XO PLEDGES ALLEGIANCE TO SIZE

At about 5 a.m. on Feb. 13, when Qwest Communications finally relented and let XO Communications win the auction for the assets of bankrupt competitive local exchange carrier Allegiance Telecom, exhausted XO executives went home, slept for a few hours and then returned to the office. The real work was just beginning.

Before XO and Allegiance can combine to form the country's largest independent CLEC (which will retain the XO name), two businesses, two staffs and two nationwide networks will have to meld into one — a process expected to take 12 to 18 months.

The two customer bases don't overlap greatly — Allegiance has about 100,000 small and medium-sized business customers, and XO has more than 84,000 medium-to-large enterprise and carrier customers — but the two networks are all over each other. XO's OC-192 backbone is more extensive than Allegiance's OC-48, and both have a lot of presence in top-tier cities. XO will look to shed redundancies, including about 300 co-location centers and an unknown amount of metro and long-haul fiber.

XO also will move Allegiance's inter-city traffic onto its own national backbone, saving what XO CEO Carl Grivner estimates is $20 million to $30 million a year.

Eliminating overall network redundancies should save XO $60 million to $80 million, he said, and total corporate synergies should save $150 million to $200 million — a good chunk of the roughly $650 million in cash and stock XO paid for the assets. The combined company should pull in at least $1.6 billion in annual revenues, Grivner said. XO gave analysts a revenue estimate of $1.1 billion for 2003.

By all accounts, though, the toughest part of the marriage will be integrating the back-office systems, which is why the companies will likely take their time doing it. Allegiance's processes are more automated, optimized for the pace and volume of the small-business market. XO's processes were more customized for its high-end clients. The two carriers have some platforms in common (ADC's Singl.eView billing and Lynx's order entry, for example) that will help it adapt systems to accommodate both markets, Grivner said.

Meshing the two businesses also provides potential cross-pollenization of services. Although Allegiance made most of its money from bread-and-butter circuit-switched telephony, XO is well versed in newer offerings such as VPNs, fixed wireless and Ethernet services.

“[XO] can offer small businesses some interesting and attractive packages,” said Deb Mielke, president of consultancy Treillage Network Strategies. And with its IP backbone, XO could help small businesses transfer to IP services, though it's still working on an IP Centrex offering.

Grivner and Allegiance CEO Royce Holland are already trash-talking about their national rivals, boasting that none of the major carriers have their combination of long-haul transport and local facilities. Grivner puts the pair's local presence on par with MCI (a hard claim to disprove since MCI doesn't release such numbers).

Not everyone is optimistic about the CLEC's odds, though. “XO is still losing money, and Allegiance always has,” said Kate Gerwig, principal analyst of network services for Current Analysis. “Maybe together they can make this work, but I don't think it's any kind of slam dunk.”

Still, if AT&T focuses more on giant corporations and MCI leans toward the residential market that XO doesn't serve, as Mielke thinks they're doing, XO could have plenty of room to maneuver in the small-business space. “I don't think there's another service provider exactly like them,” she said.

Soon XO's majority owner, Carl Icahn, will decide which executives to keep and which to “synergize.” Holland said he would prefer to work for XO, but when asked if he would accept a non-CEO role, he said it would depend on the specifics of the offer. For the moment, he's still reeling from the auction.

“We've been working for about a month, planning for a transition to Qwest,” Holland said.