PAETEC: Expect More M&A From Us Over Next 5 Years

PAETEC (PAET) plans to buy more companies over the next five years now that its board has approved a new strategic plan “to start looking a little bit more aggressively.”

That was the word from Keith Wilson, PAETEC’s CFO, on the company’s Nov. 5 third-quarter earnings conference call.

In fact, if the situation warrants, PAETEC may be willing to leverage a purchase four times its operating cash flow. That is, if, in “a very short period of time … we can see network cost and expense synergies quickly bringing that down … just like we did with US LEC and McLeod,” Wilson said.

Meanwhile, PAETEC also expects to invest in “high-quality people,” as well as product development, said PAETEC’s Chairman and CEO, Arunas Chesonis. That’s because, as the economy recovers, albeit slowly, companies still will rely on broadband to replace face-to-face meetings and to facilitate collaboration worldwide. Indeed, broadband adoption only will increase from here on out.

Nevertheless, while the demand bodes well for PAETEC, it does not necessarily translate into more customers, who have yet to rehire “the people they laid off in the last 18 months,” Chesonis explained in an exclusive interview with xchange and its sister publication VON on Thursday.

“We’re optimistic but we’re cautious about how fast everything’s going to crank up as far as new jobs created,” he said. “But that doesn’t mean usage can’t go up.”

3Q Losses Higher Than Last Year

Yet even as it looks for new opportunities, PAETEC is keeping its current financials in mind. On Thursday the Rochester, N.Y.-based CLEC reported third-quarter 2009 earnings that, while not mind-blowing, highlighted it is riding out the recession with promise.

“Even though we are still experiencing a difficult economic environment, we grew enterprise business over 1 percent from the second quarter to third quarter of this year,” Chesonis told analysts.

On a regional basis, though, and like its peers, PAETEC is dealing with fewer sales in areas where unemployment is high and demand from verticals such as real estate is low.

“You can expect that in locations like California, Florida, [business] still tends to get harder hit,” Chesonis said.

However, PAETEC is “actually seeing some good sales results” in parts of the Midwest, even as key markets such as Michigan have been slammed by the automotive industry’s collapse, Chesonis said.

All of those factors contributed to PAETEC’s third-quarter losses of $6.5 million. Still, that’s better than the same period last year, when the Rochester, N.Y.-based company lost $6.9 million. Revenue was down, though – in 2008, sales amounted to $406.1 million. This time around they came to $395.7 million. Fewer carrier-services sales helped account for that drop – those deals fell by $1.5 million.

Energy Business ‘Plants the Seeds’

PAETEC continues to diversify, in part to combat those problems.

First, similar to rivals such as XO Communications (XOHO.OB) and Level 3 Communications Inc. (LVLT), PAETEC is sniffing out more data-centric sales experts.

“It’s not so much of focus on people that have traditional competitive telecom industry experience, but it’s people that can come in and really speak to the office of the CIO,” Wilson, referring to direct sales recruitment, told analysts.

PAETEC also wants those internal marketers to be knowledgeable about national accounts, “rather than just the traditional relationship managers,” Wilson said.

At the same time, the CLEC continues to diversify its network services. PAETEC has been experimenting as an energy broker for “several hundred” gas and electric customers in New York, to determine if an additional focus on the utilities sector makes sense. It does, Chesonis said.

“More CIOs and IT directors are being pulled into energy-purchasing decision-making,” he said. That translates into the need for data centers with redundant backup power, green efficiency methods, disaster recovery and more.

PAETEC’s energy business represents just a small piece of the company’s overall revenue, “but it sort of plants the seeds for the next five to 10 years,” Chesonis said.

US LEC, McLeodUSA Integration Progress

Finally, PAETEC is finishing the integration of its 2006 US LEC purchase and expects the same work on the 2007 McLeodUSA acquisition to wrap up in nine to 12 months.

“I think US LEC is virtually done,” Chesonis told xchange and VON.

The final task is to migrate a few stragglers onto PAETEC’s billing platform. That will happen at the end of the year, marking the “last piece” of the US LEC integration, said Chesonis.

It’s a different story for McLeodUSA. Integration work is about two-thirds complete and should be done in nine to 12 months, Chesonis said. The transition is taking a little longer because McLeodUSA used a “home-grown” billing system based on older technology, he explained.

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