PAET Paetec Corp (MM)

Windstream Corporation (WIN), a fixed-line voice and DSL Internet service provider has won the approval of Federal Communications Commission (FCC) for the acquisition of PAETEC Holding Corp. (PAET). The company also stated that it has received all the required regulatory approvals and expects this deal to close by December1, 2011.

In August, Windstream entered into the $2.3 billion transaction to buy out PAETEC. The company filed for FCC approval in the same month. Under the deal, PAETEC shareholders will get 0.46 Windstream shares for each PAETEC stock. Windstream expects to issue approximately 73 million of shares at approximately $891 million. In addition, the company will refinance PAETEC's net debt of $1.4 billion. Upon completion, PAETEC stockholders would own approximately 13% of the combined company.

The buyout of the personalized U.S. broadband services provider, PAETEC is in sync with Windstream’s broadband business expansion plan to improve its top line and streamline its cost structure. The combined company is estimated to generate annual revenues of $6.1 billion and adjusted EBITDA $2.4 billion. Upon completion, approximately 70% of the total revenue will stem from business and broadband revenues. The new Windstream will cover 100,000 fiber route miles in 46 states, up from the current 29.

Further, the acquisition will reduce Windstream’s operating expenses by about $100 million every year and capital expenditure by $10 million a year. It will also allow Windstream to reduce its taxes by about $250 million by claiming the losses that PAETEC incurred last year. However, Windstream would incur roughly $50 million of merger and integration costs of in the first year and $55 million of capital expenditures over the first three years.

Going forward, the transaction is expected to be accretive to free cash flow in the initial year itself. The transaction will help in deleveraging the company’s balance sheet, which is currently at 3.6 times. Windstream is focusing on bringing its balance sheet back to historical levels of 3.2–3.4 times through EBITDA growth and modest debt reductions.

In terms of market penetration, the PAETEC deal will expand the company’s fiber network to the West Coast, including Los Angeles and Seattle. This will increase broadband availability to roughly 93% of customers as well as upgrade network and broadband speeds in underserved areas, leading to attractive growth opportunities given greater demand in these areas.

We believe Windstream’s continued focus on expanding its broadband business via acquisitions and investments in fiber-to-the-cell projects and data center expansion will fuel growth going forward. However, the company remains challenged by sustained erosion in voice access lines, due to stiff competition from cable and wireless operators.

We are currently maintaining our long-term Neutral rating on the stock. For the short term (1–3 months), the stock retains a Zacks #3 (Hold) Rank.

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