With the consolidation of major telecom carriers and vendors well under way, rural carriers may follow suit, following the introduction of two new stand-alone rural exchange carriers: Embarq and Windstream Communications. But major carrier combinations will probably lag behind smaller acquisitions, analysts say.

“There will be a lot of M&A activity in that space over the next few years,” said Todd Rethemeier, who covers Embarq for Soleil/Sur Terre Research.

Embarq, launched last week after being spun off from Sprint Nextel, is the country's largest rural carrier. The second largest, Windstream Communications, is being launched later this year by combining Alltel's former wireline business with Valor Communications. And as rural carriers are facing the same access line and revenue loss as the Bells, conjecture of rural consolidation echoing Bell consolidation has naturally begun. Embarq, which has $7.25 billion in debt, expects flat or slightly declining revenue this year and predicts possible access-line erosion of 5.5% to 7.5% per year. The company is planning an aggressive quadruple-play push, but some might say increased economies of scale would help its bottom line.

Because big RLEC networks are generally scattered across the country, any big mergers that do occur will have less to do with complementary geography and more to do with simple valuation. Given that fact, the high valuations of some RLECs will forestall big mergers to some extent, analysts say. For example, Citizens Communications is currently valued at nearly eight times its earnings before interest, taxes, depreciation and amortization, which will likely deter potential suitors.

Before RLECs engage in big mergers and acquisitions, analysts say, they're more likely to scoop up smaller independent operating companies (IOCs) and rural access lines dumped by Bell companies focusing on broadband. The IOC rollups that have been going on for years (FairPoint Communications alone has acquired more than 30 IOCs since the mid 1990s) will accelerate, Rethemeier said. “A lot of mom-and-pops are going to be getting out of the business in the next few years,” he said.

Earlier this month, the Wall Street Journal reported Verizon Communications' plans to sell about 5 million rural access lines in two chunks: 3.4 million in Indiana, Illinois, Ohio and Michigan and 1.6 million in Vermont, New Hampshire and Maine.

Analysts suspect Verizon may look to sell those lines the same way Alltel spun off its wireline business, through what's called a Reverse Morris Trust transaction. In such a deal, Verizon would spin off its rural lines and merge them with another company, with Verizon shareholders retaining at least 50% of the resulting entity. The deal structure has the benefit of being tax-free, but it narrows the number of possible buyers for those lines.

Since Verizon shareholders would retain most of the combined company, only companies with lower market capitalizations than those rural lines (estimated to be worth $8 billion) would be interested. That would theoretically exclude Embarq and Windstream but include CenturyTel and Citizens, as well as smaller players such as Iowa Telecom and FairPoint.

Buying Verizon's access lines would make Citizens the biggest RLEC in the country in terms of access lines, tying it with Embarq. Or it could make FairPoint or Iowa Telecom a new major player, second only to Embarq. Either move might in turn motivate CenturyTel to make some acquisitions. In the larger context, said Christopher King, a Stifel Nicolaus analyst. “Certainly CenturyTel would like to be the acquirer.”

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