CLECs slow to merge: ATG proves the exception with buying spree

While the dollar value of global mergers between telecom companies led all high-tech sectors in 1999, surging to $686.4 billion from $252.3 billion in 1998, the number of transactions did not increase by much, according to a report by Broadview International (see figure). The sky-high public valuations of telecom companies were only one factor. 1999 was a year for big companies to consolidate, seek greater economies of scale and widen their horizontal product offerings.

But competitive local exchange carriers (CLECs) were conspicuously absent. CLECs often relegate M&A to the back pages of their business plans for myriad reasons,but size or stock value to fund takeover deals is not one of them. Indeed, one principal reason for the lack of consolidation among CLECs is relatively easy access to other means of capital, said Don Bechter, senior vice president of Daniels & Associates, a boutique investment bank.

Even the CLECs that spend cash as fast as they can raise it haven't had much reason to sell or invite bidders because Wall Street and venture capital firms, among others, have been willing to fund them.

"For a while, the junk bond market provided a lot of capital, but that market has become much more selective in the last year," said Katharine S. Klein, senior vice president of corporate development and strategic planning for Advanced TelCom Group. "Now, however, leveraged buyout firms and other private equity sources have begun to target the sector and put large sums of money to work."

What's more, until recently, competitive carriers have been valued by these stakeholders at multiples of the investment they've made in property, plant and equipment, Bechter said. So likely acquirers sometimes find it just as cheap to build their own networks and customer bases.

However, as the market matures and competition stiffens, that's likely to change. "Some carriers may have trouble getting that next round of financing," Bechter said.

Klein agrees, noting that leveraged buyout firms have been choosing to back strong franchises with solid management teams: "We're starting to see the emergence of the haves and have-nots."

ATG may be one of the haves. Formed in mid-1998 by a group of senior managers from Brooks Fiber Properties, the integrated communications provider has $280 million of equity capital to pursue its strategy of building a national footprint in Tier 3 and adjacent Tier 4 markets.

ATG already has purchased NewCommNet, a CLEC based in Frederick, Md., and Shared Communications, a reseller of local and long-distance services in the Pacific Northwest. ATG buys other service providers to jumpstart a subscriber base in markets adjacent to its facilities-based network, to enter far-flung markets quickly and efficiently and to gain technical and management talent.

Acquiring talent is not unusual today, especially as small service providers such as ATG try to make up for a lack of data expertise and a dearth of experienced executives. "In NewCommNet, we largely acquired a management team with a business plan," Klein said. "They had already done a lot of market development on the East Coast, but their networks had not yet been completed."

But buying an early-stage service provider also can have its downsides - including post-acquisition integration. "It can be difficult to integrate two companies when they have each developed their own [operations support systems]," Klein said. And purchased customer bases can't always be migrated "on-net" immediately.