draw from credit secured before the current crisis; the carrier's $100 million revolving line of credit, which expires in late 2011, bears interest at the rate of 2 percentage points above the London interbank offered rate (LIBOR). Last summer, many high-yield lenders were offering interest rates 3 to 5 points above LIBOR, Granovsky said, and 8 and 10 points above LIBOR has become more common.