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Telecom scavengers bulk up with bargains

While many telecom giants retrench, some of the communications industry's surviving middle-tier companies are scrounging around the sector's wreckage for useful assets.

While many telecom giants retrench, some of the communications industry's surviving middle-tier companies are scrounging around the sector's wreckage for useful assets at bargain prices.

As venture capital dollars evaporate and carriers cut their spending in the face of a slowing economy, many would-be challengers are looking for buyers or have already merged. For the smaller and midsized competitors that remain, gobbling up their fellow upstarts could give them the size to compete more effectively against the telecom titans--particularly at these rock-bottom prices.

"In this industry, there's so much on the cheap. But you have to figure out what's worth having," said a source at one would-be industry buyer who declined to be named.

In one example of the declining valuations, Liberty Media Group was said to have received just $37.5 million in stock for an investment in Teligent, a fixed-wireless service provider. According to a recent regulatory filing, the stake was originally valued at almost $1.4 billion, Bloomberg News reported.

IDT, the former parent company of Internet voice provider Net2Phone, is one of several companies at the forefront of the telecom fire sale.

IDT recently invested in Teligent--buying Liberty Media's low-cost stake--and ICG Communications, an alternative local phone company. For IDT, which primarily offers long-distance voice services, the strategy behind these stakes is an entree into the local phone markets.

Others, too, are eager to partake in the bottom fishing.

McLeodUSA, a local phone company, opened its wallet to acquire assets that could enhance its services. The company closed its merger with CapRock Communications at the end of last year that was valued at $532 million when announced in October. McLeodUSA also announced in March plans to acquire Intelispan for $40 million in stock.

The downturn has also forced other small phone companies out of the market, making their assets attractive as acquisition bait. Rhythms NetConnections and ReFlex Communications announced this year their intention to sell themselves, and E*Spire Communications filed for Chapter 11 bankruptcy protection. Dozens of other companies are facing similar fates.

Because size is critical in the communications industry, to reduce the per-customer costs of network operations, upkeep, and marketing and advertising, many smaller providers such as IDT and McLeod are likely to continue to prey on their fallen brethren, analysts say.

Purchases and investments such as those by IDT are a way to grow quickly. Plus, with the bargain prices, some well-heeled companies are asking themselves: Why not?

"We have a lot of management time on the line, but we don't have much in the way of bucks on the line," said a source speaking on condition of anonymity.

But mergers can cause headaches and require time-consuming technology integration, which makes companies reluctant to merge unless there are clear benefits, says Ken Kotylo, an analyst at investment bank William Blair, who follows local phone providers such as XO Communications and McLeod.

Kotylo believes that IDT, McLeod and the others might be buying headaches as much as cheap assets. "They are buying companies that have had significant operational issues," he said.

For these reasons and others--including the fact that the assets of many would-be challengers are duplicative--the major telecom companies are largely watching from the sidelines.

"Some of them are unable to buy due to debt or future expectations in their own market sectors," said Elliott Hamilton, a communications analyst at research firm The Strategis Group. "Some will just wait until the prices go lower and they can get them for even less in bankruptcy."

The industry's biggest companies, however, already have spent the past three years rounding out their networks by buying one another.

These massive mergers, such as the combinations of SBC Communications with Ameritech and Bell Atlantic with GTE, were designed to use their established communications networks to go after large business customers. Similarly, AT&T acquired Tele-Communications Inc. and MediaOne Group with the consumer market in mind. Collectively, the massive mergers leave the cash-strapped alternative providers to fight for the leftovers.

Overall, analysts doubt the large communications companies are worrying about the communications scavengers.

"I don't think the (Baby Bells) really care. They probably have bigger fish to fry," said Pat Comack, an analyst at Guzman & Company in Miami.