Finding the Next Fairpoint

To Verizon, closing the deal to sell its access lines in three New England states to Fairpoint Communications in April was the spring following a long, hard winter — the end of a grueling, months-long wrestling match with three separate state regulatory agencies that drew a lengthy list of concessions from both carriers. But on the Fairpoint conference call in April detailing the close, at least one analyst was already wondering when Verizon would do it again.

A month later, however, Verizon execs were brushing off thoughts of another Fairpoint-like deal. When asked at an investor conference in May about spinning out more rural lines, Doreen Toben, executive vice president and chief financial officer for Verizon, said, “The regulatory process with Fairpoint was exhaustive. It took a very long time. So for right now, at current course and speed, I'd say we're happy where we are. Not forever. But for right now, I don't think we're looking at more [spin-outs of rural lines].”

Even for those willing to take on the challenge, repeating the Fairpoint spin-off would truly be a rare feat. Due to the unique structure of the deal, only very few companies could attempt something similar. To avoid the considerable tax charges that would accompany such a sale, the deal was couched in a tax-free transaction known as a reverse-Morris trust, in which the spun-off assets are actually sold to shareholders of the parent company and then merged with another company, requiring the resulting entity to be majority-owned by the shareholders of the company shedding the assets. For that reason, only a few service providers fall into the range of capitalization (not too big, not too small) that would allow such a move.

“The big players — CenturyTel, Citizens, Windstream — they could do it, but it would have to be a very large transaction,” said Bill King, president and managing principal of JSI Capital Advisors. “I'm just not inclined to think that would happen.”

And some of the largest RLECs are soon expected to combine into even larger entities, making a reverse-Morris trust even less likely.

Still, when Verizon is ready, analysts say, it is likely to look at shedding rural assets in Ohio and Michigan (the former GTE territory). Likewise, AT&T might shed some rural lines in the Midwest as well. And analysts say that Qwest Communications may be the most likely to create the next Fairpoint.

“Qwest has 80% to 85% of its lines in five metro markets, but 20% of their lines comprise probably 95% of their service territory,” said Gerald Granovsky, senior analyst and vice president for Moody's Investors Service. “It's a challenging position to be in. It probably could make sense for them to get rid of the more rural states.”

Cincinnati Bell, Consolidated Communications and Iowa Telecom, given their size, are plausible candidates for a reverse-Morris trust, King said. In addition, Alaska Communications Systems is the right size, he said, though its geographic isolation makes it less likely to seek such a move.

To those hopefuls, Fairpoint may serve as a cautionary tale about the difficulty of these deals. But the next Fairpoint is likely to face a somewhat milder regulatory process, Granovsky said. “New England may have been a unique case in that those three states are probably three of the most vocal state regulatory regimes in the country,” he said. “The regulatory environment in Qwest's incumbent markets — especially Montana, Iowa, Idaho — probably will not be as vocal.”