Service-provider M&A activity seen heating up this year

After a wave of bankruptcies, North American service providers are well positioned to begin executing mergers and acquisitions this year, most likely in the form of strategic rollups by tier two and smaller service providers and a mega merger between an ILEC and IXC that will offer national long-distance voice and data as well as local service, contends telecommunications analyst firm RHK (South San Francisco).

The North American market remains overcrowded, suffers from excess capacity, and continues to endure a slow take-up of new services, say RHK analysts. Thanks to high fixed costs, the market cannot support the current number of competitors. The aggressive pricing practices that result from this intense competition will prove unsustainable in the long-term. RHK believes that consolidation will enable price discipline and remove excess capacity from the market.

"Market conditions may have pointed to consolidation for the past three years, but service providers were not positioned to pursue M&A [mergers and acquisitions] then," reports Shing Yin, program director of RHK's telecom economics program. Heavy debt loads prevented tier two providers from making acquisitions—and made them unappealing targets for acquisition by others. The large incumbents were also burdened by debt.

As a result, service providers have recognized the need to fix their capital structures first, while holding onto their most valuable assets: customers and networks. According to RHK, even those that did not file for bankruptcy have spent the last few years restructuring their debt, securing sources of capital, and streamlining operations. "In effect," says Yin, "they have prepared themselves for the next step: mergers and acquisitions."

For more information about the telecom economics report, "Industry Consolidation to Pick Up Speed in 2004," visit www.rhk.com.

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