Tuesday, July 18, 2017

An unlikely merger – Cincinnati Bell and Hawaiian Telcom

It is not a surprise to see another telecom acquisition. The industry perpetually moves toward consolidation whenever greater efficiencies can be found by bringing more users onto a common network. But among all likely buyers and sellers in the telecom world, this combination is surely a bit odd: Cincinnati Bell and Hawaiian Telcom. Geographically, Honolulu lies 4,428 miles (7,126 km) to the southwest of Cincinnati, a six-hour time difference and a big cultural gap. There won't be many opportunities for network consolidation, joint customer integration or operational synergies.

The deal is structured as a cash and stock transaction in which Cincinnati Bell will pay approximately $650 million, including the assumption of Hawaiian Telcom's net debt. The offer is a 26% premium to Hawaiian Telcom's closing price of $24.44 on July 7, 2017. Hawaiian Telcom stockholders will have the option to elect either $30.75 in cash, 1.6305 shares of Cincinnati Bell common stock, or a mix of $18.45 in cash and 0.6522 shares of Cincinnati Bell common stock for each share of Hawaiian Telcom, subject to proration such that the aggregate consideration to be paid to Hawaiian Telcom stockholders will be 60% cash and 40% Cincinnati Bell common stock. Cincinnati Bell shareholders are the prevailing party. After closing Hawaiian Telcom stockholders will own approximately 15% and Cincinnati Bell stockholders will own approximately 85% of the combined company.

Sovereignty has long been a touchy issue for the Hawaiian Islands. In this case, Cincinnati Bell said it plans to preserve the Hawaiian Telcom brand identity. It also promises to preserve the jobs of Hawaiian Telcom's 1,300 employees, to maintain local management, to honour existing union labour agreements, and to name two Hawaii residents to the combined company’s board of directors. There is also a commitment to invest in Hawaiian Telcom's Next-Generation Fiber network statewide, although this is not quantified in the press materials with any dollar figure or budget plan.

Hawaiian Telcom has been to this dance before

Hawaiian Telcom traces its roots all the way back to 1883, when Hawaii’s King David Kalākaua granted a charter to Mutual Telephone Company, which was owned by Archibald Scott Cleghorn, father of Princess Ka'iulani. In the years after Hawaii became the 50th U.S. state, Mutual changed its name to Hawaiian Telephone Company and was never formally a part of the Bell System empire. In 1967, General Telephone & Electric Corporation (GTE) of Connecticut acquired the company and it was renamed to GTE Hawaiian Tel. This marked the first time the company was controlled from the mainland U.S. GTE eventually merged with Bell Atlantic to form Verizon Communications, at which point GTE Hawaiian Tel. was renamed Verizon Hawaii. By 2004, Verizon wanted out of non-strategic landline markets, including Hawaii, and so Verizon Hawaii was sold to The Carlyle Group for $1.65 billion in cash. At the time, Verizon Hawaii operated 707,000 switched wireline access lines and annual sales of about $610 million, operating income of $58 million and depreciation expense of $111 million. By this measure, the Cincinnati Bell acquisition price is less than half the price of 13 years ago.

In 2008, the company filed for bankruptcy protection. A two-year period of reorganisation followed. In 2010, Hawaiian Telcom became a publicly listed company. In 2011, Hawaiian Telcom was granted a cable TV license. One geographic advantage on being in the middle of the Pacific Ocean is that there is limited satellite TV coverage. This has led to a duopoly market shared with the Oceanic/Charter cable network. Compared to typical U.S. cities, Honolulu is a far denser metro area. It has approximately 300,000 households. With an initial focus on Honolulu, Hawaiian Telcom currently has about 43,000 residential video subscribers on its IPTV platform, which is based on the Ericsson Mediaroom solution, compared to approximately 310,000 subscribers for Oceanic cable statewide.

With its Fioptics service, Hawaiian Telcom is looking for much better market penetration, higher ARPU and lower churn. The fibre platform also enabled Hawaiian Telcom to launch the first Gigabit residential service in the islands in 2015. Presumably, the acquisition by Cincinnati Bell will bring much needed capital to continue the residential fibre in the rest of Honolulu and then to the other Hawaiian Islands.

A stake in the new SEA-US transpacific cable system

Hawaiian Telcom is a consortium partner in the new $250 million, 15,000-km Southeast Asia – U.S. (SEA-US) cable system, which is designed to bypass congested, earthquake-prone regions (Luzon Straight) on the transpacific route. It will deliver an initial 20 Tbit/s capacity when it enters service later this year. Cincinnati Bell noted that this ownership stake provides it with direct access to the 2.6 Tbit/s of transpacific capacity.

Here are some Hawaiian Telcom highlights:

•   First quarter revenue was $94.5 million, compared to $98.8 million in the first quarter of 2016, down $2.0 million year on year; the revenue declines is associated with legacy voice and low-bandwidth Internet services, partially offset by increases from consumer video, high-bandwidth business data services, and equipment and related services.

•   Net loss for the first quarter of $2.0 million, or 17c per diluted share, primarily due to $3.7 million in non-cash pension expense and other related one-time costs associated with employee retirements in the quarter.

•   First quarter business revenue totalled $43.9 million, compared to $44.8 million in the first quarter of 2016. In business data services, customer demand for high-bandwidth IP-based services continued to rise, as reflected by a 16.1% year on year revenue increase in Ethernet and routed network services, 14.1% increase in normalised dedicated Internet access revenue, and 14.4% increase in VoIP revenue; business VoIP lines grew 15.9% year on year to approximately 20,000 lines, offsetting more than a third of total legacy voice access line decline.

•   Hawaiian Telcom has more than 7,000 total fibre GPON-enabled business addresses connected.

•   First quarter consumer revenue totalled $34.3 million, compared to $36.2 million in the first quarter of 2016. Revenue growth in the quarter from TV and high-bandwidth fibre Internet services was more than offset by the year-over-year revenue decline in consumer legacy voice and low-bandwidth copper Internet services.

•   Video services revenue grew 12.4% year on year to $10.6 million for the quarter.

•   Video subscribers grew 15.3% during the same period and the company ended the first quarter with nearly 42,800 subscribers in service.

•   Penetration rate in the company's NGN footprint is 24%, an increase from 21% in the same period the prior year.

•   During the first quarter, 1,000 additional success-based households were fibre-enabled, increasing the total number of households enabled to 203,000.

Cincinnati Bell is looking for growth opportunities

Cincinnati Bell's history also goes back a long way. The company traces its start to the 1870s, when it gained exclusive rights to the Bell franchise within a 25-mile (40-km) radius of Cincinnati. Under the unified Bell System, the company maintained a degree of autonomy because AT&T held a minority stake. Since the historic 1984 AT&T break-up, Cincinnati Bell has fiercely remained an independent company, resisting the merger fever that spread amongst Bell Atlantic, Bell South, Nynex, Pacific Bell and Southwestern Bell.

Apart from its landline business, Cincinnati Bell operated a GSM network serving southeastern Indiana, southwestern Ohio, and northwestern Kentucky from 1998 to 2015, when the network was sold to Verizon. Cincinnati Bell also owned approximately 9.5% of CyrusOne, the wholesale data centre operator. The remaining 2.8 million shares of CyrusOne were sold in Q1 2017 for $141 million, resulting in a $118 million gain for the company.

Cincinnati Bell has been a very well-managed company but like many incumbent operators has experience the long-term challenge of declining revenues for legacy services, which often offset growth in new services. The company has been on the lookout for attractive opportunities to increase revenues from strategic services (currently >50%) and to alleviated its relative geographic isolation. Cincinnati Bell is focused on its Fioptics residential FTTH service, which is now available to 545,200 addresses in its territory - approximately 68% of Greater Cincinnati. With the Hawaiian Telcom deal, the company is hoping the positive traction it has seen with its Fioptics residential service in Cincinnati can be replicated in Honolulu.

On the same day that it announced the Hawaiian Telcom deal, Cincinnati Bell also announced a definitive agreement to acquire OnX Enterprise Solutions, a technology services and solutions provider in North America and the UK, for a total consideration of approximately $201 million in cash on a cash-free, debt-free basis. OnX is focused on IT services for Fortune 500 companies. The acquisition provides Cincinnati Bell with 20+ IT sales offices and access to 50+ data centres through strategic partners.

Cincinnati Bell highlights:

•   Total Internet subscribers of 307,400 at the end of the first quarter, up 15,000 subs compared to a year ago ▪ Voice lines totalled 516,900, decreasing 2% from the prior year.

•   Fioptics monthly ARPU for Q1 2017 was up approximately 3% from Q1 2016. ARPU is as follows: Video – $86, Internet – $49, Voice – $27; in Q1, the company invested $36 million in Fioptics to pass an additional 11,800 customer locations.

•   Business revenue in Q1 2017 were down slightly to $71 million, however fibre-based business Ethernet services were up 11%.

•   Carrier revenue decreased year-over-year due to on-going FCC switched access rate reductions and the fact that national carrier customers are increasingly focus on reducing costs.

•   IT services and hardware sales amounted to $86 million for Q1 2017, down $16 million from Q1 2016 due to the cyclical nature of these transactions and customers shifting to the cloud.