Rural Local Exchange Carriers Could Consolidate

In the wake of Verizon Wireless' proposed acquisition of Alltel, rural local exchange carriers could become the next hotspot for M&A activity as they scramble to compete with major wireless providers, analysts say.

Companies such as Citizens Communications (CZN), Iowa Telecommunications (IWA), Consolidated Communications (CNSL), Windstream (WIN) and Embarq (EQ) have come under pressure as consumers swap traditional phone lines for wireless substitutes, such as AT&T (T).

Analysts have questioned whether these increased access line losses will affect the sustainability of revenue and free cash flow for these rural local exchange carriers, or RLECs. Additionally, extra competition has come in the form of cable companies that offer triple-play packages including voice services, like Comcast (CMCSA) and Time Warner Cable (TWC).

Instead of focusing on the weaknesses of individual RLECs, though, Credit Suisse analyst Chris Larsen says that these stocks are buying opportunities as several companies remain solid takeover targets.

"Although the fundamentals of the business have not changed, the weakness in the stocks has made the yields more attractive and increased the likelihood of industry consolidation," Larsen writes in a research note. "We believe this provides investors with a short-term opportunity to capitalize on potential acquisition targets with limited downside risk, as the stocks should be supported by their high yields."

Stifel Nicolaus telecom analyst Christopher King says that anything is possible, but recent economic conditions would make it tough for any sizeable deal to be completed. "Most of the acquisitions you'll see done in this space will be smaller carriers being bought up by the larger midcap names," says King. "Windstream would very much like to be a consolidator of properties."