|
When Dan Caruso reached into his back pocket and slapped his bulging wallet on the table in front of delegates at Capacity magazine’s annual Metro Connect conference this February, he set in motion a chain of events that will significantly reshape the metro landscape over the next few months.
Speaking on a panel of experts discussing the outlook for the industry, the charismatic Caruso, one of the most successful playmakers in the entire telco arena, was looking to make a point: The finance markets were open, he stressed, and Zayo was looking for a deal. Come and see me if you want to sell, he joked with the audience.
Sitting alongside him on the podium was William LaPerch, chief executive of AboveNet, the largest metro provider in terms of revenues and the only company in the sector to boast a stock market listing. As Caruso recovered his wallet, LaPerch looked on impassively.
Hours later, the two chief executives met in one of the private suites of Miami’s 1930s-style Eden Rock hotel. Caruso was no longer joking. He had secured the financing to offer LaPerch $80 a share for his company. The Zayo chief may not have known that LaPerch was within days of closing a sale of the business to two private equity partners in a deal that would have valued AboveNet’s shares at $78 a piece. Neither may he have known that one of the private equity bidders had failed to get approval to proceed with the bid from its own investment committee. But his timing was at least faultless: a day earlier, and LaPerch would have been bound by an exclusivity clause. Instead, LaPerch told Caruso to put something in writing. Later that day, Caruso’s lawyers formalised the offer and talks began in earnest.
The private equity team was not told of Zayo’s bid until late on the evening of March 15, by which time Caruso had raised his offer to $81. A day later, the consortium came back with an offer of $78.50, prompting AboveNet’s board to go back to Caruso with a suggestion that it would recommend his offer if he put an extra $3 a share on the table. Caruso agreed and the proposed deal was approved on March 18.
AboveNet’s exit from the public markets may not be at the hands of a sleek cable company, as some analysts had hoped. But it is immensely significant nevertheless: rarely, in the metro fibre arena, does a trade buyer go head-to-head with deep-pocketed private equity investors and win.
Hitherto, financial buyers have been able to outgun trade rivals at the negotiating table by padding out their war chests with debt leverage. It’s a simple question of firepower: while fibre providers might consider themselves lucky to borrow any more than three times their earnings before interest tax depreciation and amortisation (EBITDA) in the bond markets, private equity houses can typically tap lenders for five or even six times earnings. Caruso’s bid for AboveNet – his nineteenth (blink, and you might possibly have missed his twentieth, announced just two days later) turns that dynamic on its head. His mission is to drive down costs through consolidation.
All other things being equal, the difference between Zayo’s bid and that of the private equity consortium should reflect the synergies Caruso thinks he can strip out of the combined company – about $165 million. That might be a good deal more than the numbers circulating among analysts at the moment, but it still equates to less than 7% of the deal’s value.
With each successive acquisition that Caruso now targets, the synergies that he brings to the table will become relatively more important. In other words, the AboveNet deal is a game-changer, not because it represents the biggest merger yet in the metro arena, but because it could well establish a new precedent where synergies might ultimately drive valuations to a greater degree than leverage.
Which is not to say that Caruso will win every deal he goes after from here on in by playing the synergies card. But rather, that every metro he takes a tilt at will ultim-ately go for a higher price because of it. Had AboveNet’s board grasped this key point when it first hired JP Morgan to flush out a buyer back in February 2011, it might not perhaps have locked Zayo out of the original sale process. That process ultimately failed when AboveNet rejected a bid of $74 a share from a consortium of three private equity firms in June 2011.
But AboveNet’s much-admired chief executive comes away with at least one sweet irony to savor: those very same private equity firms that have criticised him for not doing enough to bolster AboveNet’s underwhelming stock market rating, will find life considerably harder now that he has done something about it.
Perhaps the most vexing question that remains unanswered as Caruso starts the complicated task of bedding down the AboveNet acquisition, is how this leaves Zayo’s main rivals –Fiberlight, Fibertech, Lightower and Sidera.
Do they hang by the telephone nervously awaiting a call to join the court of Caruso – a move that will require them to blithely sacrifice their own destinies and buy into Caruso’s grand vision for the ultimate end game? Or do they try to form a second superpower bloc and wrestle back control of their own exit strategies?
For now, at least, there is little pressure to sell: bandwidth demand continues to double every two years, supporting Wall Street forecasts that top-line revenues in the sector should grow by more than 20% over the next three to five years. And yet, to defer a move is to risk getting sidelined. No one will want to be the last metro left on the table. By definition, Zayo will need to focus on bigger and bigger acquisitions to continue to drive revenue growth, making smaller metros less relevant.
Time is of the essence. Caruso will doubtless be under some pressure to ease up on the deal-making and concentrate on making the AboveNet acquisition work. Experienced as he is at integration, this is more complex and challenging than anything that Zayo has done before – AboveNet employs more than 700 staff in seven countries and brings with it a broad portfolio of products as well as its own highly specialised back-office systems. But he is unlikely to stay out of the market for long – if at all, and Zayo’s competitors probably have no more than six months to execute a plan if they want to take the fight back to Caruso.
Then there’s Caruso’s own exit strategy. Zayo has a complex ownership structure involving a raft of private equity firms, some of whom will want to cash-in their profits in the near to medium term. That Caruso has managed to persuade Charlesbank Capital Partners, an early backer, to put additional financing into the company, as well as attract a new player in the form of GTCR, a Chicago-based private equity firm, is testament to the Zayo chief’s unshakeable belief in the consolidation that still must reshape the metro landscape. Clearly an enlarged Zayo, with annual EBITDA of $400-500 million, will give much larger players such as Level 3 a run for their money. It will also flash more brightly on the radar screens of those elusive cable companies – Comcast, TimeWarner Cable and Cablevision.
One of the many fascinating details to come out of AboveNet’s recent SEC filing, was confirmation that as many as six trade buyers – including one cable company - lodged expressions of interest during the first sales process. If a cable company really is ever going to chase the enterprise vertical through the acquisition of a metro fibre player, then Zayo now offers enough scale and reach to warrant the associated execution risks.
