The return to the original investors in the seven months was 35.3%. Annualized, the return to the investors was approximately 60% on the total amount invested.
Extensive research brought to light the opportunities that existed in the Telecom industry especially in the CLEC sector in 2003.
After Carl Icahn acquired XO Communication we recognized that consolidation in the sector simply made sense because assets were incredibly cheap, a customer line that once cost $300 to build can be bought for anywhere from $50 to $100. Carriers without their own facilities would hope to partner with those that have them, their value being in their customer base. There were sound business reasons for consolidation. Despite all the chaos in the business, local exchange carriers have continued to capture market share from the Bell operating companies.
We believed that with over 70 CLEC’s the sector was very fragmented and that there would be many mergers and acquisitions happening.
We came to see that there would be combinations that would make perfect sense like XO Communications and Allegiance Telecom. XO built a high-end data and phone-line infrastructure; Allegiance Telecom is customer rich.
Most markets were still overcrowded, like Atlanta, where six different major CLECs including Allegiance Telecom, Nuvox, U.S. LEC, Cbeyond and ITC^Deltacom compete with the regional Bell company. There are also a handful of even smaller and weaker CLECs in that city trying to establish a foothold. Any combination would result in immediate overhead savings, then putting more customers on existing infrastructure could yield even more profit.
ICG was in the hands of the hedge fund Cerberus Capital Management, which has over $9 billion in assets, which has used its debtor-in-possession financing business to give it an edge in acquiring telecom assets for a song. Not only did it pick up ICG out of bankruptcy, but also it was the lead representative for bondholders in the WorldCom bankruptcy. The year prior with a partner it acquired a Canadian long-distance backbone called Teleglobe, with $1 billion in revenue, for $155 million.
Bain Capital and Thomas H. Lee, losers in CTC Communications, still share a stake in U.S. LEC, in which they initially invested $200 million. Welsh, Carson, Anderson and Stowe, which had a big stake in bankrupt Winstar, held positions in two CLECs: a privately held one in Raleigh, N.C. called BTI Telecom, and ITC^DeltaCom, which the firm acquired by buying ITC’s bonds while it was in bankruptcy. They’ve been forced to buy up the company’s bonds at discounts to maintain control.
Brown Brothers Harriman, through its 1818 fund, has a few CLECs, too. Among them Z-Tel Technologies and privately held Xspedius. Brown Brothers, an early investor in Xspedius, traded its stake in a Pensacola, Fla.-based local exchange carrier to Lucent Technologies to reduce the debt Xspedius owed Lucent. Then Brown Brothers threw in more money to up its equity stake in Xspedius. That left the local exchange carrier with enough resources to do acquisitions. It soon acquired the network and customers of both e.spire and Mpower Communications (Texas customers).
WE made a list of possible acquisition targets to define the best possible strategies. Out of over 30 CLECs we looked into we picked our first target company to invest in which was Pac-West.
The Company was performing well and we believed to be very cheap. Pac-West had $164M in revenues and $60m in EBIDTA ($25M in normalized EBITDA). The market cap of the company was $16M and had debt of $95M, which was selling at .55 ($52M). Pac-West had $57M in cash on hand. We thought the equity could be bought for approximately $40M. For a total purchase price of $92M less the cash of $57M they had, gave it an enterprise value of $35M. We felt that the company was very cheap and also would be a perfect candidate for a merger or as an acquisition target. TPI also felt that the bonds were undervalued because they never missed a payment and the company was profitable. We believed that the bonds would eventually trade back to par.
We also looked at Mpower Communications.
Mpower had sold off all of its assets except for California, Nevada and Chicago. This makes it a perfect match up for Pac-West. Both had equal revenues ($150M) in basically the same markets. Mpower had no debt and a market cap of $13M. It had $11M in cash at the end of 2002 and was receiving additional cash from the sale of some of its assets. They claimed they would be EBITDA even after selling their losing operations.
If the companies merged, the combined companies would have revenues of $300M and would have become the major player in California. The cost saving between the two would make the combined companies very profitable probably in the neighborhood of $40M-$50M of EBITDA.
TPI believed that the combined companies would have been a great fit for XO, Allegiance or others that wanted to consolidate the CLEC industry.
We also believed Allegiance itself was a great target acquisition for larger CLEC’s.
We engaged Communication Technology Advisors LLC, one of the best consultants in the Telco space, to advise us in all aspects of the transaction and to confirm that the strategy was sound.
TPI raised capital and started to acquire the bonds of Pac-West; we believed that there was very little risk in the bonds with great upside potential.
TPI also started to purchase bonds in Allegiance Telecom, Inc.
XO Communication ended up acquiring Allegiance Telecom out of bankruptcy in February of 2004.
Pac-West and Mpower appreciated substantially, validating our analysis.
TPI closed out Telecom Pacific Investments, LLC on February 5th 2004.