Windstream-Frontier seen as next rural telecom deal

NEW YORK (Reuters) - Rural America may be the next hot spot for telecommunications mergers and Windstream Corp WIN.N may be the first to pull the trigger with a bid to buy Frontier Communications Corp FTR.N.

Rural phone service providers need to consolidate to cut costs and boost earnings, as home phone lines continue to decline with consumers switching to services provided by wireless and cable companies.

Windstream, the second-largest rural operator by revenue, said this month it hoped to participate in consolidation, fueling speculation that it was on the hunt for deals.

The largest rural phone company Embarq Corp EQ.N, No. 3 player CenturyTel Inc CTL.N, as well as smaller operators Consolidated Communications Holdings Inc CNSL.O and Iowa Telecommunications Services Inc IWA.N, could also take part on a wave of deal-making, analysts said.

“The most likely takeout candidate for Windstream would be Frontier because of Frontier’s size,” said Stanford Group analyst Michael Nelson. “They’re really the only one that would move the needle significantly.”

Fourth-ranked Frontier, based in Stamford, Connecticut, has a market value of about $4 billion and more than 2.3 million access lines. Windstream, created by merging Valor Communications Group Inc and Alltel Corp’s wired business, is worth $5.6 billion and has over 3 million access lines.

Nelson sees a Frontier deal in about six months, costing Windstream $9 billion, including the assumption of about $4.6 billion in debt. He said it would provide enough savings to boost Windstream’s earnings the year after a deal.

Big deals that maximize cost savings would make sense for Windstream, according to Jefferies analyst Jonathan Levine, who said closing even small deals require a lot of money and time as they involve reviews from the regulators of each state where the target companies have operations.

“I think they’re going to probably look at some of the larger players,” said Levine.

RELUCTANCE TO SELL

CenturyTel, with about 2.1 million access lines and a market value of over $3.9 billion, may be an attractive target for Windstream but analysts noted that it has shown a preference to stay independent and do its own acquisitions.

Monroe, Louisiana-based CenturyTel is expected to try itself to buy companies such as Iowa Telecom or Consolidated Communications.

Stanford’s Nelson said Iowa Telecom, whose market value is about $568.3 million, may cost as much as $830 million. He noted that CenturyTel could also spark a bidding war for Frontier. Consolidated’s market capitalization is about $448 million.

CenturyTel said that its strategy has been to make acquisitions but declined to reveal plans. Windstream and Frontier were not immediately available for comment.

Of the four top operators, Embarq, a spin-off from Sprint Nextel Corp S.N, is the least likely to look for an acquisition, said analysts who think it has most room to improve its earnings by cutting costs without having to merge.

Embarq’s relatively weak valuation of 9.5 times estimated 2009 earnings per share, compared with multiples of more than 11 for Windstream and CenturyTel, could also make it tougher for Embarq to use its shares as currency for a deal, at a time when credit markets are tight.

Some analysts said Embarq would be too big for Windstream to buy for now, but as credit markets improve, Windstream might be able to swallow such a deal as its management has a proven track record of integrating networks.

“The Windstream management team is so good I’d be comfortable with them doing something like that,” said Soleil Securities analyst Todd Rethemeier, regarding an Embarq buy.

But he added that such a deal would be a big challenge as Embarq, which operates in more urban markets than Windstream, faces tougher competition in those markets.

An Embarq representative said the company always has options such as consolidation, but that its focus was on operations.

Most analysts agree that consolidation will take place, but some cautioned that deals could take longer than expected, partly due to the tight credit markets.

“If the capital market environment improves somewhat in the next 12 to 18 months, it’s likely to result in some deals,” said Gabelli & Co analyst Sergey Dluzhevskiy, who added that it may make sense for sellers to wait until markets improve in order to fetch a higher price than they could now.

Raymond James & Associates analyst Frank Louthan said that while many investors are hopeful that Windstream buys either CenturyTel or Frontier, he does not see consolidation happening until stock valuations for the entire sector improve.

“If multiples for the group were to expand, they’d all probably move together,” he said. “The valuations will come back in the next 12 months. The consolidation could take another two to five years.”