Still integrating its acquisition of US LEC, Paetec has agreed to acquire another fellow CLEC, McLeodUSA, for $557 million in stock, it announced this morning.

The deal would give Paetec a total of 3.4 million access lines, making it one of the largest CLECs in the United States. Between them, the two carriers reported $1.6 billion in revenue for the 12 months ending in June.

“The combined company will be the premier alternative to the incumbent [local exchange carriers] in over 80 of the largest markets in the U.S.,” said Royce Holland, McLeod’s CEO.

Publicly held Paetec will exchange 1.3 of its shares for every share of privately held McLeod, issuing 40 million shares to fund the deal. The purchase price includes $492 million in common stock and the assumption of $65 million in McLeod debt.

Leaders of the combined company—three fourths of which will be owned by Paetec shareholders and the rest by McLeod shareholders—expect to save $20 million in synergies during its first year and $30 million in run-rate synergies the second year. Both companies expect the deal to close in the first quarter of 2008.

McLeod is focused on a slightly more low-end business than Paetec's, focusing largely on T-1 service. Paetec plans to leverage McLeod’s network to target the larger enterprises in McLeod’s footprint that McLeod has so far ignored. While Paetec has a lot of network assets in the Northeast and along the East Coast, much of McLeod’s network is in the Midwest and Texas (though it leases fiber from others in the Lone Star state). Chicago is one of their few points of overlap. McLeod would introduce Paetec to new markets such as Dallas, Houston, Detroit and Cleveland. But Paetec executives cited Seattle, Denver and Phoenix as examples of new markets on which they would focus particular effort.

Another attractive opportunities Paetec sees in the merger is using McLeod’s network to offer services to the branch locations of larger enterprises across the country.

“A lot of our metro fiber is in places like Chicago, Minneapolis, St. Paul, Michigan,” Holland said. “Most of the buildings we have on that fiber are collocation centers—ILEC central offices and carrier hotels. One thing we haven’t done is put lot of that fiber in office buildings, because our business been the small and medium enterprise business. That doesn’t mean we couldn’t light a lot of buildings throughout the Midwest. That’s one of the potential upside advantages of getting together with Paetec. Our fiber can be useful for that. It’s easy enough to get into a manhole and get the fiber into a building.”

McLeod spent more than $2.5 billion building its network, which Paetec executives said today they are acquiring “for cents on the dollar.”

Of the millions in synergies Paetec executives anticipate, two thirds will come from consolidating network infrastructure, and the remaining third will come from general and administrative expenses. As the two companies combine to form one with about 4,000 employees, Paetec executives don’t expect layoffs on the order of 20% of the workforce. Through normal merger attrition, the company claims to have kept layoffs resulting from its US LEC merger down to less than 3% of its workforce and expects to see similar results with McLeod. “We need more people,” one Paetec executive said on today’s call. “We have open positions at Paetec today. We only have one significant overlap; that’s in the Chicago market. Every other market is new. In Chicago, we need all the people we can get.”

Paetec closed the $450-million acquisition of US LEC earlier this year. But it doesn’t expect to migrate all of US LEC’s customers to Paetec’s billing system until the second half of next year. It plans to take a similarly cautious pace in migrating McLeod’s billing systems—perhaps taking two or three years, the company said.

And McLeod is not likely to be Paetec’s last acquisition. During this morning’s conference call, Paetec executives said the increased scale afforded by McLeod gives Paetec “the opportunity to seek out further acquisitions once we integrate this.”

The company’s Chief Operating Officer, E.J. Butler, described its acquisition strategy in a recent TelephonyOnline podcast.

Founded in 1991, McLeod declared Chapter 11 bankruptcy for the second time in late 2005, four months after its CEO and CFO departed following a fruitless search for an acquirer. It emerged from bankruptcy in January 2006 with Holland as its new CEO.