The final stage of consolidation in the US metro market
Twelve months ago, six premier metro fibre providers were jostling for position ahead of a final round of consolidation. Two have emerged to lead the pack, two have been snapped up and two remain as targets.
At first glance, Rob Shanahan, chief executive designate of the newest behemoth in the North American metro market, seems an unlikely contender to take on Dan Caruso, chief executive of Zayo, architect of more than 20 acquisitions and the undisputed king of consolidation.
But dig a little beneath the surface and you find that the two men have much in common: both are grand visionaries who were quick to spot the enormous potential of fibre assets as demand for bandwidth exploded; both are skilled M&A practitioners who bring a deft touch to the often painful process of integration; and both command unfaltering loyalty from private equity backers who have (unusually) passed over several opportunities to cash-in their profits.
Now the pair, who know each other well, are set to go head-to-head in the race to mop up the last remaining fibre providers of any meaningful size in the metro arena.
In one corner towers Shanahan, a publicity-shy industry veteran with more than 28 years’ experience. Best known for founding Conversent Communications in the late 1990s, Shanahan joined Lightower as president and chief executive after his company was sold to One Communications in 2006.
Shanahan is backed by Berkshire Partners, a Boston-based private equity firm that has a strong record in the communications sector (the company is a major investor in Telx) and which has been trying to elbow its way into the metro market for some time. The firm is understood to have been close to buying Fibertech two years ago and is also thought to have been among the many investment firms that lodged an expression of interest in AboveNet when the company first hoisted the “For Sale” sign early in 2012.
Speaking at the time of the merger announcement, Randy Peeler, Berkshire’s managing director said that the combined company would be “well positioned for further growth… serving customers with ever-increasing needs for high bandwidth performance”.
One source with detailed knowledge of the firm, goes further, saying that it expects to participate fully in any future consolidation: “The message is that there is plenty of gas in the tank,” the source says.
In the other corner, looms Caruso, co-founder, president and chief executive of Zayo, a high-profile convention breaker who many believe has single-handedly put the metro market on the map by opening up his company’s financial metrics to public scrutiny and thereby laying the demons of the dotcom bubble to rest.
Caruso, too, has a host of private equity backers – eight in total, including Battery Ventures, Charlesbank Capital Partners and MC Ventures. There is no question that Zayo’s shareholders are not fully committed to a further round of consolidation. But the ownership structure is complicated and it is not clear under what time scale some members of the consortium might be required by their own strict guidelines to cash-in their investment.
The immediate prize is a rapidly dwindling clutch of remaining fibre assets. These include the last two operators in the fibre provider premier league, FiberLight, which received an approach last spring that ultimately came to nothing, and Fibertech.
Other likely contenders include DukeNet, the fibre arm of Duke Energy, which is part owned by Alinder Capital Partners, and Lumos, which was spun out of Ntelos in 2011.
What a difference a year makes
Berkshire’s $2 billion move to merge Lightower and Sidera will undoubtedly speed up a final round of consolidation that was already gathering pace after Zayo swiped AboveNet from under the noses of a private equity consortium with an audacious $2.2 billion deal in March 2012.
The combined company, which is expected to trade under the Lightower brand, will operate a 20,000-mile network connecting 6,000 locations. It will also boast one of the largest fibre footprints of any rival north of New York and will be a major force in the ultra-low latency market linking Chicago and New York.
Berkshire declined to break down financial details for the deal but analysts believe that Lightower fetched a multiple of between 11 and 12 times earnings before interest, taxation depreciation and amortisation (EBITDA), while Sidera raised around eight times EBITDA.
Sidera’s lower valuation comes partly from the fact that the company owns just half of its network, electing to lease the rest, and partly because revenues are expected to grow by just 5-6% this year – less than one third that of many of its peers.
While it is not clear whether Berkshire has made overtures to Lightower in the past, it is understood that the private equity firm was not one of the two separate bidders that came close to signing a deal with Sidera for between $700 and $800 million last year.
Berkshire’s eleventh-hour gambit will surely change the dynamic in the metro market by establishing a second credible platform on which to build fibre assets, thereby halting Zayo’s free-handed land grab in one fell swoop. That should in turn tickle up the price of the few remaining fibre assets of scale still on the market.
As one insider with detailed knowledge of the current round of deal making explains, it looks increasingly unlikely that another player will be able to build a platform to match Lightower or Zayo: “On balance, that’s probably good news if you’re still a seller of fibre assets, because you have some competitive pressure in the auction process.” But it also reduces the chances of another play maker, such as Level 3 or Windstream, perhaps, trying to establish a third platform on which to develop a metro fibre business.
Analysts speculate that such a player might have a short window of perhaps four to six months during which neither Zayo nor Lightower will be in a position to pull off a big deal, possibly leaving the way open to put, say Fibertech and DukeNet together.
But given the synergies that Zayo and Lightower will be able to eke out of any further acquisitions – and indeed their ready access to debt financing through the capital markets – the duo stand a good chance of outbidding any outsider looking to establish a toehold from scratch.
That might not bode so well for some sellers, as the deal maker, who declined to be named, explains: “You have to appreciate that some of the players that are still out there are drinking at the last chance saloon. If neither Zayo nor Lightower pick up the tab, there’s nowhere left to turn.”
At least one of the companies regularly cited as a potential acquisition target, for example, is understood to have leased out fibre to competitors at rates that are unlikely to prove attractive to potential acquisitors, prompting speculation that the company will be forced to slash its asking price in order to attract any buying interest whatsoever.
Beyond the end-game
The big question now facing the metro market is what happens after Lightower and Zayo mop up the last remaining pockets of fibre network worth having. Both Berkshire Partners and the consortium behind Zayo clearly believe that there will be ready buyers for their businesses when they come to cash-in.
One clue lies buried deep in the regulatory filings that AboveNet published shortly before the company closed its deal with Zayo. According to the documents, three separate cable companies expressed an interest in the business and one of those, which Capacity has identified as Time Warner Cable, was active in pursuing negotiations throughout the auction process, though it never got as far as tabling a formal bid.
Historically, cable companies have avoided buying metro fibre networks for fear of contravening an unwritten gentlemen’s agreement precluding them from competing head-to-head in each other’s core geographical markets. But the pressure to develop their fibre footprint continues to mount as they target the high-premium enterprise market.
The chief executive of one metro company is sceptical: “I do not see now, nor at any time in the future, a scenario whereby any one of the big cable companies will understand and commit to a footprint beyond their cable franchise territory.” For one thing, he says, the price of fibre assets is prohibitively expensive: “On a good day, cable companies trade on a multiple of seven times EBITDA. The stock market is not giving them much credit for the revenues they are currently generating so there’s no way shareholders are going to sign off a deal where they have to go and pay 10 times EBITDA for future growth.”
But more damning, says the metro chief, is the mentality that still lurks inside cable companies: “At no point do the management of these businesses ever consider working with one another to enable the power of their networks. They view joint ventures with deep suspicion and they don’t have any understanding of what it means to try to sell to a multi-location business customer. Quite simply, the metro market is light years beyond their current mindset.”
But not everyone agrees. One highly regarded analyst sees the cable sector as a keen buyer of fibre assets: “I don’t think Berkshire would have got involved at this seemingly late stage in the game without a pretty clear idea of what their exit strategy might be.
The ultimate driver in the metro end game is infrastructure, because ultimately, that’s how you are going to attract enterprise customers. Zayo and Lightower are going to have it and cable companies are going to want it. Period.”