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Finance, Operations Shifts Signal Change for Deltacom

Financial and operational changes taking place at Deltacom (ITCD.OB), the Huntsville, Ala.-based CLEC, appear to signal new directions for the company. And influential industry observers are taking notice, a welcome improvement for the nearly 30-year-old company that has endured several tough years.

This week, ratings service Standard & Poor’s heightened its outlook on Deltacom, upgrading the CLEC’s ratings on word that it plans to refinance $325 million in debt. In a Feb. 1 Securities and Exchange Commission (SEC) filing, Deltacom said it’s working to get better terms so it can pay off other obligations and free up money for “general corporate purposes.” S&P analyst Catherine Cosentino approved of the strategy, saying the move gives Deltacom “more flexibility to weather execution errors or an unforeseen drop in the base of business.”

Deltacom hopes to wrap the debt offering some time next week, just as some big changes – on both the money and operations fronts – foreshadow new pursuits. The one exception to that seems to be M&A. Experts don’t think Deltacom will be on either end of takeover activity as a result of the refinancing.

When it comes to money, Deltacom told the SEC on Feb. 1 it expects to report losses of $11 million for 2009. That sounds like a lot for a smaller service provider until 2008 and 2007 results come into the picture. For 2008, Deltacom recorded a net loss of $22.9 million; 2007 ended with net losses of $177 million. Deltacom, then, is forecasting some of its lowest losses in years, and more free cash flow than it’s had in some time. At the close of 2008, the CLEC had $19.3 million in cash. It disclosed to the SEC that, on an unofficial basis, it should have $31 million in free cash flow for year-end 2009.

Much of the rally stems from “a major recapitalization” in 2007, said Brian Washburn, a research director at Current Analysis. Washburn said replacing debt with stock stabilized Deltacom, one of the many CLECs reeling from the worsening economy while still suffering side effects of FCC-imposed deregulation. Over the years, the FCC has upended several precepts of the 1996 Telecom Act that fostered the CLEC industry. Commissioners delivered one of the worst blows when they reversed the requirement that incumbents charge CLECs wholesale rates for network access. For companies including Deltacom, which built much of its business model on cheap use of LECs’ lines, the order meant sticker shock.

But now, years after the ruling, the surviving CLECs – including Deltacom – have come to new arrangements with the Bells. And with more financial stability underfoot, Deltacom’s options are unfolding.

That’s where some operations shifts come in.

In mid-January, Deltacom signed with Avaya Inc. as a channel partner. Deltacom already was pitching ADTRAN equipment and NEC unified communications (UC) to its SMB, enterprise and wholesale customers. But adding Avaya, which bought Nortel’s enterprise assets last September, beefed up Deltacom’s UC and contact center appeal, not to mention its IP platform portfolio. Combined, that opens up a range of new customer opportunities for Deltacom.

And that’s something the CLEC needs. Right now, most of its revenue comes from digital T-1 products, including local, data, long-distance and mobile services. The company also sells broadband capacity. However, Deltacom’s wholesale and equipment sales fell last year even as enterprise and core retail numbers rose somewhat. With the communications industry speeding toward an all-IP future, connecting with Avaya made sense.

To that point, Washburn predicts Deltacom will use some of its refinancing proceeds to upgrade its infrastructure, again. The CLEC owns an optical transport network and related gear that supports IP/MPLS and VoIP services, he said.

“But it also still has many customers on traditional TDM services, including ISDN PRI. Maybe Deltacom is looking to build out more IP/MPLS-based services and Ethernet, or possibly it may want to ramp up more carrier Ethernet,” Washburn said.

Indeed, if Washburn is correct, that could shed light on why Deltacom suddenly, and without explanation, axed an unspecified number of its independent and master agents just weeks before announcing the Avaya partnership.

Yet, in spite of the channel brouhaha, Deltacom seems poised for a better year than it’s had in some time. S&P’s Cosentino agreed. She anticipates Deltacom will operate at net free cash flow on a sustained basis and that profit margins will continue to strengthen. That’s due largely to a recent network upgrade on Deltacom’s part, which allowed the CLEC to move more traffic to the lower-cost, on-net facilities, Cosentino said.

Deltacom’s shares traded on Tuesday for the first time since Jan. 29. The company’s stock closed 2.56 higher, at $2, not far from the 52-week high of $2.50. The higher value pushed Deltacom’s market cap from $158.2 million to $162.3 million.

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