With the merger finally closed, the real work begins

After more than a year of vaulting regulatory hurdles, FairPoint Communications' purchase of 1.7 million Verizon access lines in Maine, New Hampsire and Vermont is expected to close soon. In other words, the easy part is over. Now the new FairPoint — suddenly the eighth-largest telco in the U.S. — must tackle a series of competitive, financial, integration, labor and regulatory challenges. And although the company is tight-lipped about exactly how it will address them all, some industry analysts have their own suggestions.

One of the first tasks for FairPoint will be examining precisely what it bought. The company did due diligence on the assets, obviously, but admits that plenty of unknowns remain and plans to conduct a thorough analysis after the merger closes. The copper plant in New England is some of the oldest in the nation, and as Verizon rolled out fiber, it was accused of neglecting the copper in some areas. When Verizon itself acquired Nynex, it discovered that some taps, coils and other maintenance issues had been documented improperly over time. As a result, there were some affluent neighborhoods that didn't get Verizon broadband service until the company deployed fiber-to-the-home (FTTH). FairPoint could well have the same experience, but whether that would convince the carrier to deploy FTTH is another matter. FairPoint will inherit a small number of FiOS customers, which it has vowed to support, but it hasn't said whether it will expand that network, a move that would be uncommon among rural telcos its size.

“Time to market is their enemy, so it is doubtful that they will do FTTH,” said Teresa Mastrangelo, principal analyst for broadbandtrends.com. “Most likely they will follow a [fiber-to-the-node] deployment model.”

FairPoint already is tasked with rolling out broadband in the new territory post-merger, thanks to state regulators that required that commitment in exchange for merger approval. Funding those network upgrades won't be easy, as FairPoint will be saddled with more than $1 billion in debt following the merger. And the current state of the debt market casts an ominous shadow over FairPoint's future. “Having seen those margin calls making their way through the industry, I don't know where it's going to stop,” said Brian Washburn, network services research director for Current Analysis.

In fact, some regulators resisted the merger in part because they feared FairPoint's financial weakness would hinder service in their states. So they tacked on more merger conditions, including earnings-to-debt ratio requirements and dividend stipulations. To get the deal approved, FairPoint agreed to spend roughly $50 million per year in each of the three states, with an additional $50 million from Verizon for network upgrades in New Hampshire, where, if access line loss exceeds 10% post-merger, Verizon will have to pay another $15 million. FairPoint also agreed to remove a large number of dual utility poles in Vermont.

“For the next 24 months, their goal will be to get broadband service out quickly,” Mastrangelo said. “The main thing is to quickly upgrade the network to provide a baseline level of service and make sure that they can provide broadband services to a large percentage of the serving area. FairPoint expects to provide broadband capability to 80% of its New Hampshire customers by the first quarter of 2010. In Maine the commitment is to provide broadband capability to 85% of customers within 24 months of the completed acquisition.”

That goal notwithstanding, one of the first things FairPoint should do following the merger is drive hard at the business customers in the new territory, Washburn said. Verizon Business will retain those customers, but FairPoint will inherit the last-mile access lines that connect them and should use that advantage to steal Verizon's market share.

“That's the first place I'd look for additional revenue,” Washburn said. “That's the low-hanging fruit.”

The portions of the network surrounding business customer clusters are likely to be in the best shape, ready to go from day 1. And the business market wasn't laden with requirements from state regulators. On the other hand, some portion of those business customers may be committed to multiyear contracts, preventing FairPoint from quickly taking market share.

Business services aren't the only arena in which FairPoint and Verizon will compete once the landline deal closes. The residential voice customers that FairPoint purchased will be under attack immediately from Verizon Wireless. For that reason, Washburn said, FairPoint may do well to follow the example of another rural telco, Embarq. As Embarq was spun out of Sprint, the two brokered a deal wherein Sprint wholesaled wireless service to Embarq, which bundled that offering with wireline services. FairPoint could strike similar deals with both Verizon Wireless and Verizon Business, Washburn said.

“If I were in their shoes, I'd look toward Embarq as a potential model,” he said. “[FairPoint should] look to Verizon Business and figure out how it needs to, in some cases, work with Verizon Business and compete with it to get the best outcome.”

Integrating the adopted network with the existing one shouldn't be much of a problem, Washburn said, but integrating the new work force could be tricky. After the merger, FairPoint's employees will more than triple to 3800 people. It also will go from six union contracts to eight, employing many union workers who vocally protested the merger in recent months. Job cuts will no doubt follow. And rumors are swirling that FairPoint is recruiting management from outside the area rather than exclusively promoting existing Verizon employees, who outnumber FairPoint employees.

“That could put some noses out of joint,” Washburn said. “They may be setting themselves up for an acrimonious relationship with the linemen and techs on the ground, the union workers.”

Unrelated to the merger, another long-term issue for FairPoint is an anticipated overhaul of the federal government's Universal Service Fund for rural telecom services deployment. The FCC is looking for ways to spend less on USF. And FairPoint, pre-merger, is more dependent on universal service than its peers. According to data recently compiled by Stifel Nicolaus, more than 18% of FairPoint's revenue this year is expected to come from universal service; no other telco will get as much as 15%, including even Alaska Communications. The extent of the merged company's reliance on USF isn't known, and FairPoint declined to answer questions on the subject.

FairPoint has promised to break its silence this month with a more detailed view of its post-merger plans. Until then, about all FairPoint will say is what CEO Eugene Johnson said in the company's last earnings call in February: “We're chomping at the bit. We're ready to get going now.”