Rural Telcos Shift Strategies With New Hybrid Ipo Format
Byline: Ed Gubbins
Rural telcos are poised to wipe away much of their debt in a rash of IPOs, but the new cash comes with strings attached that could affect their strategies down the road.
Rural local exchange carriers FairPoint Communications, Iowa Telecom, Valor Communications and Alaska Communications Systems all filed for IPOs in the past three weeks, planning to raise a total of more than $2.7 billion.
Though the carriers can’t talk about the IPOs for regulatory reasons, their prospectuses show they will use their new funds mainly to pay down debt and to fund their strategies in the future. The latter generally includes expanding their CLEC operations and growing through acquisitions.
The timing of these filings probably was dictated by a more hospitable IPO market and the recent availability of each company’s complete financial information for 2003.
“You couldn’t do an IPO a year ago,” said Yankee Group analyst Steve Hilton. “I’d bet these RLECs have wanted to do this for quite some time.”
All four companies are using a new type of IPO that debuted in the United States in December after having been popular in Canada. Income deposit securities (IDSs) are hybrid offerings of debt and common stock that are well suited to companies with solid cash flow but modest growth – a perfect description of most RLECs. For venture capitalists that may be looking to liquidate at least part of their late 1990s investments in the RLEC space, IDSs in particular offer a better return than regular IPOs.
Because IDSs are brand new in America and not well known, the RLECs may have trouble finding a market for the offering. And even if they do, they face another risk: IDSs offer higher dividends than regular IPOs. And because the shareholders that IDSs attract are mostly motivated by dividends (institutional investors, most likely), those shareholders will want the RLECs to keep their cash flow high.
That may be fine, but if the RLECs face more competition down the road from cable or wireless firms, they may need to invest in new assets (fiber, for example), which will cut into those dividends, leading to the risk that investors will flee.
“This handcuffs management, to some extent, from being able to react to competition because the way you react to competition is, you spend money,” said Bill King, president of JSI Capital Advisors.
Iowa Telecom already illustrated this shift in priorities in its recent prospectus, which described the carrier’s future acquisition strategy this way: “One of our acquisition criteria will be the potential of any proposed transaction to permit increased IDS distributions.”
ACS, the only company in the group of four that is already publicly held, has been facing stiff competition for years from CLEC GCI Communications, which has taken more than a third of the market the two carriers serve.
Still, going public leaves the door open for future fund-raising. And overall, the risks attached to these IPOs, paired with the benefits, could amount to a wash. In a statement regarding the ACS IPO, Standard & Poor’s said it was “concerned that an ongoing call on free cash flow from a quarterly dividend could erode some of the financial cushion important to weathering the company’s narrow, competitive and stagnant market.”
At the same time, S&P’s outlook on ACS is “not immediately affected,” the statement said.
RLEC IPO FILINGS
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